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Rising interest rates have helped to slow certain parts of Canada’s red-hot housing market. But Francis Fong, Senior Economist at TD Bank, tells Greg Bonnell that even as sales and prices slip, many Canadians may still be priced out of the market.
Transcript:
– Rising interest rates are having a cooling effect on some parts of the Canadian housing market. But just because prices have been declining and are forecasted to decline, it doesn’t actually mean real estate is getting more affordable. Let’s dig into that now with our feature guest of the day Francis Fong, Senior Economist at TD Economics.
Francis, great to have you with us. This is an intriguing notion, right — the idea that, OK, we do have home price forecasts, including from TD Economics, that we’re going to see a pullback in prices. You say don’t get excited about affordability showing up on the heels of that. Explain that to me.
– Yeah. So if you’re a prospective home buyer and you’re thinking, hey, home prices are starting to fall, maybe this is the time to get in. Unfortunately, the story is not going to be that simple. So let’s take a bit of stock, shall we?
We’ve already seen home prices fall about 10%. Sales are down about 25%. And we’re anticipating that through the rest of the year we’ll probably see another 10 percentage point, roughly, decline in average prices. So in total, about 20% peak to trough through the end of the year. But all of that is coming on the back of rising interest rates, as we all know.
Bank of Canada’s already raised rates by about 125 basis points. Mortgage rates are up about 140 basis points from kind of the fall of last year. So if we kind of anticipate even more interest rate increases, we’re seeing quite an increase in mortgage rates in totality.
And so what we estimate is that if interest rates rise by roughly a percentage point, you need at least, roughly, an 8% to 11% decline in prices just to keep your mortgage monthly payment in line. So, essentially, what we’re seeing is the decline in prices is pretty much consistent with what we’re anticipating interest rates to do.
So by and large, even though prices are a little bit lower, you’re still going to be making a higher monthly. And so that’s going to be a challenge for folks that are hoping to get in. Now, obviously, it does help with the down payment. But on the same token, if your savings have been in the market over the past year, it hasn’t really been all that positive either.
– And you talked about the headline number, that if the forecasts play out, you’re talking about a 20% reduction in price from the peak. But that doesn’t even take us, I think, back before the pandemic– there was a big run-up in prices during the pandemic.
– That’s right. That’s right. And so let’s take Ontario, for example. We saw an eye-watering increase of over 2/3 in the GTA. But price increases outside of the GTA all across the province were actually higher than that.
So really, you’ve seen this kind of decline in affordability hit everyone, as we saw a lot of folks during the pandemic, were kind of leaving the big cities and searching for more affordable real estate elsewhere. So yeah, there was definitely a massive run-up in prices post-pandemic. And this 20% decline really just undoes that. So we’d be back going back to kind of early-2020, late-2019 levels, which I can’t remember that time being, all that affordable for folks either.
– You have voices, obviously, saying that when you see this kind of rate increase pressuring mortgages, pressuring households, that it could spell some very bad things for the Canadian housing market. I have no predictions, because I’m not an economist. That’s why I have you sitting here.
But what are the dynamics of the market? I just think about for the past 10 years where I’ve really been covering Canadian real estate, a lot of hurdles get thrown in its way, and it seems to jump over all of them. I think people are saying, when does it finally tripped up on one of these hurdles?
– Yeah, this resiliency story has really been, I think, a defining feature of the Canadian economy relative to a lot of other countries around the world. And that narrative that we’ve told has always been kind of based on a few key elements. I think if we looked at boom-bust cycles that we’ve seen in other housing markets in the past, let’s say the US, the obvious example, between 2000 to 2006 — huge run-up in prices, huge crash during the financial crisis.
The differentiating feature between the US and Canada is really about credit quality, where you saw the big run-up in prices in the US was really driven by borrowers that fundamentally couldn’t afford those homes. Well, compare that to Canada, and what we’ve seen over the past 10, 20 years is this just gradual uptick in credit quality, which I think is kind of mind-boggling for a lot of folks.
Because, essentially, what that’s saying is the people that are purchasing at these, to many people, egregious level of prices are, perhaps, the ones that can best afford those level of prices. Now, add that to continued household formation outpacing housing supply or new housing construction and just overall demand growth from all sorts of folks, and we’ve seen basically the Canadian housing market sustain itself through all of these kind of shocks we’ve seen over the past little while.
A great example of that, a perfect example, is Alberta post-2014. Oil prices crashed. You would think that this huge run-up in prices that they had prior to that — because you had a doubling of the unemployment rate, and that was also associated with an increase in interest rates at that time as well. And yet we never saw a major crash in home prices. They kind of just languished, actually, up until relatively recently when we saw things pick up.
So yeah, no, to your point, there’s been a tremendous amount of resiliency. But we’re now kind of testing that on a nationwide basis. We’re expecting this really, really big run-up in interest rates. And this whole notion of Canadian housing market resiliency I think is really going to be tested.
– Does it come back, ultimately, to the labor market? I can think before the dislocation of the pandemic and before everything that we thought we understood went sideways, if I had guests in front of me talking about the housing market, I’d say, ultimately, what would be the greatest challenge for Canadian housing? And they said jobs, jobs, jobs.
When people have jobs, they’re going to try to make their mortgage payments. It’s that lack of employment. What’s the situation in Canadian employment right now? I know what the situation is — where are we headed on that front? Could that be a challenge?
– Yeah, no, absolutely. So, obviously, record low unemployment rate of 5.1% — the lowest level since 1974. So we’re in an extremely, extremely tight labor market position now. So that’s obviously a good thing.
It’s a good starting point. But on the same token, that means that there is some risk that we’ll see some reversals– certainly, as we see interest rates start to creep up. So to that point, I think there definitely is some vulnerability in the housing market to job losses.
But I think the real challenge, again, is looking back even in our recent history, looking back at Alberta — again, a doubling of the unemployment rate during that time. They were the only province to kind of get hit that hard because they’re the most exposed to oil prices, and yet we still didn’t see any kind of structural decline in home prices.
So it kind of really begs the question , at the end of the day, what can hit it? If we’ve already hit markets with a huge increase in unemployment and interest rate increases, what more does it take to kind of take it down?
– I’m going to throw one more thing at you.
– Sure, yeah.
– Because everyone’s trying to figure out what had been going on in Canadian real estate, what was the real driver. Was it a basket of things? Investor interest — even the Bank of Canada’s been doing research recently about how much investor activity there is in the market. And it’s substantial. Is there a danger that in a downturn like this, the investors start to disappear?
– Yeah, no, absolutely. So recent Bank of Canada data, which has some phenomenal research coming out of their financial system hub, talking about how the share of purchases that are first time homebuyers, which typically represent over 50%, has been on this kind of gradual decline. But it’s kind of sharpened in terms of how much its fell with investors picking up the slack just over the last two years– kind of post-pandemic bit of story.
So does that reverse? I think the real challenge here, we need to talk about is where household demand growth comes from. Ultimately, there’s been a tremendous amount of household demand coming from immigration, from just young people leaving their parents’ home and kind of going elsewhere. Does that kind of pull back if interest rates start to increase and affordability starts to deteriorate? Because we are getting into a really, really tough spot from an affordability perspective just because rates are so high.
Does that pull back? Absolutely. Absolutely. I think that’s absolutely a risk. But certainly, time will tell whether we see that kind of trigger any kind of structural problem.
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