In this episode, Caroline Dabu, Head of BMO Wealth Planning and Advisory Services at BMO Private Wealth is joined by our in-house experts Sal Guatieri, John Waters, and Lydia Potocnik to discuss a number of perspectives on Canadian real estate. Sal Guatieri is a Senior Economist and Director with BMO Capital Markets; John Waters, is a VP, Director of Tax Consulting Services at BMO Private Wealth; and Lydia Potocnik, is Head of Estate Planning and Philanthropic Advisory Services at BMO Private Wealth.
You might also be interested in these related articles:
Article 1: Canada’s Real Estate Market: 5 Things Your Need to Know
Article 2: Federal Budget 2022: 8 Measures that Could Make Real Estate More Affordable
Article 3: All in the Family: A Primer on Gifting Property
Caroline Dabu: Hello everyone. I'm Caroline Dabu, and I'm Head of Wealth Advisory Services at BMO Private Wealth. I lead a team of professionals and experts that provide wealth planning, estate tax, philanthropic, insurance and other specialized advisory services for BMO Private Wealth clients. Today, I am joined on this podcast by Sal Guatieri, John Waters and Lydia Potocnik.
Sal is a Senior Economist and Director with BMO Capital Markets; John is Vice President, Director of Tax Consulting Services at BMO Private Wealth; and Lydia is Head of Estate Planning and Philanthropic Advisory Services at BMO Private Wealth. Thank you to all of you for doing this podcast and sharing your perspectives on Canadian real estate, a topic that is at the top of everyone's mind everyday, it seems.
As Canadians, home ownership is one of the most significant and important assets we work towards. Our homes provide security and comfort for families, a place that can represent stability and where we see our families grow.
It's also a place to store and grow accumulated wealth, especially as your mortgage gets paid down and as home prices have historically been steadily rising over time. But the paradigm has now changed, and so I want to start with you, Sal. Can you provide us with that context about what has happened recently in the Canadian economy overall?
Sal Guatieri: Well, Caroline, the Canadian economy is weakening. It had a nice run following the omicron wave and easing of restrictions, so we came flying out of that slump quite strongly through the winter and then first half of this year. But all the recent signs suggest the economy is downshifting quite dramatically. And it's those familiar headwinds, so the high inflation that's squeezing household budgets, rapidly rising interest rates, and a global economy that's weakening as well. In fact, parts of Europe are in recession right now.
Unfortunately, we do expect things to get a little worse before they get better. We do expect the economy to basically stall at the end of the year and contract modestly next year before resuming growth. The big probability here is high inflation – those rising food costs and still high gasoline prices, supply chain disruptions are ongoing, rising rents and rising wages are all adding some persistence to inflation. And unfortunately, even though it does look like inflation is peaking, it's going to be a pretty slow decline over the next year or so. And as a consequence, we already have the Bank of Canada raising policy rates by 300 basis points just since March – the most aggressive tightening cycle since the 1990s. And we do expect about another 100 basis points of rate increases by the end of this year. So, the bank likely to take its policy rate up to 4.25%. That's more than double the peak of the last tightening cycle.
It's not a great backdrop at the moment. The higher inflation and rising interest rates are making it pretty difficult for the average family to afford a home in Canada, especially after the blistering rise in home prices over the past couple of years.
CD: Thanks, Sal. It happened so quickly, all of these factors, and we're seeing just the convergence of all these factors pointing to a much more challenging time ahead. Can we talk specifically about how rising inflation and higher interest rates impacted a family’s ability to participate in the Canadian housing market?
SG: Yeah, I mean I was talking about the higher inflation. That I don't think is the main problem. Even though it's reducing spending power for most Canadian households, a lot of the increased inflation is at least being partly offset by fast-rising wages. And that, unfortunately, is what's adding some stubbornness to inflation. But it's also helping families make ends meet.
