If you’ve been paying close attention to media headlines, there has been an overwhelming amount of information about rising mortgage interest rates in Canada and how it is affecting affordability of homeownership. For anyone involved in the home buying process, knowledge of the current market is advantageous in easing housing market apprehensions and finding strategies to maximize your or your clients’ real estate investments against inflation trends.
We’ve put together an overview on inflation, how to navigate through the effects of higher interest rates and the long term outlook for the Canadian real estate market for 2023/2024.
Long Term Housing Market Outlook
With rising interest rates peaking, how long before interest rates start declining?
It is anticipated that rates will not decline until the inflation rate is down to around 2%. As of December 2022, the inflation rate sits at 6.3%, a decline from the 6.8% in November 2022, and the 8.1% at its peak in June 2022.
Even though we are amid the most aggressive monetary tightening cycle seen in recent years, there are signals that the rate-hiking is nearing an end. RBC has predicted that they do not see any of the central banks raising rates beyond the first quarter of 2023. In their 2023 Economic Forecast, RBC also predicts that a mild recession will be felt throughout Canada in the first quarter of 2023.’
CPI inflation is forecast to return to target in 2024
As the economy responds to higher interest rates and the rippling effects of elevated commodity prices and supply disruptions, the Bank of Canada expects inflation to fall to about 3% in late 2023, then return to 2% in 2024.
TD Canada Trust predicts that by 2024, inflation should be tamed, and the Bank of Canada will likely be lowering interest rates. Which means this may be an ideal time to be purchasing pre-sale homes. Modest improvement in household income growth is also expected to manifest improvements in housing demand. This improving demand will likely yield an increase in average home prices.
The long-range forecast for 2024 is projected to be more stable. With factors like increases in immigration and the ongoing shortage of housing, the affordability issue in Metro Vancouver and Fraser Valley will not be diminished despite the correction to home prices that’s taken place.
What does this mean for home buyers in Metro Vancouver and Fraser Valley?
Under more stable market conditions, there will be strong opportunities for well-priced, well positioned properties across all categories. A stronger provincial economy and rising in migration will keep demand-supply conditions at a slight easing —remaining on the cusp of a buyer’s market.
RBC predicts “housing [will] start to ramp up to 49,800 units in 2023 from 48,000 units in 2022, as builders, developers and policymakers address long-standing supply issues. Record immigration flowing into the province will further add to the urgency to build.”
Even with a much cooler housing market, 2023 will present opportunities for both buyers and sellers in the Lower Mainland, BC. We can expect budget and affordability to be the main priorities of homebuyers this year.
The Inflation Cycle
Heading into the pandemic, the housing boom was ignited by the Bank of Canada’s low-interest rates. Until 2022, this further propped up Canada’s housing market with large purchases of mortgage bonds. With the rising cost of homes, many sellers walked away with excess cash contributing to inflation. The excess capital in the market combined with supply shortages created a shift in the real estate market.
In an effort to curb inflation in Canada, last year we saw interest rates rise incrementally throughout the year and now into 2023. The Canadian government has been aiming to slow consumer spending and the demand of homes, so that supply can catch up.
In their year end review, the Fraser Valley Real Estate Board shared that the Fraser Valley real estate activity returned to a more balanced market by the close of 2022, due largely to interest rate increases designed to stave off inflation.
“As the market has adjusted to rate hikes, we’re starting to see a resumption of interest among the public,” said Sandra Benz, President of the Fraser Valley Real Estate Board.
“For some time, buyers and sellers alike have delayed decisions in somewhat of a watch-and-wait mode. This has dampened sales as well as supply since fewer new listings come onto the market. We expect activity to pick up in the coming months as this pent up supply and demand starts to emerge.”
Now that the Bank of Canada has pivoted into a period of quantitative tightening, we are experiencing higher interest rates and slower sales volumes and home pricing dips. And while lower house prices in the Metro Vancouver region may seem like the ideal solution home buyers are looking for, the higher mortgage rates have had a counter-effect. The increased cost of borrowing has lowered how much consumers can qualify for with monthly payments now double that of 2020.
Rising Interest Rates and Purchasing Power
Interest rates can have a significant effect on the buying power of potential home buyers in British Columbia. When interest rates are low, the cost of borrowing is less expensive, so borrowers will have lower monthly mortgage payments as the interest portion of their payment is lower. This can make it easier for buyers to afford a home and potentially increases their purchasing power.
On the other hand, when interest rates are high, it increases the cost of borrowing. Meaning, that it is more expensive to take out a mortgage, as they will have higher monthly mortgage payments since the interest portion of their payment is higher. This can make it more difficult for buyers to afford a home, and potentially decreases their purchasing power.
