Ordinary Canadians turn bankers as shadow mortgage lending rises

TORONTO — Canada's housing boom is increasingly driving homebuyers to seek mortgages from private lenders, who demand rates that can be more than five times higher than those charged by the nation's banks.

Canadian house prices have risen 36 per cent since June 2009, according to the Teranet-National Bank house price index. At the same time, Canadian banks have become more conservative and regulators are making it harder to lend, giving rise to an alternative market, including Canadians who refinance their own homes at low rates and then use the money to become mortgage lenders themselves.

Some analysts say a housing investment is increasingly risky because the pace of price increases has vastly outstripped wage growth, all amid a time of historically low interest rates and record debt levels. 

If and when interest rates rise, the concern is that consumers would have little ability to increase their payments, because they have so much debt.

"The risk arises if the unintended consequence of regulation is to push out the risk profile of the less regulated sector and to encourage it to grow quickly at the same time," said Finn Poschmann, vice president of policy analysis at the CD Howe Institute, a think tank. 

"In dollar terms, it is not a huge part of the economy [but] my concern is that we pay attention, because small problems sometimes get unexpectedly large, and quickly so," he added.

Mortgage broker Lou Perrotta indicated that in terms of volume, 20 per cent to 30 per cent of the mortgages he puts together are now privately financed, typically because borrowers are declined for a bank loan for reasons like a low credit rating or unsteady income. 

That represents about C$4 million to C$5 million of the C$20 million ($15.69 million) of mortgage business he does annually, he remarked.

"Business is brisk, without question. [It has] probably tripled in the past three years," said Perrotta, president of Domus Financial Corp. in Toronto, where house prices have increased by 55 per cent in the last six years.

Perrotta acts as a matchmaker between individuals who have money to lend and who are seeking higher rates of return than can be had in stocks or bonds, and borrowers who are willing to pay a higher mortgage rate to get into the market.

He also invests his own money, lending between C$25,000 and C$250,000 each to "five or six" borrowers a year who offer a good balance between risk and return.

"It's not for the faint of heart, and you need to understand the dynamics of real estate," Perrotta said.

One private lender, who asked not to be named because she is close to the real estate market and fears hurting her business, took out a C$400,000 mortgage on her paid-off home at 2.49 per cent and then gave that money to a broker that lent it to a borrower at a higher rate, for a fee.

"Who the hell is going to give me 9 per cent return?" said the lender, who noted that she has recourse to the borrower's assets if he defaults.

According to CIBC senior economist Benjamin Tal, the shadow lending market represents about 4 to 5 per cent of Canada's overall mortgage market.

"This is something that is growing very fast, because many borrowers are not having access to banks because the banks are highly regulated," said Tal.

In Ontario, Canada's most populous province, private lending accounts for about 4 per cent of new mortgage originations, or C$1.1 billion ($878.8 million), or 2 per cent, of total mortgage lending by dollar value, according to Teranet.

While that's a fraction of the sub-prime lending that got the US housing market into trouble seven years ago, analysts are concerned that the market is growing rapidly and may be concentrated in hot housing markets such as Toronto and Vancouver where a sudden downturn could take hold.

Legal practice

The practice is legal, and can be done through a person-to-person loan, in which the lender is named as a lien-holder on the mortgage, or through a Mortgage Investment Corp., in which investors can pool their money to lend to those who either don't qualify for a traditional loan.

While major Canadian lenders offer five-year fixed mortgage rates at about 2.5 per cent to qualified borrowers, rates in the private market range between 7 per cent and 15 per cent, one mortgage broker indicated.

Traditional lenders also send business to alternative lenders, feeding the pipeline.

Royal Bank of Canada (RBC), the country's biggest bank, said when a client does not qualify for a mortgage, the bank will recommend an alternate lender, which may include a trust company, a mortgage broker or a private mortgage corporation, an RBC spokesman said in a statement.

Canada's financial system regulator, the Office of the Superintendent of Financial Institutions (OSFI), said it monitors the alternative mortgage market but would not comment on its size, whether it was growing or whether OSFI had any concerns.

Anthony Croll, the vice president of Individual Investment Corporation, a Montreal-based private lender that has been in business since 1958, said he's seen a rise in the number of small private lenders over the last few years competing with the 10 per cent to 12 per cent interest his company would charge.

He also thinks inexperienced lenders may be underestimating the risks associated with non-payment of a loan.

"Occasionally an accountant or someone else has said, after hearing about our rates, or what the deal is, 'I can do that myself'," Croll said. "But you know everything is easy and fine to do until you have a problem."

In a separate dispatch from Vancouver, Reuters said that after years of watching housing prices climb, driven in part by Chinese investment, Eveline Xia came to a painful realization: Despite having a master's degree and solid career prospects, she might never be able to afford a home in the city where she grew up.

