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January 25, 2018 | The Misguided

A best-selling Canadian author of 14 books on economic trends, real estate, the financial crisis, personal finance strategies, taxation and politics. Nationally-known speaker and lecturer on macroeconomics, the housing market and investment techniques. He is a licensed Investment Advisor with a fee-based, no-commission Toronto-based practice serving clients across Canada.

In little more than a week will come the first indication of how stressed we are about the stress test. In Toronto, for example, an average of 14 properties have changed hands daily during January. That compares with 63 a day last year – a 77% decline. Ouch!

Similarly, the time it takes to flog a property has exploded – from just 8 days last January to 32 this year (a four-fold increase, and twice the number for December). Meanwhile average prices are down about 4%, despite a weirdly busy condo market.

So, something has obviously happened. Unknown for another four or five months will be whether or not the market’s just pausing for breath, or has entered a long-term corrective phase. As reported here yesterday, new-home sales crumbled by 82% and are running 76% below the 10-year average. No wonder homebuilders are gingerly dropping prices. The frenzy’s gone.

The stress test is probably why. As veteran mortgage broker Rob McLister said a few months ago, this is the most consequential, earth-shaking event since the first fish crawled out of the Nile (or similar). It changes everything. Overnight it all but doubled the effective mortgage rate, and knocked 15% or 20% of all potential buyers to the sidelines. A newbie who could afford a $450,000 condo last autumn now qualifies for one worth $370,000. So it’ll only be a matter of time before prices fall another 17%.

As forecast here, the Bank of Canada benchmark five-year mortgage rates has just increased to 5.14% (see here). All buyers must qualify to borrow at that rate or the one their bank’s offering, plus 2%, whichever is greater. The cheapest bank five year rate is currently 3.39%, which puts the stress test bar at 5.39%. This compares with 2% fixed-rate loans being offered last January.

So now you can see, vividly, why sales have plunged.

Why did the evil bank regulator think we needed a stress test? Because of the B of Mom. So many moisters were using parental money for 20% downpayments in order to avoid the CMHC test for high-ratio borrowers that Ottawa acted. Bank portfolios were filling up with uninsured mortgages made to people who should never have been approved. That’s risk. The feds worried an economic or market reversal would lead to big bank losses. So here we are.

While it’s fashionable to blame rich foreigners for nutso house prices, speculation and familial stupidity are likely bigger culprits. The number of households holding multiple properties has exploded. Home equity loans to buy ‘investment’ condos have been rampant. HELOCs amount to more than $211 billion with six in ten not being repaid or having interest-only payments. And loans/gifts to adult children appear to be out of control.

The Financial Planning Council says 37% of all Canadian parents have given (or plan to give) money to their spawn to buy a first home. Mortgage Professionals Canada says the flow of B of Mom downpayments has doubled in the last 17 years and some agents in Vancouver claim more than 80% of first-time buyers have a parental assist.

So what?

Well, by borrowing money from their inflated real estate (through a HELOC) to give to their kids so they can invest in more real estate, families become dangerously over-exposed to a single asset class. Worse, it’s a Ponzi scheme – pumping money from the market into the market, keeping valuations inflated. Ironically, all that cash prevents a normal cool-off when prices get out of control. So parents make matter worse, while ensuring their kids swallow historic levels of debt.

While thrusting their children into a borrowing morass, parents are also raiding retirement assets or creating new debt through secured lines of credit. The risk is obvious. If real estate tanks, crashes, corrects or even just swoons for a few years, Junior is pooched with a total loss of equity (and would have been better off renting), while mom & dad’s nestegg shrinks and their own equity is sucked off by a line of credit whose rate keeps increasing. Lose, lose.

But there’s more.

If real estate stays on this track and Junior defaults, the whole family is affected. If your adult child is an insensitive lout and causes a divorce, big trouble. All could be lost. In order to protect the parents, it would be best to structure the transfer as a loan registered against the deed, to be repaid when the house is sold – but that runs afoul of the B20 rules. Loans increase the debt-to-income ratio and may disqualify kiddo in the first place.

Besides CMHC insists any downpayment cannot be a repayable loan. In fact, Mom may have to sign a letter confirming exactly that – so gifting to a married child means taking a big chance that a fresh marriage will stick. More risk.

Meanwhile the stress test itself is upping the pressure on parents to loan money, since everyone qualifies to borrow less.

They could turn off the spigot and let prices fall. But that would involve logic.

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January 25th, 2018

Posted In: The Greater Fool

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