Negative Interest Rates Aren’t Good For Real Estate. They’re Actually Really Bad

Canadians are increasingly discussing negative interest rates. Since negative interest rate policy is unconventional, there aren’t many examples. Further, there isn’t much discussion from experts that understand the concept. Despite what I’ve heard some real estate agents tell people, it won’t lead to the market boom they assume. In fact, it typically requires a horrible economic environment to be implemented. Here’s a quick intro on negative rates, the environment required, and how experts believe it influences consumer behavior.

Negative Interest Rates 

Interest rates are the amount paid to borrow money, usually expressed as the annual percentage rate. For example, when money is borrowed at an annualized 2%, the borrower will pay 2% more than they borrowed. It also influences the deposit rates, since deposits are, in a way, the bank borrowing from you. This usually means the bank will pay you interest in order to deposit money. Overall, the higher the interest rate, the less people tend to borrow.

Negative interest rates are when this rate falls below zero, meaning the bank is charged to store money. By charging banks, central banks hope to encourage lending more freely. It also means households that deposit money may receive less than they deposit. More simply put, it’s a penalty for saving. It’s assumed this means people will borrow more.

Negative Rates Are Reserved For Disastrous Economies

I hear a lot of people say they need to get into the real estate market before negative rates hit. They fear once negative interest rates arrive, prices will catapult even faster. Negative rates are an unconventional policy tool, reserved for the worst economic scenarios. They’re used to prevent deflationary spirals, and to prevent savers from “hoarding.” Savings rates jump when people are afraid to spend money, not when they’re spending a lot of it.

For negative rates to be rolled out, the economy needs to fall into total disrepair. People need to be hoarding money, and not spending it. Usually this type of environment is accompanied by a very weak labor market. This isn’t the time you see bidding wars, and wage gains.

Mortgage Rates May Not Get Much Lower

Mortgage rates are unlikely to turn negative, even if interest rates are negative. Actually, there’s a good chance mortgage rates don’t fall much lower than today. Lenders are in the business of making money, not giving it away. As risk rises, they want more compensation – not less.

The mechanics are not in favor of seeing negative mortgage rates. Mortgage rates are based on consumer prime rates. These are at least 2 points higher than the overnight rate. For a shot at negative mortgage rates, you would need a deeply negative overnight rate. As rates drop, there’s fewer incentives to lend, which often leads to higher mortgage rates. Higher mortgage rates mean even less lending. Even with deeply negative rates, research shows banks stop lowering rates at a certain point. It’s almost like bank shareholders want to make money or something. 

There’s also the issue of stacking unconventional monetary tools. Currently the BoC is engaging in another unconventional monetary policy tool – quantitative ease. In this round, the BoC is competitively bidding on mortgage bonds. This floods the market with cheap mortgage credit. Unless the massive mortgage bond buying is scaled much higher, rates can be similar to today.

Negative Rates Make It Harder To Save Down Payments 

Once again, negative interest rates are designed to stop people from saving money. The whole purpose is to lower any incentives to save money, and spur consumer spending. Actually, the purpose is to penalize anyone for trying to save. Bad households!

Those saving for a down payment are incentivized to invest in the stock market instead. As central banks encourage more people to buy stocks, market returns tend to improve. When you’re making money on one asset class, your incentive to stop investing, and rebalance into another is slim. This should be obvious, but isn’t to everyone for some reason.

Negative Interest Rates Mean A Weaker Loonie

Negative interest rates make a currency a less desirable investment, weakening the value. When the ECB adopted negative rates, the Euro plummeted against the USD for months. Many Canadian consumer necessities are imported or priced in USD (oil, lumber, etc,). This will translate into a higher cost for necessities. A weaker dollar would also boost the replacement cost for insurance companies. As discussed yesterday, that intensifies the insurance industry’s “condo coverage crisis.”

Most important, Canada is a lot further away from negative nominal rates than some think. For deeply negative rates, we would need to see this recession go into a further recession. While this recession isn’t great, it’s also not as bad as it should have been. Most of the GDP decline and job losses have been attributed to temporary measures. This is very different compared to a permanent loss of economic capacity.

Government support also means many inefficiencies purged during a recession, will instead persist. This makes it almost as likely to see a rate hike before we see deeply negative rate declines. If we see negative rates, most people would be more worried about their job than scoring a sweet backyard with a pool.

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  • Ethan Wu 4 years ago

    You mean the magical world where the government pays you to take out a mortgage isn’t just around the corner? (I’ve ACTUALLY) heard real estate agents say house prices will rise because the government will pay people to take out mortgages, and they’ll take out as much as possible.

    Negative rates are for institutions and the super rich. They aren’t for your dumb ass to buy a third condo.

    • GTA Landlord 4 years ago

      Imagine paying a MIC money so they could fund real estate development? bahaha.

  • fred 4 years ago

    Macklem puts ‘dangerously over-leveraged’ Canadians on notice

    It is funny they are the cause of it and they give warning too.
    I might be joe s fault.

    • GTA Landlord 4 years ago

      Classic stuff yesterday. We lowered rates to borrow more, but you weren’t suppose to borrow more. Really it’s your fault.

  • Lawrence J 4 years ago

    Same negative cap investors that pay to have people in their homes will flock to pay people to borrow their money.

  • Rob Turner 4 years ago

    Good read on what experts think happens, with recent observation on how central banks were nuts to try it. It doesn’t mean they won’t try it, but they will and then blame it on the users, not the service providers.

    “this makes people feel so anxious that it undermines the benefit of cheaper loans. ”

  • Bankster 4 years ago

    Fundamentally the so called “housing strategy” aka creating housing bubble because the oil sector is doomed was an idiotic plan.

    1. Canada have the lowest population density in the world.
    2. Canada suffers tremendous brain drain since the US is next door. Lower housing, taxes and pay a lot more. Housing bubble in Canada depletes our intellectual capital.
    3. Over financialization of one industry creates inequality and drains other industry. For example if everyone is paying a high mortgage or saving for a down payment they are likely to spend less.

    Canada have one of the highest resources per capita in the world, if we can turn resources into high value products we will be the wealthiest nation on earth (per capita). Therefore we should focus on high tech and high value manufacturing. To do that we need to attract young talent not push them away with real estate bubble. If the government is too corrupt to pop this bubble we need to change the government.

    • straw walker 4 years ago

      Canada’s population density? Really? 90% of Canada’s population lives with 100 miles of the US border..
      And that population density is extreme because of immigration. Just visit southern Ontario.
      Maybe if all immigrants had to live in Ellesmere island we would see a reduction in immigration.

  • Arthur Robb 4 years ago

    Presumably many savers will continue to save with negative interest rates – only they will sell their Canadian dollars for other currencies to obtain foreign positive returns as institutional investors do.
    Bank of Canada can then further inflate their balance sheet to flood all major domestic borrowing markets to prevent a bank funding crisis. We cannot have big banks suffer any interruption to profits and their CEOs’ compensation in an underperforming economy.
    In such a monetary climate, many world financial markets will start to look to be a much safer financial risk for Canadian and foreign investors. I wonder how far the Canadian dollar can actually fall before we recover our sanity

  • Uditha 4 years ago

    Well researched and logical article. Assumes that the government is logical. There is the problem.

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