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Ontario government not yet maximizing the economic benefits from its foreign buyers’ tax to increase housing affordability

By: Diana Petramala and Matthew Taylor U E
October 23, 2017
 

In April of this year, the Ontario government followed B.C.’s lead in introducing a foreign buyers’ tax on purchases of residential properties. The province laid a 15% Non-Resident Speculation Tax (NRST) in the Greater Golden Horseshoe (GGH). The tax applies to all non-resident purchases made after April 20, 2017. Home prices in the Greater Toronto Area (GTA) were on an unsustainable trajectory over the preceding months rising by an average annual pace of 20% between 2016 and the first half of 2017.  All levels of governments were challenged with the financial risks of rapidly rising home prices and a sharp deterioration in affordability.

If the objective of the tax was to stabilize the housing market, mission accomplished. The recent Canadian Real Estate Association (CREA) report showed that housing sales activity as of September was 34% below the peak reached in March and average home price growth has slowed to just 4% year-over-year in September of this year.  But, the tax was part of a broader policy package dubbed Ontario’s Fair Housing Plan, aiming to bolster housing affordability. To do this, the province needs to think big in its spending on affordable housing.
 

What the literature says about foreign investors


A recent article in the Journal of Real Estate Finance and Economics, Housing Markets and Foreign Buyers, studied China to highlight the impact of foreign buyers on home prices and what the optimal policy was to address it [1]. The research recognized that foreign buyers can push prices up generating increased equity for home owners. It also recognizes that this creates affordability challenges for renters and potential homebuyers.

The research then highlights that taxing foreign buyers does two things. It reduces demand and stabilizes home prices, but doesn’t lead to a price correction. This tax hurts homeowners because their houses now make a smaller contribution to their wealth. However, the economy can be made better off overall if the tax revenue is invested into subsidized and other forms of affordable housing. The benefits to those who need affordable housing far outstrip the cost to homeowners. This principle was recently applied in New South Wales, Australia where they raised real estate taxes on foreign buyers, but at the same time reduced the land transfer tax on first-time homebuyers, along with subsidies for new home construction.

This conclusion was underscored by research released in August out of New York University and the University of British Columbia on the impact of foreign buyers on the markets of Vancouver, Toronto and New York. The authors found that non-resident buyers purchasing homes and holding them vacant, pushed home prices up 5% and rents up an even greater 10%. The research also recommends taxing foreign buyers, but using the revenue to invest back into the housing stock.
 

Estimated revenues from the NRST between April 24th, 2017 and August 18th, 2017 suggests Ontario should have room to beef up its spending on affordable housing


In its full plan, Ontario earmarked $125 million over five years to support rental housing – but by our estimates that is a very small fraction of what they already have and will earn in revenues from the NRST.

The Ontario government data shows that from April 24th, 2017 through August 18th, 2017, foreign buyers purchased 2,553 housing units across the GTA. Based on this we can estimate the NRST revenue received from the GTA in those months. If we assume they transacted at the average priced home, the total revenue would be $300 million for that four-month period alone (Figure 1). The caveat is that we don’t know how the data captures purchases from non-residents who are exempt from the tax, such as students and temporary workers.

We have to recognize that by implementing this tax, there is also foregone revenue from the existing land transfer tax due to a drop in demand. To do this, we have to parse out what the impact of the NRST has been on housing activity in the region over that same period.

The foreign buyer’s tax has not been the sole driver of the 36% decline in housing sales and the $116,000 drop in average housing prices between April and August. The tax came at a time when a number of headwinds were building against housing demand in the GTA, the most impactful being (Figure 2):

  • A large deterioration in affordability: The rise in home prices meant that the carrying costs on buying an average-priced home had risen by almost 60% over 2015 to early 2017. Despite interest rates remaining low, affordability in the market was the lowest it’s been in almost three decades. This has likely shaved 10% off of sales.

  • A lagged impact from changes to mortgage regulation rules: The federal government introduced a restrictive package of mortgage regulation changes in October of last year that resulted in higher borrowing rates for many households and stricter qualifying rules for insured borrowers. We estimate the result was a 12% reduction in activity in the GTA.

  • Sentiment:  As the market became heated, confidence in the ability to sustain double-digit home price growth likely started to wane. Speculators and homeowners quickly put their homes on the market, trying to get out on the high. The rise in listings between April and May had the most significant impact on average home prices during that time.

Once we strip away the impact of other market and economic forces, we estimate that the NRST only contributed to a third of the decline in existing home sales and a quarter of the decline in average home prices. Real estate transactions totalled roughly $24 billion across the Toronto Real Estate Board (not seasonally adjusted) between May and August. Based on our model estimates, total dollar sales would have been roughly $3.3 billion dollars (not seasonally adjusted) higher had the tax not happened. This implies the tax itself would have led to roughly $53 million in lost provincial revenues from the impact of the drop in sales on the domestic portion of the land transfer tax, at an effective rate of 1.6%. 

While this estimate is based on a number of assumptions, the illustration still holds – the net revenue gained from the NRST in the period between April and August is twice as large as the $125 million they have committed to spend over a five year horizon. 
 

Where to go from here?


When implemented, the tax was cloaked in uncertainty regarding its impact on the housing market and government revenues, especially since there was a lack of data of foreign buyers. However, we are now six months out since the tax was implemented and the full impact of the policy should now be in the review mirror. The recent CREA data showed that the market has finally stabilized. This would provide the province an opportunity to invest in affordable housing to achieve their long-term objectives of making housing affordable throughout the GTA. The economic research suggests that the province should use all the net tax revenue to enlarge its commitment to rental housing.

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(1) Dr. Chi-Chur Chao, Eden S.H. Yu. Housing Markets with Foreign Buyers, Journal of Real Estate Finance and Economics, Berlin, Germany, 2015 vol. 50, pp. 207-218.

Diana Petramala is Senior Researcher at the Centre for Urban Research and Land Development (CUR) at Ryerson University

Matthew Taylor U E is a Research Assistant at the Centre for Urban Research and Land Development (CUR) at Ryerson University

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