Homebuyer’s Purchasing Power
From a home buyer’s perspective, as mortgage rates increase, affordability decreases.
Example: Sally wants to qualify for a $400,000 mortgage at 4% interest, but based on Sally’s qualifications, lenders can only offer her 5% interest for a $355,000 loan.
A 1% increase in mortgage interest decreases Sally’s purchasing power by $45,000.
Sally’s best option is to work with a trusted mortgage lender to secure her optimal rate. She can also as suggested by the Government of Canada:
- Improve her credit score before applying for a mortgage
- reduce expenses so she has more money to pay down debt
- pay down the debt with the highest interest rate first to pay less interest over the loan’s term
- consolidate high interest debts, such as credit cards, into a loan with a lower interest rate
- avoid getting the maximum mortgage or line of credit that a lender offers
- avoid taking on unnecessary debt
- avoid borrowing more money
- find ways to increase her income to help pay down debt
- make sure that she has an emergency fund to deal with unexpected expenses, such as covering higher loan payments to avoid penalties
Impact on Sellers
Though not in the same way, rising mortgage rates affect sellers as well.
For example, if Harry wants to sell his house for $600,000, the cards are still in his hands.There is nothing stopping him from listing his house at that amount.
However, due to the rising interest rates, potential buyers may only be able to afford Harry’s house for $555,000.
Harry can still make a profit on the sale of his home, but a 1% increase in mortgage rates diminishes the market value by about $45,000.
For sellers, like our friend Harry, working with a real estate agent that has a good grasp on navigating the real estate market will be integral in this current landscape. Though we are shifting away from a sellers’ market, a home seller has something that people still want, your home. With reduced housing inventory in most markets, less competition in your neighborhood can be advantageous right now.
Affordability of homes is affected by supply and demand.
Affordability relates the cost of housing to income. It is driven largely by house prices, which are in turn determined in the housing market where demand for housing equals its supply.
Supply: The supply of housing comes from the inventory of existing housing for sale in the resale market, the flow of new builds, and from old and new rental units.
Demand: Demand for housing will increase over the long term if household numbers and incomes rise, and interest rates fall. Without an increase in housing supply to match this demand increase, house prices will rise, and affordability becomes more challenging for homebuyers.
Is there a correlation between inflation and home prices?
If the supply of homes remains constant and the demand increases, then the price of homes will increase. This is called a positive correlation between inflation and home prices.
Demand for housing can contribute to the relationship between inflation and home prices. When inflation is high, people may be more willing to pay higher prices for homes in an attempt to preserve the current value of their money by investing in assets that are also appreciating in value. This increased demand can lead to higher home prices.
Other relevant factors that will influence the cost of a home includes the cost of building a home, which tends to increase with inflation. This is because the materials and labor needed to construct a home become more expensive as prices rise. As a result, builders must charge more for new homes to cover their costs, which can drive up the price of homes.
Overall, while there is a positive correlation between inflation and home prices, it is important to note that the Market reacts to the many variables at play that can greatly affect home prices like: interest rates, regulatory changes, or supply chain issues.
Rising Interest Rates and Real Estate Investing
With the interest rates rising, not all is negative. With the right information, real estate investors can think more strategically about how to achieve their financial goals.
In the Lower Mainland, because qualifying for a mortgage has become harder, we are noticing that the market for rental properties is seeing an increase in demand again. It will be important to consider how high inflation will impact rental rates.
That said, if home investors have the capital available, the reduced price of homes may make this a good time to buy real estate.
The long game.
Home prices tend to rise over time and can be a long-term investment. Appreciation in the value of a home takes time, and this payoff is only realized when you sell your home. Most savvy investors will recommend holding onto real estate. Based on previous market trends, real estate investments can benefit an investor during an inflationary period because generally it is an asset that retains and increases its value over time.
The long range forecast for 2024 are projected to be more stable. For sellers, it will be important to play the beat of the market and homebuyers affordability. There are signals that the rate hiking is nearing an end. RBC has predicted that they do not see any of the central banks raising rates beyond the first quarter of 2023. Affordability of homes is affected by supply and demand. It is driven largely by house prices, which are in turn determined in the housing market where demand for housing equals its supply. There is a positive correlation between inflation and home prices. If the supply of homes remains constant and the demand increases, then the price of homes will increase.
When interest rates are high, it can make it more expensive for borrowers to take out a mortgage, as they will have higher monthly mortgage payments. This can make it more difficult for buyers to afford a home and potentially decreases their purchasing power. From a home buyer’s perspective, as mortgage rates increase, affordability decreases. Demand for housing will increase over the long term if household numbers and incomes rise, and interest rates fall. Without an increase in housing supply to match this demand increase, house prices will rise, and affordability becomes more challenging for homebuyers.