The HST and the real estate market
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01/09/2010 8:09:00 PM
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As of July 1st, when HST came into effect, interest rates were on the rise and sure enough, the real estate market came to a grinding halt compared to the headier days of spring. The real question is; ‘how much of the current market conditions are a factor of HST and how much of the current market is due to rising rates and misleading headlines?’
What happened?
Let’s take a look at some of the facts and put a little perspective on this. It was just over a year ago that the entire global economy was on the brink of collapse. It was feared that the global recession would turn into the next depression. Everyone you spoke to was quick to tell you about how much they had already lost in their home, and one actually sold their home at a loss. Everywhere you turned the message was one of doom and gloom. And how did governments around the globe react? They started spending money and, at the same time, tried to get consumers to do the same. The end result was that the economies in every country in the world experienced deficits. The other result was record low interest rates.
Now let’s look at Canada in particular. First of all, the country had one of the strongest economies going into the recession but we were not immune to global economic influences. However, since homeowners and businesses were not significantly overleveraged, Canadians were able to take full advantage of record low interest rates. We started spending and spending in a way that surprised even the most optimistic of economists. In fact, by the end of 2009, the fears were no longer about recessions, but about another pending housing bubble. Prices in virtually every part of the country, and especially Vancouver and Toronto, had not only rebounded, but in some cases set new records.
This amazing rebound was in large part fuelled by two things: large government spending and record low interest rates. When you combine this, with the fact that Canada did not have a true fundamental reason for being propelled into a recession, it is easy to see how we were able to exit it so fast. However, all good things must come to an end. Record low interest rates, by definition have nowhere to go but up, and once the provincial governments realize they don’t need to keep spending their way out of the recession, they will need to find a way to pay for their newfound debt. And so, the governments of Ontario and B.C .are faced with the difficult task of trying to convince an unsympathetic public that a new harmonized sales tax is necessary to make up for the spending spree that got us out of the recession.
And this is where it gets interesting. The past spring was one of the strongest spring markets in recent history for the real estate industry. Why? Well, let’s think about it:
- We are exiting a recession with strong economic fundamentals.
- Consumer confidence is strong.
- Canadians and Vancouverites in particular are feeling proud of their country/city following the Olympics.
- Interest rates are at record lows.
Take all of this and now add a spring market – which, by definition, is stronger than a winter or summer market. Also add the fact that consumers are being bombarded by the media with warnings about the tax hike. By adding the incentive to save money, Canada had one of its strongest spring markets in real estate history.
How will the HST affect real estate?
The answer is twofold. On the one hand, the advent of HST will have very little real impact on the real estate markets and home values, namely because the new tax is only applied to new homes over $525,000. The sales of existing homes, which make up a far greater percentage of the market, will not be greatly and we will begin to see very creative measures by contractors and developers to help offset the real cost of the extra tax on new home sales.
However, from an emotional perspective the impact will be strong and unpredictable.
There were three reasons why the spring market was so strong:
- Fear of rising rates
- Fear of impending HST
- It was a spring market
The inference is that rising rates and HST will cause the market to slow down and, in some cases, that is exactly what appears to have happened. But let’s take a look at these fears and see what is really happening.
Rising rates
Are rates going to go up? Of course they are. But, are they going to skyrocket - not exactly. The reason the Bank of Canada (BOC) lowered rates to historic levels in the first place was to get us spending and buying and it worked. We literally spent our way out of the recession. The reason for raising those rates is to keep a lid on inflation. The BOC has an inflation target of two per cent. When there’s concern that inflation may run past two per cent raising rates will keep it in check.
Currently, the Canadian economy is strong and will probably grow beyond the two per cent mark, which will justify a slight rise in rates. However, just as we saw during the past two years, Canada’s economy is not immune to what goes on beyond its borders and is, in fact, largely dependent on the global economy.
The result: The BOC will raise rates slightly over the summer but be unable to continue to do so into the fall without risking an economic slowdown. Rates will rise – but not to the degree that matches people’s fears.
HST
Many consumers in Ontario and B.C. rushed to get into the market before the HST came into effect. The truth is that the new tax – whether warranted or not, was not sold to the populace very effectively – especially in B.C. In fact, it caused confusion, anxiety and fear among consumers, and none of those emotions are conducive to building consumer confidence. The reality is that the new tax should have a short-term impact on consumer spending but it won’t last. However, the emotional impact of the new tax will be much stronger and unpredictable.
The result: A population lacking consumer confidence and is uncertain will typically do nothing. The confusion, anxiety and fear, largely a result of poor education on the government’s part, will result in consumers holding off on large purchases until they see the real impact of the HST.
The summer market
Every real estate market has an ebb and flow and the spring is always busier than the summer. In fact it is quite natural for home sales to slow in the summer months simply because people are on holidays.
What should happen?
The reality is that the real estate markets in both B.C. and Ontario should see a slight softening over the course of the summer with prices coming off about three per cent from their spring peaks. This may be slightly increased by the very real fact that interest rates will have risen another quarter point and the additional cost of the HST thus making real estate that much more expensive in what are already Canada’s most expensive markets and, therefore, that much more unaffordable. These prices should settle over the course of winter, only to rebound in the spring of 2011, once Canadians realize that HST is here to stay and they have adjusted to the new reality. Fear and confusion will be replaced with knowledge and acceptance. They will see that rates have not risen as much as they feared and that even a full percentage higher is still very cheap money. And so, consumer confidence will rebound as it should and the spring of 2011 should recapture the losses of the fall and summer and the market will continue as it always has. That is what should happen.
What may happen
We will have to wait and find out, but I can guess one thing. The headlines in papers all across the country will start comparing month over month comparisons showing the impact of HST and rising rates. Canadian consumers will see a drop in real estate prices and mistake, what is in fact a natural occurrence of the summer market, with the implementation of the HST and rising rates. Fear and confusion will replace confidence and what should be a three per cent drop could be misinterpreted as a rebounding recession.
Canada has some of the strongest economic fundamentals in the world. We are the envy of the global banking community. Our real estate is very strong. We know that rates will have to rise, but we also know that they can’t go up too much too fast. We know that HST is now here. But we also know that we are resilient by nature, and although this will have an impact on the cost of housing, it is not as great as some would have us believe and we will learn to adjust. Here’s hoping knowledge replaces fear and that Canadian consumers recognize the difference between a summer market and a false recovery.