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2 Stocks to Watch as Canada’s Housing Market Enters a Rough Patch

Canada’s housing market has been through a lot of changes in 2017. As the year started, the prices in the nation’s largest market, Toronto, skyrocketed with gains exceeding more than 30% in some categories.

But what we’re going to see in the coming months won’t be that rosy. The headlines may show a drastic fall in prices in the GTA when compared to the last year’s winter and spring months.

January is also the month when the stringent mortgage rules kick in, forcing many buyers out of the market. Last fall, the country’s top banking regulator OSFI announced changes to the existing mortgage stress test rules to make sure prospective home buyers aren’t borrowing too much.

Borrowers now will have to qualify for a rate roughly two percentage points higher than the rate they agree on with a lender. That rule, according to some estimates, will affect about 10-15% of the potential home buyers in 2018.

Hikes in interest rates

Another big risk for Canada’s housing market will come from higher borrowing cost, as the Bank of Canada prepares more rate hikes in 2018 after its two increases in 2017.

Economists are forecasting at least two more increases in 2018, encouraged by the Canadian economy, which fired on all cylinders last year.

Any further rise in borrowing costs will directly hit Canadians who have already taken on record debt after benefiting from a decade-long boom in the real estate market.

Tighter regulations and rising mortgage costs are the two most important factors which signal a significant slowdown in the housing market.

Stocks to watch

A severe correction in the Canadian housing market has very negative implications for the whole economy. Canadians love their houses and the equity they have built in them. When they will see prices fall, it will force them to spend less, slowing overall economic activity.

For equity investors, Home Capital Group Inc. (TSX:HCG) and Canadian Imperial Bank of Commerce (TSX:CM)(NYSE:CM) are two financial stocks that could react negatively to a slowing housing market. Short sellers love these two stocks, because their destiny is directly tied to the performance of the housing market.

Home Capital, which is struggling to put its house in order after being bailed out by the Warren Buffett’s investment firm last spring, might come under fresh attack from short sellers if home prices began to decline.

Similarly, CIBC has the biggest uninsured portfolio of mortgages among the top Canadian banks. The lender will struggle if the homeowners fail to pay their mortgages.

The bottom line

I don’t think the Canadian housing market is going to crash. I’m in the camp of those forecasters who believe Canada has robust housing market due to increasing demand from a rising population and the shortage of housing.

Still, investors should keep an eye on these stocks to adjust their strategy if they see a severe slowdown. These stocks are likely to underperform the broader market in such a scenario.

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Fool contributor Haris Anwar has no position in the companies mentioned.

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