The big problem is the rising mortgage rates. We're coming up record lows at the start of this year. Mortgage rates have essentially more than doubled now since then. And that's posing quite a challenge for many Canadians who are thinking of getting into the housing market, because, remember, it's not just the higher mortgage rates; it's the fact that prices rose so dramatically through the pandemic, by more than 50%. It was a record increase over those two years. And that really has led to the worst affordability in the housing market in a generation.
Now, a lot of that is in Ontario and British Columbia. Most other parts of Canada are still pretty healthy in terms of affordability, especially much of the Prairie Provinces, Atlantic Canada and parts of Quebec. But Ontario and British Columbia, especially some of the smaller cities and rural regions where teleworkers were moving to, are driving up prices. Affordability is pretty bad. And, as a result, we've already seen house prices fall now by 9% since their peak of earlier this year. In fact, in some regions, you're looking at close to 20% decline already in prices. Home sales are now well below their normal levels.
Now, the one thing that’s preventing prices from falling further is that sellers are kind of holding back. They're not listing their properties like they normally would, and some are just turning to the rental market. Now, unfortunately, we do expect house prices to fall further, probably at another 10-11% decline in house prices by next summer. So, that'll take prices essentially back to where they were in early 2021. But we really need to get to that better price point where more buyers can then come back to the market. By summer next year, we would expect the housing market to stabilize and then resume an upward course.
CD: Wow – that's such a drop – like the 20% drop in some markets for the price of Canadian homes. And it all seems to have happened faster than anyone would have ever predicted, even six months ago.
I just want to pivot, because many of our own clients own not only their own homes, but they also own secondary properties, as investments that they use to earn rental income. So, I just want to ask you how these properties are affected by the change in the economy and housing market. And as people are wondering, do they still have a place in my portfolio of assets?
SG: For investors in the housing market, those owning properties to rent out, basically the rental market has been a savings grace. Yes, you know, the value of that property has partly retraced its big run-up of the previous two years, but rents are rising pretty dramatically right across the country. In fact, in many areas, especially in Ontario, we're seeing double-digit rent increases from a year ago.
So, you know, good news for investors of those properties; obviously not great news for tenants. And it's really a reflection of how tight the rental market is, how low apartment vacancy rates are right now. And, you know, part of that is just stemming from the fact that the unemployment rate is still quite low. Most Canadians are working right now. Wages are going up, so many tenants can afford to pay some of that rent increase.
That said, yes, the rapidly rising rents are really hurting younger families, recent graduates and immigrants to Canada. But again, they are benefiting investors who own those properties. I mean, they're seeing a steady increase in rents that's going some ways to allaying the increased costs of owing the property, especially the increased borrowing costs. And that's probably why we're not seeing many investors selling their properties. They're holding onto those properties because they're renting them out. They're earning an ever-higher increase in rent.
So, you know, overall long term, again, we think the housing market is probably a good place to invest once we get to this better price point, and once the house prices start to stabilize. The longer term, you know, the direction for the housing market is probably still upwards. It's just we're going to need to get to a better affordability price point.
CD: Yeah, and you brought up the impact this is having on the younger generation, and the people that are currently renting are facing not only rising inflation in day-to-day purchases, but they're facing increased rental costs. And really, it is affecting the younger generation, who may just be starting their careers, or, in fact, delaying their ability to purchase their own homes.
I do want to turn to Lydia, because with that backdrop, we're hearing so much more from our clients too around how they help support their children. So, what I want to ask you, Lydia, is how can parents and grandparents do their part in, I guess, helping and supporting their younger adult family members? And I'm thinking about their adult children that are currently renting, or maybe they're ready to move out of the family home.
Lydia Potocnik: Well Caroline, you bring up a really interesting point, and against this challenging economic background, parents and grandparents still want to help their children get into the Canadian housing market. In fact, families can help by sharing their resources and gifting assets to younger family members to help them get started.
