Alternative mortgage lenders could become a risk

A slower housing market resulting from effective policy was a positive development this year, CIBC deputy chief economist Benjamin Tal says. But there’s another side to the story.

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Borrowers unable to qualify for mortgages under the Office of the Superintendent of Financial Institutions’ new mortgage rules that came into force at the start of 2018 are turning to alternative lenders at an “extremely high” rate, Tal said in a Nov. 19 interview.

This has made alternative lenders the fastest-growing market segment, accounting for roughly 10% of mortgage transactions, Tal said, which is a record high he expects will rise to 12% to 14% over the next year.

“We are transferring risk from the regulated segment of the market to the less regulated segment of the market,” he said. “We are transferring risk from where there is light to where it’s dark. That’s suboptimal.”

Tal said he and CIBC supported the new mortgage rules as a way to “save some Canadians from themselves.” Over time, however, the subprime—namely, alternative lending—market could grow too big.

He said there’s an “urgent need” to start regulating the space the way regulators are now focusing on banks and other financial institutions.

The combination of mortgage policy and higher interest rates contributed to 2018 being a “transition year” for Canadian real estate, Tal said. New construction in Toronto and Vancouver will continue to soften, he said, while the resale market stabilizes.

“The next shoe to fall, especially in Toronto but also in Vancouver, probably will be the condominium market, where we are starting to see some increase in supply and reduced demand, especially from investors,” he said.

Close to 50% of condo buyers in those markets are investors, and about 45% of those investors are in negative cash flow, losing money on a monthly basis because of rising interest rates, Tal said.

“So, the economics of investing is different than it was two, three or four years ago, and the number-one risk facing the condo market is that those investors will start selling or simply stop buying,” he said.

That’s significant given investors make up roughly half the market, and it’s one of the reasons the condo space will slow in 2019, Tal said.

“Not a disaster, not a crash, not a freefall—but clearly it will slow down, following the example of the low-rise market that is now slowing,” he said.

A report Tal co-authored says the housing market is more important to the overall Canadian economy than ever before: residential investment, which makes up 7.5% of the Canadian economy, is just off its historical peak, as is the share of residential construction workers and those employed in real estate to overall employment.

“As a result, any slowdown will be magnified in terms of its impact on the Canadian economy relative to an equal decline in activity during past cycles,” the report says.

Read the full report here.

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