RBC Risk Model Shows Canadian Real Estate Prices Can Fall 30%, No Growth Expected

Canada’s largest bank doesn’t see much happening in real estate over the next year. RBC risk models show the bank expects almost no price growth over the next 12 months, and modest growth at best. At worst, the bank sees a 30% drop in home prices and 18 months of deteriorating conditions.

Base and Alternative Scenario Forecasting

Under IFRS 9, institutions need to prepare three forecast scenarios: a base case and two alternative scenarios — downside and upside.

A base case scenario is your working assumption. Not too hot, not too cold. Little out of the ordinary occurs, such as monetary policy missteps. The CEO of the bank recently criticized the central bank, so it’s hard to see that happening. That’s how they defined their base case.

A downside alternative scenario is when things go worse than planned. The bank specified it would involve economic shock in Q2 2022. This was filed the same day Ukraine was invaded by Russia, so they were likely unaware how much risk was possible.

In the alternative upside scenario, the economy goes better than expected. They note this would mean no offsetting of monetary policy, which hasn’t come up in Canada yet. However, the US Federal Reserve said they might need to do exactly that.

Banks have to make reasonable assumptions about these scenarios to prevent risk. Too optimistic and they wouldn’t be ready for any economic shock. Too pessimistic and they wouldn’t be taking sufficient market risk, reducing profits. It’s a careful balance and the models aren’t meant for consumers so much as they’re meant for risk balance.

Canadian Real Estate Prices Forecast To Stall In The Base Case

The base forecast at RBC shows they aren’t expecting a lot of growth over the next 12 months. By Q1 2023, home prices are forecast to see just 0.5% annual growth, a significant change from the current pace. The following four years after, they see compound annual growth of 4.2%. A modest but very different growth rate compared to what Canada has seen recently.

The Downside Scenario Shows Canadian Home Prices Fall 30%

In the bank’s downside scenario, they see the potential for a sharp fall — sharper than most expect. In a contraction, their forecast shows prices falling 30% over a 12-month period. This would be large enough to be considered a crash. The following four years are forecast to see an average of 4.2% compound annual growth. RBC’s downside scenario is the biggest of any bank.

The Upside Scenario Shows Home Prices Rising 11%

The alternative upside, where prices rise more than expected, shows double-digit growth. Home prices would rise 10.9% in this scenario, followed by four years of compound annual growth at 9.6%. It’s hard to see home prices growing 5x the rate of income for five years, but that’s the forecast.

RBC isn’t forecasting much for prices, but the downside is much bigger than the upside. Policy missteps can extend the trend in a different direction, but experts warn this is a mistake. As Oxford Economics pointed out recently, higher price growth can increase risk substantially.

9 Comments

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  • Rod 8 months ago

    Nobody “sees” the future, including RBC. Prices could fall well outside their 30% worst case.

    • Yoroshiku 8 months ago

      Since Ontario house prices were up 30% in 2021 alone, a 30% fall doesn’t seem so terrible. Most people I know in the GTA have expectations of continuing dramatic price growth that are, in my view, irrational.

    • Yolo 8 months ago

      or increase another 30% 🤔

    • Jack Kennedy 8 months ago

      How about raising rates…..inflation is running hot. Central Banks must send a message, but are pressured by politicians to keep rates low, and continue with cheap money, so the politicians can continue to give it away free, and repay years later with their respective deflated, worthless currencies.

  • questions guy 8 months ago

    I know the future is impossible to know, but it would be amazing if someone went back through the vaults to see if ANY BANK forecast has been spot on, or close to.

    anyone?

    • Murtaza 8 months ago

      In line with your views, it would be interesting to review the banks’ historical forecasts and its comparison with actual data. One factor worth pointing out here is that banks have traditionally been conservative and causious in their lending approach, so reflected in their official reports.

  • C.Rose 8 months ago

    American rates will be rising rapidly over the next few months- already affecting the american home builders and they’re not even close to our over valuation. It could really get ugly here.

  • A Kumar 8 months ago

    This housing bubble primarily created on the concept of “fear and greed” is about to burst. Fear was created among first home buyers: ” buy it now or you will never be able to buy later”. Greed was created among investors:”You only need to make 200k down payment and you will get 400k within a year which is 100 percent profit in a year.” On top of that a dangerous but convincing piece of misinformation was given to fuel the fire of fear and greed: “People from around the world are coming to Canada. There are not enough houses. Demand will always outpace supply”.
    No commodity or commodity index in this world can continue its rally forever at a pace five times higher than inflation. It is against fundamentals of economics. I agree with C.Rose comparison between US and Canada housing market. People in the US have much higher income that in Canada and they pay an average house price of 450K USD. In Canada almost every home owner is sitting on a mortgage of 1 million or more. This can get much uglier than predicted.

  • Jack Kennedy 8 months ago

    How about raising rates…..inflation is running hot. Central Banks must send a message, but are pressured by politicians to keep rates low, and continue with cheap money, so the politicians can continue to give it away free, and repay years later with their respective deflated, worthless currencies.

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