https://www.cwbwealth.com/en/news-and-stories/insights/canadian-housing-market-seeks-balance
- Interest rate indicators
- Housing is a growing risk to Canada’s economic growth
- Inflation holds the key to housing prices
After a difficult first six months of the year, July brought some relief with most major bond and equity markets up on the month. Markets were spurred along by more reasonable valuations and stronger than expected corporate earnings. But perhaps the most significant factor driving the rebound was a growing belief that inflation may be near its peak and will start to show signs of abating in the second half of 2022.
Interest rate indicators
Positive indicators include a significant fall in shipping rates and a softening in many commodity prices. If inflation is indeed topping out, then interest rates may not have to rise as high – or as quickly – as previously believed. In fact, the futures market is indicating that a rate cut may be in the cards in 2023.
Obviously, interest rates are also critical drivers of the housing market, especially in the short to medium term. Rising rates suppress prices, while falling rates do the opposite. Figure 1 illustrates this point by comparing 5-yr mortgage rates obtained from the Bank of Canada to the average selling price of a home in Canada from 2005, as calculated by the Canadian Real Estate Association (CREA).
For the most part, the trend has been a decline in rates at an orderly pace with a corresponding orderly increase in prices. The pre-financial crisis period (’05-’07), where housing and rates moved up in tandem, is an outlier. Back then, the economy was very strong (especially in western Canada) which helped consumers absorb both higher rates and prices for a period of time.
Figure 1: Housing prices and mortgage rates
Source: Canadian Real Estate Association (CREA), Bank of Canada
Housing is a growing risk to Canada’s economic growth
We’ve often heard through the pandemic period of March 2020 until today, that the supply issue was driving up housing prices in Canada. While there are long-term supply issues in some of Canada’s major markets, the overriding issues during the pandemic period have been excess demand brought on by excess stimulus, limited spending options due to lockdowns, and falling interest rates.
All of that is unwinding now. Stimulus has been pulled back, the economy is open again and rates are rapidly spiking up. In short, the housing market is doing exactly what you’d expect it to. The question now is, “What will be the impact on the Canadian economy?”
To answer that, let’s look at the economics behind buying a home in Canada. Figure 2 shows the average selling price for a home in Canada as of June 30 for the last four years, the 5-Yr fixed mortgage rate pulled, and the corresponding monthly payments. Calculations include a 20% down payment. We can see that prices rose in 2020, but rates fell and the mortgage payment stayed relatively constant.
In 2021, rates fell again (down almost 1% over a two-year period) but housing prices rose 26% over the previous year, causing monthly payments to rise by 20%. The average housing price stayed flat year over year in 2022, however, rates increased a full 1.75% and mortgage payments increased another 17%.
In summary, mortgage payments from June 2020 on the average house in Canada have risen an eye popping 40%. It’s no wonder housing prices are falling in Canada and sales activity is down. Interest rate increases are starting to bite and, undoubtedly, this will affect our economic growth.
Figure 2: Average house price/mortgage rates in Canada
June 2019 | June 2020 | June 2021 | June 2022 | |
Average House Price | $506,523 | $538,955 | $678,280 | $665,849 |
- | 6%* | 26%* | -2%* | |
5-Year Mortgage Rate | 4.23% | 3.77% | 3.30% | 5.05% |
- | -0.46%* | -0.47%* | 1.75%* | |
Monthly Payment | $2,182 | $2,215 | $2,652 | $3,113 |
- | 2%* | 20%* | 17%* |
*Rate of increase or decrease from the year prior.
Source: CREA, Bank of Canada
The housing market is a key driver of the Canadian economy and has long been a concern of economists. According to a recent report from Desjardins Capital Markets, Canadian housing makes up about 10% of Canada’s GDP while our debt-to-income ratio is around 180%. Both figures are about twice the size of similar numbers for the U.S., indicating housing has twice the impact on the Canadian economy relative to the impact it has on the U.S. economy.
How concerned should we be about the housing market? Over the short term, it will likely be a manageable drag on growth, primarily due to the highly publicized slow-down in sales activity. Home sales tend to drive spending on other things, like furniture and renos. We see bigger issues if rates stay elevated or keep rising.
Most Canadians are on fixed rate mortgages and many variable rate mortgages have a fixed monthly payment (less principle gets paid off as rates rise). When mortgages need renewing at these higher rates, significant increases in monthly payments will crowd out other spending. Some recent home buyers could find themselves with little or no equity and we could see rising defaults. Housing then becomes a bigger issue for our economy.
Inflation holds the key to housing prices
Like everything else these days, our housing market is beholden to inflation. Rates will keep rising as long as inflation is high. Only when the Bank of Canada is satisfied that we’ve won the war on inflation will rates stabilize and potentially trend back down. The longer that takes, the bigger the impact a housing slowdown will have on our economy, and the higher the odds are that housing could drive a significant economic slowdown.
Most economists are calling for more softness in prices. When put into context of the type of increases we’ve had since the pandemic started (average prices are still up over 20%), it seems like such a correction would be manageable but painful none the less.
It’s also relevant to note that the housing markets that have seen the highest increases, such as Vancouver, Toronto and surrounding areas, are also the most vulnerable. Some areas, like the prairies, have seen flat prices for over a decade, and may see more stable pricing.
On the whole, we see the rebalancing of the Canadian housing market as manageable if inflation comes under control and rate increases abate next year. That being said, it’s a risk to our economy that needs monitoring even if prices in your neighbourhood remain stable.
Sources: Canadian Real Estate Association (CREA), Bank of Canada, FactSet, Bloomberg
This blog is for informational purposes only. It is not intended to provide legal, accounting, tax, investment, financial or other advice and such information should not be relied upon as advice. Please contact your lawyer, accountant or other advisor for relevant advice. CWB Group takes reasonable steps to provide up-to-date, accurate and reliable information but is not responsible for any errors or omissions contained herein. Information obtained from third parties is believed to be reliable, but no representation or warranty, express or implied, is made by CWB Group or any other person as to its accuracy, completeness or correctness. CWB Group reserves the right at any time and without notice to change, amend or cease publication of the information. Click here to view the full disclaimer.