And, you know, there's a number of ways in which they can help the next generation. So, for example, writing a cheque or transferring cash directly to them is one way, or they can even transfer investment securities to a younger family member's investment account. They can also assist by purchasing real estate for them, or even settling a trust fund with assets to benefit the younger family member. And finally, people can still leave assets to younger family members through a will. So, there's a number of different ways in which parents can help their children and grandparents can help grandchildren.
CD: And so, what would you say is the most important consideration among the options that you've laid out here?
LP: Well, financial planning continues to take a real priority with our clients. And I think it's very important that when a gift is made, a financial plan takes that into consideration to ensure that the parent or grandparent can actually afford to make the gift, and that making the gift will not cause them future financial hardship.
This is best done, as I said, through a financial plan, because once a gift is made, it can't be taken back. And therefore, it's likely that those funds will not be available to the parent or grandparent in the future. So, again, planning ahead before you make a decision to part with that money or that asset is critical. And that's where we can certainly help.
CD: So essentially, you're saying that parents and grandparents should make sure that they can afford to help their adult kids, so they don't cause themselves future financial hardships. I think that's great advice, because you can really get fixated on helping out now and not realizing the downstream impact it will have on your own personal situation down the road.
I think this is a good segue, as we're talking about housing affordability, and so John I'm going to pivot to you. The federal government in 2022 budget made housing affordability a priority. They made it a priority in the last budget, and so what opportunities are available for families as they're looking to potentially buy a home?
John Waters: Thanks Caroline. Housing was certainly a significant theme of the federal budget this year, and there were a number of measures that are seeking to address the affordability issue, particularly with first-time home buyers.
I would say the most interesting measure that was introduced is the tax-free, first-time home savings account. So, this was a new registered account that is expected to become available sometime in 2023. And essentially, it takes the best of both an RRSP, as well as a TFSA. So specifically, there would be a tax deduction for contributions into the account, and a tax-free withdrawal when the funds come out specifically for a qualified home purchase. And of course, the growth and the plan similar to a TFSA would also be tax-free.
So, contributions would be limited to $8,000 annually and a lifetime maximum of $40,000. But it's important to note that the owner of the account must be a first-time home buyer. So, this would fit well with families trying to help younger family members afford a first home. But one downside with this new account is that it could not be combined with the existing RRSP home-buyer's plan, which is potentially borrowing from your RRSP and repaying that money back over 15 years. So, you can't use both that home buyer's plan, as well as this new account.
There were a number of other proposals in the budget, as well. Another interesting one was something called the Residential Property Flipping Rule. And the goal of this, again, is to make homes more affordable. So, specifically, what is proposed in this draft legislation is that for real estate that is owned for less than 12 months, any profit on the sale of that real estate within that 12-month period would be treated as fully taxable income. And, of course, this would be different than the existing treatment, typically as a capital gain, a 50% income inclusion rate that would normally be associated with the sale of real estate property. So, this would effectively double the tax that would be paid on that appreciation if that property is sold within that first 12 months of ownership. And it would also prevent the use of the tax-free principal resident's exemption.
Now, there are certainly exemptions to this new proposed rule that would excuse sales within 12 months from being subject to this new rule of this fully taxable income for certain life events, such as death, birth of a child, new job or divorce.
There str a few other initiatives that were introduced in the federal budget to assist with home-buying affordability, mostly around introducing some new federal tax credits, as well as some increases in some existing tax credits for home buyers or owners. The budget also proposed a temporary prohibition on foreigners who purchase Canadian real estate.
The final thing I want to mention with the budget – there were some future changes to this first-time-home-buyer incentive program, which was introduced a few years ago and the hope is these changes will increase the uptake of this program.
So, just in summary, a number of proposals from the budget with the goal of increasing home affordability, I would say particularly for first-time home buyers.
