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.