As interest rates rise, end of the party in sight


Special to the VOICE

“Just like the buyers are extremely happy in a rising market, they have to appreciate that the same decision could go the other way.” Brad Carr, President, Mattamy Homes Canada.

As I mentioned in a previous column, many rules have changed since January 1 regarding the purchase of a house in Canada. These rules were imposed to attempt to restore order in a chaotic housing market that has been rising to levels that are putting people into financial peril.

As I write this, debt levels in Canada have reached even more highs and the results of this debt binge are beginning to show. An Ipsos survey discovered that 33% of debt holders can’t make regular payments. Forty-eight percent of those surveyed said they have less than $200 left at the end of the month. Four in 10 say they have borrowed too much. One in 5 have credit card balances higher than their life savings.

Forty percent of all mortgages come up for renewal this year. Interest rates have gone from 0.50% to 1.25% in six months. Variable rate loans, home equity loans, lines of credit and variable rate mortgages are all more expensive now. A 1% increase in interest rates requires an additional 8.3% of income to make the payment on an average mortgage in the GTA.

To get approved for a mortgage requires passing a stress test that adds 2% to the mortgage rate, meaning most borrowers will have to prove they can pay a mortgage at 5.54%. The average Ontario resident owed $154,000 in 2016. Paying down that debt cost an average of $12,500 per year. This will rise to $15,500 by 2021. Many municipalities have also acquired an enormous level of debt on the expectation that this market will pay for all of their expensive projects. But how did we get here?

After the Great Recession of 2008-09, central banks dropped interest rates to encourage spending and to discourage saving. People were given access to cheap money with few questions asked. This cheap money encouraged a spending spree in Canada that saw house valuations rise to ever higher levels.

Governments, large and small, used this mania to push up costs to new developments by raising land prices and development fees and by maximizing the number of units built on the land. Condominiums were seen as the way to really get the most bang for the buck.

As housing prices continued to rise, money was borrowed or gifted from the Bank of Mom and Dad or secured through 2nd or even 3rd mortgages at high rates of interest. This became the new normal. It’s truly different this time everyone said, especially the real estate industry.

People tend to follow the herd. It’s easier to go along with the majority of one’s peers. Decision-making is simplified if we are all doing the same thing. This mentality explains the proliferation of SUVs on the road. It also explains Bitcoin, social media and distrust of news sources. It also is the reason housing is just like any other investment. When it’s rising, everyone, including local municipalities, jumps on board. When it’s falling, everyone will try to run for the exits.

Some, like a municipality, will have nowhere to turn but to the local taxpayer (or banks with blinders on, willing to make risky loans). Most will have to cut spending, or let go of workers, or both. And it’s unlikely that Sunshine Listers will be the first to go.

Whitby, Ontario is just down the road from the town where I grew up. It was a nice town with great older homes and a good, solid industrial jobs base. The town—or city now, I suppose—is situated about 35 minutes from downtown Toronto, on a good day. It has GO train service, Highway 401 and access to Highway 407, which has just been extended. It is a commuter town and it has grown a lot over the last few years.

Mattamy Homes is one of the largest house builders in North America, the largest in Canada. They have built homes all over the GTA and continue to do so. Last January they opened Phase 1 of Queens Common, 100 lots located off the new Highway 412 that links the 401 to the 407. Phase 2 of this development has just been announced and purchasers of Phase 1 are shocked to see that the same houses, on the same sized lots, are being sold for up to $90,000 less than what they paid a year earlier.

Neither Phase has begun; it’s all just dirt for now. But these houses should be built by February 2019.

It seems the new house market in Whitby, a highly desirable place for commuters to live, has slowed down since the new rules and higher interest rates have come into effect.

Mattamy Homes is a large company. It probably purchased the land for this development when prices were much lower. It can afford to lower prices and still turn a profit, so long as prices don’t continue to drop.

“Company president Brad Carr says some housing developments stall when the market dips and Phase One buyers should be happy Mattamy is pushing forward.” (CBC News)

The message here is that Mattamy Homes doesn’t have to build these houses and probably won’t if it doesn’t make financial sense. In a rising market the developer can simply pass on the extra costs imposed by municipalities to the buyer. In a falling market the builder must absorb the costs or wait it out and build when the market conditions are more favourable.

There are only two reasons I can think of for people to buy a house two years before it is to be built. Either they are suffering from FOMO, fear of missing out, and have decided they better buy anything now or be priced out forever; or they are speculating that house values will go up even more and they could sell the unfinished home for a profit.

Either way, the best thing that could happen for them would be for Mattamy Homes to cancel the project due to diminishing profits, refund their deposits and consider themselves lucky to walk away financially unscathed.

This should serve as a cautionary tale. If you are in the market for a house, wait. If you got pre-approved prior to the rule changes it would still make sense to wait until prices are more affordable and selection is greater. There is no need to rush into anything.

Prices are falling. Many people are in way over their heads. Mortgages have to be renegotiated at higher rates. The market may very likely become saturated with houses for sale. The rush for the exits by the herd will become a stampede. Remember, the herd rushed into this market when prices were high. The herd isn’t really that clever. For municipalities that have banked land sales and development fees into their budgets in order to offset the ridiculous tax increases they keep adding onto every year, I hope they have a Plan B; but somehow I don’t think they, like the rest of the herd, are smart enough to be that forward-thinking.

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