Time for your cheat sheet on this week’s most important stories.
Canadian Real Estate
Canadians were hit with the highest inflation in 30 years and mortgages aren’t far behind. A major financial institution sees the 5-year fixed rate mortgage hitting up to 7% this year. That would be a level most thought impossible just a year ago, as the cost of capital surges with inflation. This isn’t expected to persist long, with rates forecast to fall over the following years. Great news, unless that’s due to a real recession, and not an induced one.
Real estate prices are soaring pretty much everywhere, but not like Canada. Canadian home prices have increased 219% since 2005, more than double the next G7 country. Growth in Canada is 3x that seen in the US, where the central bank’s researchers have declared a bubble. At 3x the growth rate in Canada, no state organization has declared a bubble, which may be the most bubbly sign of all.
A large Canadian financial institution sees mortgage rates slowing hot real estate markets. Over the next year, Desjardins expects mortgage rates will climb towards generational highs. As these costs rise, qualified demand will drop sharply, reducing competition for homes. Less demand can mean lower prices, which the firm sees in the coming months.
Canada’s bank regulator sees amplified risk for lenders due to real estate. OSFI’s annual risk report shows high leverage and income verification were problematic. Tightening regulations in this area will help to mitigate future issues. They also see new international regulations lowering investor leverage in the coming months. If risks are still rising by the year end, they plan on adjusting the stress test rate.
The Bank of Canada (BoC) got some things wrong, according to the central bank’s head. Governor Macklem told lawmakers that inflation will be higher and last longer than thought. He reiterated that the central bank is aggressively trying to resolve this issue. Interest rates are 4x what they were at the start of the year, and expected to double from here. The BoC says Canada’s economy is strong and will handle the hikes to reduce “excess demand.”
The threat of inflation derailing Canada’s recovery was apparent in the latest payrolls. In February, the average payroll employee made $1,160/week, up 2.4% from last year. This is very robust growth during stable inflation, but not when annual CPI growth was 5.7% in the same month. Adjusting for inflation, real wages fell 3.3% from last year. An eroding quality of life is an ominous sign this early in a recovery.
Canadians are suddenly in a rush to borrow from their home equity line of credit (HELOC). Outstanding HELOC debt reached $168.5 billion in February, up 1.2% (2.0 billion) — an unusual amount. Over the past 386 months, only 10 have ever been higher. This is particularly interesting since it occurred the month before rising interest rates. We won’t know why the rush to borrow happened for a while, but down payments before the mortgage rate increases, is likely a factor.
Canadian inflation is lower than the US but that’s forecast to flip in the coming months. BMO sees both countries taming high inflation towards the end of this year. By the end of 2023, they see both countries close, but not quite on target. Canada in particular is forecast to be higher than the US, likely due to the US having more room to hike rates.
A Toronto real estate developer filed for insolvency after inflation problems, they claim. The project was nearly sold out and began construction in 2019, but saw costs suddenly surge. By November 2021, they estimate total costs increased 12.4%, pushing it higher than the cost of units sold. Their cost increase is actually tame compared to what Canada estimates. In Toronto, the cost of building homes increased 35.1% over the same period. It’s easy to see how that story checks out, but if it is the reason — a lot more projects are in trouble.
The Bank of Canada (BoC) is warning they may need to raise interest rates higher than neutral. At least for a brief period, the Governor explained to Canadian lawmakers. Going above the neutral rate involves intentionally creating a drag on the economy. The idea is to reduce demand to the point of slight excess, helping to stabilize cost inflation. It may not be needed, but the fact it’s on the table shows how serious the BoC thinks the inflation crisis is.
US Real Estate
US mortgage rates have hit the highest level since 2009, and demand for real estate has fallen off a cliff. Higher mortgage rates resulted in falling mortgage applications (-17%) and pending home sales (-8.2%). Both metrics are leading indicators for the market, showing much slower activity ahead. If this persists, the robust price growth seen in the past few months is likely to fall as competition fades.