Real estate investors were cautioned that risk happens fast, from Canada’s oldest bank. BMO Capital Markets warned clients to expect the housing market to “be tested.” Higher interest rates and the end of “too loose” policy are expected to cool price growth. In frothy real estate markets, sentiment can shift very fast when prices slow, and the FOMO fades. If that’s the case this time, expect fewer buyers and more inventory.
Canadian Real Estate Prices Have Been Rising Even Faster
Canadian real estate prices surged higher with Toronto being the latest to report. In February, a typical home (aka the benchmark price) saw 35.9% annual growth. BMO also cites Vancouver and Calgary as additional examples of price growth acceleration. This is on top of already lofty gains seen for the past two years. “On an annualized basis, price growth is running at around a 50% rate more recently,” says Kavcic.
The End of “Too Loose” Policy Will Slow Home Buyers
Low interest rates have supported Canada’s high home price growth, and that’s coming to an end. As interest costs fall, buyers can support larger budgets that cut less into cashflow. It also pulls forward future buyers who are now incentivized to buy early with cheap debt. Existing buyers with bigger budgets and increased competition is a recipe for price growth. With the first rate hike of several this year, these conditions will reverse.
“Now the test begins,” he says. “This is a market that has run ahead of itself because of too-loose policy and buyer psychology. Fundamentally, we probably need at least a few more 25-bp rate hikes to see the market slow meaningfully. But, as shown in 2017, psychology can change quickly the minute price expectations change.”
For those unaware of BMO’s reference to 2017, it was the last time interest rates began to take off. With the help of other policy tools, tight markets like Toronto and Vancouver saw prices drop. All of a sudden, inventory started to appear. Lofty immigration targets used to justify rapid price growth didn’t matter. That is until 2019, when the mortgage market got a little stimulus and went on roids in 2020.
Investors May Be Deterred, But Home Buyers Unlikely To Suffer
Slow price growth may erode investor demand but won’t be catastrophic for homeowners. Interest rates are normalizing fast, but mortgages would still be affordable. Lower incentives and short-term profit potential fading, is only an immediate issue for investors. There are a lot of investors in Canada though, representing over a quarter of demand.
“Canadians also have capacity to handle higher rates, and they’ve been stress-tested accordingly. But there’s little question that there is some froth to clean up…”