Is The Worst Behind Canada’s Housing Sector?

Aggressive rate hikes by the Bank of Canada have weighed heavily on housing markets across the country. But as the pace of hikes look set to slow, is the end of the downturn approaching? Greg Bonnell speaks with Rishi Sondhi, Economist with TD Bank, about the outlook for Canada’s housing sector.

Transcript

Greg Bonnell: Rising mortgage rates have weighed on home prices and sales across the country. But with some signs of inflation easing and the pace of hikes beginning to slow, our featured guest today says we may be at or near a bottom for the housing market. Joining us now with more, Rishi Sondhi, the economist with TD Bank. Great to have you on the show.

Rishi Sondhi: Thanks for having me, Greg.

Greg Bonnell: So let’s talk about this, what we’ve seen this year. I mean, no one is — no one is a stranger to the fact that we have seen the housing market cool significantly in the face of higher borrowing costs. Where are we in the cycle right now?

Rishi Sondhi: Well, I mean, we think– TD Economics thinks that a lot of the downside in housing with respect to sales and prices has already taken place. We did get to October data last week showing resales and prices in the retail market. And excuse me, home sales actually increased on a month-on-month basis in October, which is the first time in I think seven or eight months that’s taken place. So that’s kind of a hopeful sign for some individuals like homeowners and the like.

Prices were still down, unfortunately. But we did have — again, we did have sales increase. And when you look at sales, they’re trending at levels last seen in at 2012. They’re down about 40% from their February level. They’ve undershot what typically you’d see with sales levels. You’d typically see if you benchmarked them against fundamentals like income and housing supply. So there are some signs that we’re nearing a bottom. I wouldn’t say we’re at a bottom as we speak or at the moment. But there could be some signs that we’re — the worst is behind us with respect to the downtrend in sales and prices.

Greg Bonnell: Is part of the hard part of this when you try to figure out where we are on the cycle, trying to figure out, are people simply adjusting to a new reality? Because we’ve seen this in the housing market over the last several years, whether there’s some sort of regulatory change, some sort of change in the landscape that causes people just to get to the sidelines for a moment and say, I want to figure out what’s going on here before you make, for most people, including me, the biggest financial decision in your life?

Rishi Sondhi: Definitely, yeah. Yeah, it is quite difficult to figure it out. There is — in this case, I mean, the regulatory change that’s really sparking the market — I don’t think it’s anybody’s — I don’t think it’s any great mystery to anybody is really interest rates. Interest rate’s been rising since March.

Banking and housing have been on a very aggressive rate hiking campaign. And that’s really done the trick with respect to really deteriorating affordability and really weighing on the demand and prices. And this is just the other side of what we saw during the course of the pandemic.

You’ve got to remember, over much of the pandemic, prices ran up across Canada. Average prices ran up by about 46% from the bottom or the beginning of the pandemic to the top. And that was with rock-bottom interest rates. And now that interest rates are normalizing, some downturn in prices is to be expected. So that’s what we’re working through at the moment. And again, the main government trigger, of course, has been interest rates.

Greg Bonnell: It’s interesting for all the dynamics at play in the market. Of course, we know that borrowing costs are higher. And we have seen sales come off and prices come off. But there’s not a lot of supply either. You look at some of these major markets. And they’re pretty supply-constrained. What changes that dynamic, people wanting to list their homes?

Rishi Sondhi: Yeah, I mean, well, first I’ll talk about what we expect. Well, we expect — there has been some, I’ll call it sogginess in listings. Listings have fallen on average since February, which is when — or, sorry, in March, which is when the markets started to correct. So listings have — new listings have been subdued, and that’s what one would typically expect when the market goes south. Sales go down. Prices go down. Not a lot of people want to list their homes in that sort of environment, if you don’t have to. Of course, there’ll be some.

