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Is the Housing Market in for a Rough Ride?

Canadian home prices have increased significantly over the past 25 years. This is due to a number of factors, including population growth, low interest rates, and strong economic conditions. As a result, many Canadians are now finding it difficult to afford a home.

November 22, 2022
6 minutes
minute read

For the past 25 years, Canada has experienced the world's biggest housing boom, with prices appreciating nearly uninterruptedly compared to its developed peers.
Now that it is over, the pain is beginning to set in.

Rising interest rates have suppressed demand and caused home prices to fall, leaving people like Cam Ly in a difficult situation. Recently, he found himself sitting in his car with his wife and two kids, watching prospective buyers tour their modest townhouse in Toronto’s suburbs.

Ly took out a second and then a third mortgage on the property when family finances got tight during the pandemic. With the home's value increasing by 60% in just over 12 months, this seemed like a sensible move at the time. However, with both loans coming due by the end of the year, Ly found himself unable to afford the rates his lenders asked to refinance. He was left with no choice but to sell the house in hopes it would fetch enough to pay back the debt.

"Every year, people said that the housing market would go down. And every year, it didn't. But when it finally did, it happened very quickly." - Ly, an analyst with a payroll company

The next few months will give us a better idea of how many people in Canada are facing housing affordability issues like Ly.

The future of Canada's housing market is uncertain. The country was a leader in the global real estate market for many years, but now it is facing a downturn. If the downturn is relatively orderly, it may be a sign of what is to come for the rest of the world. However, if it is a brutal crash, it could be a sign of more difficult times ahead.

Housing markets around the globe are struggling as central banks raise interest rates. A handful of countries with particularly high prices, including Canada, have already seen significant price declines. According to Oxford Economics, more than a dozen developed economies, from Australia to Sweden to the US, are in the midst of a housing market downturn or will be by the beginning of next year. If these slumps are worse than expected, they could deepen a potential global recession.

Adam Slater, a UK-based economist at Oxford Economics, has warned that Canada's current housing market situation could set a precedent for other countries. Slater points to the large number of borrowers who have taken out variable-rate mortgages as evidence that a market crash may be on the horizon.In Canada, the percentage of mortgages that are variable-rate has reached 20%. This is a record high, and it means that a large number of borrowers are vulnerable to interest rate hikes. And indeed, rates have already risen from 1.5% to over 5%.What's more, alternative lenders now account for 12% of all mortgages in Ontario. These lenders often offer short-term loans with high interest rates, which can put borrowers in a difficult position if they are unable to sell their property.If a large number of these borrowers are forced to sell their homes, it could have a ripple effect on the Canadian economy, which is already struggling. This is something that policy makers have been preparing for during the long years of the housing market boom.

Stephen Brown, an economist covering Canada for research firm Capital Economics, believes that the current economic situation is likely to deteriorate further. "We're facing at least a couple of years where interest rates are above their pre-pandemic levels," he said. "And that's where we need to start getting worried about these things almost feeding on themselves."

In Canada, as in many other countries, rising home prices have been driven by years of low interest rates that have spurred demand for real estate. The Covid-19 pandemic has only served to further increase prices. However, the Canadian housing market has been stronger and more resilient than most, due in part to the fact that it was less affected by the 2008 financial crisis. This has allowed the market to build on previous gains rather than starting from a low point.

Canadian home prices have increased significantly over the past 25 years. This is due to a number of factors, including population growth, low interest rates, and strong economic conditions. As a result, many Canadians are now finding it difficult to afford a home.

While other countries whose markets defied the crash saw similar strength, Canada's particular enthusiasm for homeownership - along with outsized, immigrant-driven population growth - pushed housing investment to become a larger share of the economy than anywhere else, according to Oxford Economics. Those seemingly unstoppable price gains also made real estate a popular way for people to grow their nest eggs, with investors coming to account for roughly a third of the housing stock in major markets like Ontario and British Columbia.

In order to protect against potential risks, the Canadian government implemented a stress test for mortgage applicants. This test requires applicants to show that they would still be able to make their loan payments even if interest rates were to rise significantly. The goal of this measure is to prevent forced selling in the event of an increase in borrowing costs, as was seen in the United States during the financial crisis.

Homes make up a bigger share of Canada's economy than in other G7 nations. This is due to a number of factors, including the fact that Canadians tend to live in smaller households and have more home equity.

