A 'tale of two cities' as Toronto, Vancouver await fallout from mortgage rules

Over the course oftwo days,real-estate sales figures for the month of October suggested acontinuing boom in Toronto with a correction fully underway in Vancouver. Does the West Coast slowdown suggest a coming correctionfor Canada's largest city?

On Thursday, the Toronto Real Estate Board reported that home sales were up 11.5 per cent in October compared with the same month last year, with the average selling price for all types of homes up 21.1 per cent to $762,975.

• Toronto home prices jump 21%, putting sales at record high

In contrast, the day before, the Real Estate Board of Greater Vancouver said home sales plummeted by 38.8 per cent last month compared with October 2015. The composite benchmark price for all properties in Metro Vancouver was $919,000, up 24.8 per cent compared withOctober last year, but a 0.8 per cent drop from September of this year.

• Vancouver home sales down 39% in October

Sales in Vancouver have beendecliningsince February, and that market "is in a full-blown correction," says David Madani, senior Canadian economist at Capital Economics.

While the million-dollar question seems to be what effect the new foreign-buyerstax, which only came into effect in August, will have on the Vancouver market, the big test for all markets, according to Madani, will be new mortgage rules brought in last month.

As of Oct. 17, more mortgage applications will have to be put to a "stress test" to evaluate a borrower's ability to make mortgage payments at a higher interest rate.

The requirement, which was already in place for some mortgages, now applies to all insured mortgages, and will have the biggest effect on first-time homebuyers.

• Hot Toronto real estate market means paying more, new mortgage rules could give you less buying power

The new measures amount to the federal government "putting its foot on the brakes" of the housing market, Madani said, which "by definition will have a negative impact on home sales and prices. The only question is, how much."

The Toronto market is "holding up for now," he said. But the effect of the mortgage rules will take a few months to play out, with the real picture likelybecoming clear next spring, when activity heats up after the winter.

'It's not a crash'

When looking at the Toronto and Vancouver markets, "it's really a tale of two cities," saidBenjamin Tal, deputy chief economist at CIBC World Markets.

In Vancouver, prior to 2014, housing prices rose in a way that was consistent with a lack of supply in the market, Tal said. Between 2014 and now, he said, prices increased more rapidly, which is consistent with market speculation and some foreign investment.

So "the impact of the foreign investment tax is significant," Tal said. But it's not responsible for the more than 30 per cent drop in sales, he said. The drop in Vancouver can also be attributed to more buyers simply being priced out of the market entirely, while other potential buyers are sitting back and waiting to see how the new tax and mortgage measures play out, he said.

Vancouver's market may not bea sign of things to come in Toronto, according to Tal, because of the foreign-buyerstax in Vancouver and because the market there is traditionally more volatile than Toronto's.

"It's not a crash, it's not a free fall," Tal said. "But it's exactly what the government would like to see. They'd like to see the market slowing down, they would like to see less mortgages in the market, less people buying."

'All about the credit cycle'

For Madani, the cooling market in Vancouver has little to do with the foreign-buyerstax. Real estate market fluctuations are "all about the credit cycle," he said.

"Anything that reduces the amount of credit available to purchase a home," he said, "will slow the market down."

And the credit cycle hinges on two things: interest rates and leverage.

Interest rates have been at historic lows for years, so more people are borrowing to buy. What fewer people understand is that many buyers are more heavily leveraged. In the 1980s, homebuyers typically made down payments of 25 per cent. Today, down payments can be in the single digits.

"So the housing mess that's been created over the past decades or so, it's not just about low interest rates, it's about the increased leverage in the system," Madani said.

The federal government's new mortgage rules are needed, in Madani's view, but a few years too late.

"Introducing them now, the risk is that this could be the trigger or catalyst that everyone fears the most," Madani said.

While neither Madani nor Tal expect a crash, questions remain about how sharp the correction will be. Will younger, first-time buyers continue to feel they have to get into the market now or risk never realizing their dream of home ownership?And will the banks continue to lend as aggressively as they have in recent years whileassumingmore risk?

"I do think the Vancouver market is going to have a very, very hard landing that will probably drag out for a few years potentially," Madani said. "Now Toronto, I'm thinking about the longer term. I don't think the correction will be as bad as the Vancouver market."