CD: John, the tax-free, First-Home Savings Account sounds like a really interesting opportunity for parents and grandparents to also help their adult children to purchase their first home. I'm going to put you on the spot here, because $40,000 as a lifetime maximum contribution, and we've just heard from Sal that affordability is still an issue, and the fact that you can't combine this with the RRRSP home-buyer's plan. Is it any sense in the upcoming budget if this will be something that could be reviewed? I imagine that there's a number of people commenting that $40,000 lifetime max is not nearly enough.
JW: I haven't heard any inkling about that, Caroline. I guess it's always possible. I know that that was some of the commentary when this came out, and in certain markets, $40,000 doesn't go as far as others. So, I guess we'll have to wait and see. It's still a draft legislation, and it hasn't been introduced. So, I guess there's always the possibility that it could be increased in the same manner that, say, RRSP contributions have been increased over the years.
CD: Yeah, great. Thanks John. And I know there will be a lot more information about this account as we head into 2023.
CD: Lydia talked about considerations around making gifts to younger family members to help them out. When it comes to making substantial gifts to help family members get into the property market, there obviously has to be tax and legal considerations for everyone involved. So, John, you just laid out all the things that the recent federal budget has proposed to help. What about taxes? How much of an issue is this going to be now?
JW: Well taxes are always near and dear to my heart, Caroline, but certainly, something that families should be thinking about, particularly if they are making a gift to an adult child or grandchild to assist them with a home purchase. And you know, just as a background, for Canadian income tax purposes, if there was a gift of property, be it securities or a condo, or house, that would result in a deemed disposition at fair market value by the giver, by parent, grandparent...and any appreciation that has accrued since the purchase of that property would be subject to tax.
Now typically that gain, that appreciation would be treated as a capital gain, meaning that 50 percent of that gain is added to their tax return as income, and of course taxed at their marginal tax rates. Rates on capital gains could be as high as 27 percent depending on the level of income and marginal tax rate, and of course what province the individual lives in.
Now, I would say that, notably, Canadian cash does not result in a capital gain, because there is no appreciation. You know, that rule wouldn't really apply here. But, of course, if you had to sell something else, say an investment, to generate that cash, it's important to be mindful that that sale could result in a capital gain that would entail a tax cost.
Now, if one was to make a gift specifically of real estate, I guess one consideration first and foremost is the implications to the principal resident's exemption that gets both to the parent or grandparent making that gift and, of course, to the child, going forward. But if the property was previously used as a rental property, it's important, in addition to considering the possibility of a capital gains, that there could be a possible recapture of the depreciation for tax purposes that's been claimed on the property previously. And, of course, that would be another additional tax cost to take into account on a possible gift that's real estate to a younger family member.
Another issue to be mindful of is that it's generally advised to make a full gift of the property, because if you were to sell the property and you did not change what was considered the full fair market value of the property as consideration for that transfer, you could have significant negative tax implications. Specifically, if you sell the property to a younger family member for less than fair market value, that could create a double tax situation, where both the parent and the child could be taxed on the same appreciation.
So, the message is to make either a full gift, or if you are going to sell it to a family member, to never sell to that family member for less than the full fair market value.
CD: Well thanks John. Lots to take into account on the tax front for sure.
With changes in ownership that result from making a gift, there are also legal considerations. We just heard John outline all the tax considerations. So, Lydia, I want to ask you to tell us about the legal considerations around making gifts.
LP: Well Caroline, one of the biggest legal considerations and concerns that family members have tends to be when gifting assets or property to an adult child that perhaps is getting married or in a common-law relationship. And often parents are concerned about what will happen to the asset if that couple decides to part ways.
In Ontario, for example, the matrimonial home is considered a joint family asset for married couples. So, regardless of the source of the matrimonial home or who financed it, both spouses can have an equal stake in its value. And this also applies even if the home is only registered in one of the spouses' names. So, a lot of people may not be aware of this being perhaps a potential concern.