What could change that perhaps is interest rates, higher interest rates, rising borrowing costs, putting some pressure on people who perhaps are a little bit overstretched with respect to purchases, maybe investors and the like. And they’re forced into listing their homes because of the increase in carrying costs, particularly if they took out a variable-rate mortgage, of course, which is levered to the Bank of Canada’s interest rate. And that’s been going up quite aggressively. Or even if they have a fixed mortgage, that’s renewing at a much higher rate. So some financial pressure could lead some people to list their properties. But so far, so — I don’t want to say “good” on that front. But we haven’t seen evidence of that so far. So far, listings are quite subdued. They did pick up in October, but they’re still below their long-run average.

Greg Bonnell: Is there a psychology at play on that side of it as well when you think about people trying to wrap their heads around what’s happening in the market now if you wanted to enter it as a buyer? But if you want to enter it as a seller, anecdotally, you hear some people talk about the fact that they’re trying to match those two sides. And the seller’s saying, wait a minute. My house was worth $1.2 million just a couple months ago. There’s no way I’m selling for less than that. And on the buyer’s side, they’re saying, listen, the market has changed. And you can’t find a middle ground of agreement.

Rishi Sondhi: Oh, and I think that’s, even more than anecdotally, I think that’s what’s taking place. I mean, there’s a lot of listings that are sitting on the market for months on end. And they’re not selling. And that might be a case of I’ll call it sort of unrealistic expectations on the part of the seller. At the same time, the buyer might be saying, OK, well, there’s lots — there’s more supply on the market now. There’s less bidders. There’s less heat on the market. So I can afford to take my time and then look around. So I think that dynamic is definitely at play at the moment. And that’s a factor that we think will continue to weigh on prices a little bit moving forward.

Greg Bonnell: Now, of course, the big dynamic that is at play in Canada when it comes to the housing market is immigration levels. We have very robust levels. We have very robust targets. And of course, when people come to make Canada their home, they need to put a roof over their head. Is that one of the things that going forward could at least keep a floor under demands?

Rishi Sondhi: Oh, definitely. I mean that’s why we think that prices will eventually rise. Once the market adjusts to this rate hike cycle, I guess we’re a little bit more positive, I would say. Or we expect sales and prices to increase after this — again, the market adjusts to this rate hike cycle. And a big reason for that is because of this robust population growth.

Now, when immigrants come to the country, they disproportionately tend to rent. So that helps the condo market and rents in the condo space. So that helps people who have bought condos and investors and the like. But ultimately, these investors, they then transition their demand from the rental market to the ownership market, with a bit of a lag. But it’s there. So that makes us a little bit more confident that sales and prices will continue to move higher after the market adjusts to this rate hike cycle.

Greg Bonnell: Of course, the other interesting dynamic about this is if someone’s been sitting on the sidelines of the housing market, or even wondering through the pandemic with the run-up in prices, how do I even afford to get into the housing market, so they see the headline. And they see prices have pulled back this percent or that percent. And sales will pull back. At the same time, though, the borrowing costs are higher. Have the dynamics changed in favor of affordability at all through this?

Rishi Sondhi: Yeah, I mean, it’s gotten, I would say, merged. When we do our affordability calculations and our math at TD Economics, we see that affordability has improved a little bit, but not much because of the factors that you mentioned. Prices are coming off the low, but at the same time, that’s being offset by higher interest rates. So unfortunately, somebody who’s perhaps a first-time homebuyer may not see much relief with respect to when they initially decide to jump into the market.

Greg Bonnell: Longer term, you do worry about the next generation trying to get into the housing market. I’ve — I’ll play with the inflation calculator on the Central Bank website. What did I pay? What’s the market value right now? And obviously, it’s a very different game from when I started, say, 18 years ago when I got into the housing market. What ultimately in the housing market needs to happen to bring affordability to these people, do you think?

Rishi Sondhi: Well, I think one of the big answers there is supply, particularly with the population expected to grow as much as it has. I mean, we’ve seen higher interest rates. They’ve lowered prices. But at the same time, that overall affordability metric, that overall monthly payment is still being inflated by these higher interest rates.

So the higher interest rates are bringing down the price but at the same time keeping that monthly payment elevated. So some other organizations like Siemens, CMHC, and the like, they’ve done some estimations around that. And basically, the conclusion of a lot of this analysis, including ours, is that more supply will be needed in the market, particularly not only to keep up with population growth but to enhance affordability moving forward.

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