Role of interest rates in housing boom usually overlooked – analysis

by Ephraim Vecina27 Jun 2016
In his June 23 contribution to The Globe and Mail, Toronto-based financial adviser Alex Sloat said that while Finance Minister Bill Morneau’s formation of a working group to look into the country’s overheated housing markets is a welcome development, a crucial component remains missing in the discourse surrounding Canadian real estate.
 
“I certainly approve of the government looking into this issue, but I hope they look at some factors that are usually omitted from this discussion. Most importantly, the role that interest rates play is a huge and underappreciated factor in the housing boom,” Sloat wrote.
 
“Too many observers make the fundamental mistake of ignoring this. They look at the cost of homes, but very few people open their wallets and pay the cost of the home – they pay their mortgage,” he added.
 
Sloat contended that what really dictates purchases isn’t the listed value of a home, but the associated monthly payments.
 
“A substantial portion of the monthly payment is interest, and interest rates are at historic lows. That means that for any given payment, more goes to the principal, and thus the face value can be higher without making the home less affordable,” he explained.
 
The analyst said these developments would go a long way towards explaining the present popularity of certain property types, especially condominiums.
 
“[Geography] imposes its own limits. There’s not enough land in Toronto or Vancouver to build a detached house for every family that wants one, so those that exist are a hot commodity. A lot of people are buying starter condos, when 50 years ago they’d have bought starter houses,” he wrote.
 
Considering the steady growth in real income over the past years, “it’s just as easy for the average Toronto family to afford today’s average mortgage payment as it was when my parents bought almost a quarter of a century ago,” Sloan argued.
 
“[When] you stop looking at the easy number (home prices) and start looking at the meaningful number (mortgage payments), the narrative of foreigners bidding up property to unsustainable prices doesn’t hold up,” he concluded. “Let’s not be so quick to blame outsiders that we forget what Ottawa’s doing.”

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