How the First-Time Home Buyer Incentive will Affect the GTA Real Estate Market
In September of this year, the Government of Canada will launch the First-Time Home Buyer Incentive, a nationwide program to encourage home purchases for first-time buyers.
The program, which we will refer to as the shared-equity incentive, will allow 5% or 10% of a home to be purchased by the government in a shared-equity arrangement. The government-owned portion of the home is paid off in a lump-sum up to 25 years after closing.
In the Greater Toronto Area (GTA), the incentive attempts to counteract the effects of ever-increasing home prices, which have begun to push out many potential home-buyers. But how effective will the shared-equity incentive really be?
The $600,000 Limit
Here’s a basic rundown of the program. For purchases closed after November 1, 2019, the government will pay for a portion (10% for new homes, 5% otherwise) of the home, and take ownership of the corresponding equity in the property. The buyer will need to pay back the future value of the equity in a lump sum (5% or 10% of the fair-market value) up to 25 years after closing.
That’s a significant incentive — but not every buyer will qualify. Besides the obvious requirement of being a first-time buyer, there are three main requirements that will matter for us here:
- The buyer’s income cannot exceed $120,000.
- The buyer’s total borrowing (generally, the mortgage amount + the incentive value) cannot exceed four times his/her income.
- The buyer’s mortgage amount must be greater than 80% of the property value.
What does this mean? Requirements (1) and (2) mean the mortgage can’t exceed $480,000. Together with requirement (3), the property value must be less than $600,000. Even in the best of circumstances, then, the incentive can only help if your home’s value is less than $600k…
…which leads to the obvious question: with prices rising across the GTA, how many buyers will the shared-equity incentive really help?
The Statistics of the GTA Residential Market
We’ll start simple. How many properties are worth less than $600k? More importantly, how will this proportion change over time?
Figure 1 above shows the estimated distribution of sale prices for residential properties sold in Q1 2019. During this period, about 40% of residential properties sold in the GTA went for less than $600,000. This puts a sharp theoretical maximum on the potential adoption of the FTHBI — although, as we’ll see shortly, the true utilization is likely to be far less.
How many of these homes were bought by first-time buyers making $120k or less? (We’ll call these eligible buyers.) All we need is the following two assumptions:
- Across the entire GTA residential market, about half of home buyers are first-time buyers.2 Based on our own experience and the judgement of professionals, we estimate this percentage to be about 40%.
- About 80% of first-time buyers make less than $120k. In the GTA, about 93% of working adults make less than $120k.3 Those with very low incomes can’t yet afford to buy a home, while those with very high incomes are slightly more likely to be returning (as opposed to first-time) buyers. We estimate that the low-income effect is more significant, skewing the income distribution to the right and causing the percentage to lower slightly.
This means that roughly 30% of buyers are eligible, in the best case, which is quite different from the effect on the first time home buyers of other cities, such as Montreal. We therefore expect adoption of the FTHBI to be limited by the demand from willing buyers, and not the supply of eligible properties.
Putting It All Together: Overall Adoption Rates
We’ve seen that a maximum of 30% of buyers could theoretically use the FTHBI. In reality, only a fraction would opt to use the incentive, for several reasons:
- If a buyer expects home prices to rise in the future, they’ll be unlikely to use the FTHBI. Furthermore, those who expect prices to drop or stagnate are also more likely to rent instead of buy. Combined, these effects mean that the first-time buyer market is skewed towards price optimists who are less likely to use the incentive.
- An increasing number of first-time buyers are opting for non-traditional lines of credit, such as informal loans from family. This dulls some of the appeal of the FTHBI. While the data on this trend are unreliable, we expect this effect to drive a significant decrease in the adoption of the FTHBI.
- By making down payment of 20% or more, a buyer can avoid the 2–3% mortgage default insurance premium. This is comparable to the 5% shared-equity incentive offered for existing or resale homes — and without the obligation to repay the equity. For those who can afford it, we expect that going uninsured will be the preferred option.
In Part 2 of this article, we’ll perform a more rigorous analysis showing that about half of eligible buyers are likely to use the incentive. That cuts the overal adoption of the FTHBI down to 15% of the residential market — not insignificant, but a smaller share than many have expected.
- Data were estimated by fitting a Student T distribution to log-price data from July 2016 and adjusting the median and scale to fit recent statistics. Procedure was repeated for condo apartments, condo townhouses, and detached houses. The combined data is a mixture model with appropriate overall percentages.
- Altus Group, Better Dwelling, 2019
- Census, 2016