That didn't seem right, and so the 29-year-old grabbed a marking pen, hand lettered a sign listing her credentials, snapped a selfie, and posted it to Twitter under the hashtag #DontHave1million.

The tweet went viral, and hundreds of other young Vancouver residents soon began expressing their own frustrations in tweets about the red hot housing market, and the feverish foreign investment they believe has fuelled it.

"Average, hardworking Canadian residents are being forced to compete for housing with the global wealthy," said Xia, who immigrated to Canada from China as child. "People here are getting angry."

That anger has contributed to a simmering xenophobia in Vancouver, a multicultural coastal city long known for its inclusiveness. 

With virtually no official data on foreign buyers available, many of those squeezed out of the market are left to believe the worst.

That has residents like Xia pressing the government to track international buyers, scrutinise the source of their funds and tax property speculation, before the anti-Chinese sentiment gets out of hand.

Last summer, a small anti-immigration group covered up Chinese symbols on real estate signs in the affluent suburb of West Vancouver with stickers reading "Please Respect Canada's Official Languages."

And police are investigating incidents on neighbouring Vancouver Island, where anti-Chinese pamphlets appeared in affluent neighbourhoods and signs for Chinese real estate agents were defaced with racial epithets and messages like "Go home" and "Not welcome".

A recent poll found that two-thirds of metropolitan Vancouver residents believe "foreigners investing" is a main cause of high housing costs, and 70 per cent said the government should work to improve affordability.

Skyrocketing prices

In the last five years, the median selling price for residential properties in Vancouver has jumped 57 per cent to C$1.1 million, according to data compiled by Reuters from the Real Estate Board of Greater Vancouver. 

The price of detached homes has soared 82 per cent, to C$2.1 million. 

The median household income, meanwhile, has risen by an estimated 13 per cent in the same period, according to Statistic Canada.

But since the government keeps no records on the nationality of home purchasers, evidence that money from China is driving up housing prices is largely anecdotal.

In interviews, five real estate agents who primarily sell homes on Vancouver's exclusive west side estimated that between 50 per cent and 80 per cent of their clients have financial ties to mainland China.

A Reuters survey of 50 land titles for detached Vancouver Westside homes that sold for more than C$2 million in the last year found that nearly half of the purchasers had surnames typical of mainland China, as distinct from those of earlier waves of immigrants from Taiwan and Hong Kong.

There was no way, however, to determine the citizenship or residency of those buyers. And indeed, many wealthy newcomers from mainland China are permanent residents of Canada.

Activists like Xia are pushing the government to at least start tracking foreign buyers and to make the information public.

"By not addressing it, they're letting anger and resentment build through whispers and at dinner parties," said Xia.

Capital flight

Residents also have questions about the source of Chinese money being invested in Vancouver property, a concern that came to the fore last year when a prominent developer in the city, Michael Ching Mo Yeung, was named as one of the top 100 fugitives wanted by China as part of “Operation Skynet”.

The campaign is part of President Xi Jinping's pursuit of suspected corrupt officials who have fled overseas.

In the wake of news about Ching, there have been calls for greater scrutiny of foreign buyers and tougher enforcement of anti-money laundering standards.

"I would love someone to look into the due diligence standards [for real estate brokers] around 'know your customer'," said James McDonald, who runs a blog that maps million-dollar homes that sit empty after being purchased by speculators.

He and others note that many properties are purchased by trusts or companies that aren't transparent.

But not everyone is convinced that Chinese money is primarily responsible for the rise in housing prices, noting that it has also been fueled by interest rates that are near record lows and a tight supply of detached houses.

"The reason why we're seeing this racialised narrative is people are looking for a scapegoat," said Victor Wong, the Toronto-based executive director of the Chinese Canadian National Council.

"It's infected the population," he added. "People have bought into this narrative that there's a flood of foreign money into the market when there's just no evidence beyond a few anecdotes."

Mixed feelings

With frustrations mounting, Vancouver Mayor Gregor Robertson in May called on British Columbia's government to impose a speculation tax.

The province declined, saying there was not enough hard evidence that foreign money was driving the market and that a new tax could hurt existing homeowners.

But even those who benefit from the housing boom have mixed feelings. 

At a recent open house in Vancouver, real estate agent Fatemeh Nouripour watched group after group of prospective buyers, most of whom appeared to be from mainland China, trudge through a fixer-upper listed for C$1.58 million.

"As an agent, I want to sell to whoever will pay the most," Nouripour said. "But I'm also a mother. My daughter has a master's degree, she works hard and pays taxes, and she can't afford to buy because foreigners are parking their money here. How fair is that?"