So, what this can result in is half of the value of the home being allocated to a-soon-to-be ex-son or daughter-in-law. But what's also important to note is that family law varies by province. So, it's critical to understand the provincial rules in your own jurisdiction before gifting assets or purchasing property for an adult child.
But I also want to highlight that this potential risk can be mitigated in a few ways. So, for example, addressing the value of the matrimonial home in a marriage agreement and how it will be divided, should the marriage end, is one way to mitigate the risk. And in the case of couples who are not married, but rather, living together, a cohabitation agreement could be put in place to protect the family home, because the Family Law Act in Ontario does not provide common-law spouses with the same legal rights as it does for married couples when it comes to the family home.
So, these are really two important distinctions that I wanted to make, and it's very important for people to understand the legal ramifications of gifting real estate or gifting assets to help a couple purchase real estate that will ultimately be used as the family home.
And you know, there's another strategy that can help mitigate some of these risks, and that's actually parents or grandparents taking back a mortgage for the value of the gifted property. And one nice thing about a mortgage is that it can provide the parent or grandparent with a stream of income to help offset the risk of outliving their assets. So, the mortgage could also be forgiven at the time of passing away through the will of the giver without any tax consequences. So, if someone decides at the end of the day that they don't necessarily want to have that adult child pay back the mortgage at the time of death, they could actually forgive that mortgage in their will.
So, this brings me to another important element that individuals need to think about, and that's really about family dynamics. And how do individuals feel when they know that perhaps a parent is giving a child an asset or cash to help them during their lifetime versus another child? And this really brings up the issue of what is equitable and fair. And when we help clients with their financial plans, this is one of the deciding factors that many clients place a lot of emphasis on. They really want to make sure that family dynamics are not going to be negatively impacted when gifting assets to one child over another. So, treating them equally or equitably can help maintain family and sibling harmony.
And a big risk is that if a child feels they are unfairly treated financially through the will, they will actually challenge the will. And this means essentially costly and time-consuming legal challenges to the estate, which will deplete the assets of the estate for other beneficiaries. So, I can't emphasis enough that proper financial and estate planning, as well as communication, are really keys to maintaining family harmony at the end of the day.
CD: This is a really great perspective, because what you're really underscoring is that importance of stepping back and taking a holistic approach, and the importance of a longer-term financial plan. And, you know, especially when we're in an environment we're in today, it's so easy to get caught up and make some short-term decisions without looking back at that longer-term financial plan.
To build on that point around the importance of a longer-term plan, I do want to now pivot to you, Sal, because I really want to end with your thoughts on what's going to happen in the mid- to longer-term with the economy and housing affordability.
SG: Again, near-term, things are likely to get a little worse before they get better, Caroline. We do expect the economy to turn down modestly early next year. But on the bright side, all recessions end, as do all the housing market corrections. Again, we just need to get to that better price point. And we're already seeing affordability make some modest gains, given the recent decline in prices. Remember, the Bank of Canada won't be raising policy rates forever. Once it sees inflation on a steady downward course, we think it will move to the sidelines through next year, and then begin to cut interest rates by 2024 back to more neutral level.
So, you know, the housing market will rebound, probably second half of next year. So once the economy turns up, interest rates are stabilized and we're at that better affordability point. And remember, long term, the housing market will be driven by rising immigration to Canada. It's driving the fastest population growth among all G7 countries right here in Canada.
So bottom line, the long-term outlook for the housing remains quite positive.
CD: Great. Thanks so much. So, we will keep our sights set on that longer-term outlook. Thank you so much.
Sal, John and Lydia, thank you for sharing your experiences and so many valuable insights into the economy and how home-buying affordability has been impacted. With all of the changes in the Canadian real estate market, there is so much to consider when trying to help younger families get off to a good start. And so, I would encourage our listeners to contact your wealth professionals, accountants and lawyers to discuss these issues together and to figure out the best way to help your family members.
And with that, thank you for joining us, and enjoy your rest of the day.
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