So far, it seems to be working. Though Canada's benchmark home prices have fallen nationwide for eight straight months, the number of properties on the market is still well below the long-term average. By and large, homeowners seem to have the financial wherewithal to avoid selling if they don't want to, and economy-wide measures of strain in consumer balance sheets remain low.But most alternative lenders with short-term products aren't subject to the federal government's stress test because they are under provincial regulation. This has helped them grow market share with people like Ly. Moreover, interest rates only started going up in March, and many real estate professionals point out that financial strain from higher borrowing costs tends to compound the longer rates stay high.

Mark Morris, a real estate lawyer in Toronto, says he is starting to receive more calls from people considering bankruptcy. He expects this trend to continue as homeowners who have been holding onto their properties in the hope that rates will fall and prices will rebound begin to lose hope.

"I expect that higher interest rates sustained until February will lead to more people defaulting on their loans," he said. "To some degree, there is a mass delusion that this is just a temporary setback, based on the 20 years of growth in the real estate market. But eventually, the reality will set in and people will start to feel the pinch."

Even those who were stress-tested by mainstream institutions may not be immune to pressures. Higher costs from rate resets could force such homeowners to cut back spending elsewhere, or sell if they deem such sacrifices to be too much.

Charlene Willerton is debating whether or not to buy a condo in suburban Vancouver. She is a speech-language pathologist and her husband is unable to afford a house big enough for their family to live in, so they want to secure what real estate they can as a way to build wealth. Willerton is hesitant because she would have to pay about C$80 out of pocket each month to cover the difference between her ownership costs and what she could charge in rent, but she believes it could be worth it in the long run.

Willerton used a variable-rate mortgage to finance her purchase, but her negative cashflows have ballooned to about C$500 a month.

"We were not expecting such high interest rates," she said. "We knew that rates would go up, but we thought they would rise much more slowly than they have."

Other countries where housing prices have increased significantly may also experience similar risks. According to Fitch Ratings, the mortgage markets of Australia, Spain and the UK all had a greater share of new floating-rate loans than Canada’s as of 2020. With rates now much higher than they were just a year ago, these countries may face similar pressures.

A recent report by Goldman Sachs Group Inc. identified housing market slowdowns as a chief risk to every one of the Group of 10 major economies, given how big a role housing wealth and investment have come to play in their growth. This is regardless of mortgage market structure.

In the US, home prices are sliding in places like Boise, Idaho, and Austin, Texas, that saw a pandemic housing boom similar to Canada’s in recent years. While rate resets play less of a role in a country where 30-year fixed mortgages dominate financing, signs of broader economic pain are emerging as homebuilders scale back and major real estate brokerages cut thousands of jobs.

The fallout from the pandemic is also spreading to Canada, where the ranks of real estate agents have surged by 45% over the last decade. Royal Pro Realty, a brokerage in British Columbia that allows agents to park their licenses for a much lower fee than they'd pay elsewhere, says demand has shot up by 23% compared to before the pandemic.

"There was definitely a lot of uncertainty around jobs in B.C.," said Kirsten Clarke, who gave up her real estate license to take a more stable job. "I saw people getting really nervous - buyers, sellers, everybody."

The real estate sector's contribution to Canada's economy has increased in recent years. According to Statistics Canada, the real estate and rental industry's share of GDP was 9.3% in 2018, up from 8.9% in 2000. This sector is now one of the country's largest and most important industries.

Despite concerns about inflation, most economists believe that Canada's population growth will eventually provide a floor for home-price declines. The country's fast-growing population creates a demand for housing that new supply can't always keep up with, and this problem is not expected to go away even after the Bank of Canada's rate shock fades. Billionaire Stephen Smith cited these "structurally bullish factors" when he agreed to buy alternative mortgage lender Home Capital Group Inc. for C$1.7 billion on Monday. "This reflects my belief in the long-term resiliency of Canadian housing," Smith said in an interview.

Most economists are now predicting that Canada will fall into a recession next year, which could have a squeeze the real estate market from two sides. Higher interest rates and a surge in job losses could cause prices to take another leg down, creating a further drag on the economy. This could create a vicious cycle with a momentum of its own.

Fabiana Francis, a project-controls specialist in the construction industry, has been unable to sell her suburban Toronto home this year despite repeatedly lowering the price. "The Bank of Canada is raising interest rates like drunken sailors and nothing is happening with inflation," said Francis. "This was supposed to be my retirement fund."

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Adan Harris
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