Don’t get fooled by the ‘forward buy’
In 2009, as part of a series of fiscal stimulus measures following the financial crisis, the U.S. federal government initiated a US$2.85 billion program aimed at lifting consumption and giving struggling automakers a boost.
Known as Cash for Clunkers, the program paid automobile dealers anywhere between $3,500 and $4,500 when a customer traded in an older vehicle for a new fuelefficient one. Dealers passed on the rebates to customers to incentivize the purchase of new automobiles.
When two American economists, Atif Mian and Amir Sufi — who also are the authors of the bestseller House of Debt — analyzed the impact of the cash incentives on car purchases in 957 cities across the U.S., they found that the program had indeed induced the purchase of 360,000 automobiles between July and August of 2009.
But a deeper dive into sales data revealed that the effect of the program was not all that it seemed. Soon after the program ended, Professors Mian and Sufi, noted, automobile sales declined sharply.
“The effect of the program on auto purchases (was) almost completely reversed only seven months after the program ended,” they observed.
Rather than creating new demand, the program had essentially brought sales that were already probably going to happen forward by a few months.
The phenomenon, sometimes known as “forward buy” or “forward purchase,” can be seen in Canada’s real estate market right now.
Starting Jan. 1, 2018, stringent mortgage regulations will require borrowers to qualify at a much higher interest rate than the contracted rate with the lender.
As a result, home purchases that might have otherwise transacted in 2018 or later are being moved forward to November and December. Lenders have already reported a spike in mortgage demand in November, which is likely to accelerate this month.
The homebuyers’ response to the impending stress tests is completely rational. By advancing home purchases, buyers can be eligible for larger loans than they would when required to qualify for an interest rate 200 basis points higher than the contracted interest rate.
This kind of “forward buy” in response to a policy change can create distortions in housing statistics, and lead to an erroneous prognosis of the state of the market.
For instance, if sales volumes in January 2018 are lower, it will not necessarily be a sign of weakening housing market, but rather a consequence of those purchases having been pulled forward ahead of the new regulations.
A recent report by Mortgage Professionals Canada, a trade group representing mortgage brokers, claims that each year across Canada the stress test could affect 100,000 potential homebuyers who may not qualify for the desired loan amount. Of those, 40,000 to 50,000 may not be eligible for any amount.
The report further suggests that the stress test is likely to lower housing prices by between 2.5 per cent and 12.5 per cent or more. Hence, not only are sales volumes forecasted to be lower because of the stress test, but prices are also expected to slip. Furthermore, the report projects the impact to be substantive with prolonged consequences.
Other recent reports have also painted a gloomy picture for the housing markets for 2018 and beyond. We will caution, however, against putting too much faith in forecasts of the impending housing market slowdown. The past ten years of changes in regulations and housing market activity suggest a tremendous capacity for resilience.
Recall the predictions of a doomsday scenario when a new municipal land transfer tax was introduced in Toronto in February 2008. Despite the forecasts of a drastic impact and the lingering effects of the Great Recession, housing markets rebounded quickly.
We are witnessing similar resilience in Vancouver where the housing markets have started to stabilize after a series of tightening regulations, including a 15 per cent tax on foreign homebuyers, were introduced last year. The story in Ontario appears to be similar.
Housing is a durable good and hence lasts for a long time. Therefore, the demand for housing should also be seen over a longer horizon. Policy changes can shift some sales from one year to another resulting in distortions.
However, a healthy economy and a growing demographic, thanks to immigration, is likely to generate a sustained demand for housing in the long run.
Murtaza Haider Is An
Associate Professor At
Ryerson University. Stephen Moranis Is A Real Estate
Industry Veteran. They
Can Be Reached At Info@ Hmbulletin.Com.