Real estate, real estate, real estate: where Canadians live has been the topic of choice throughout the global pandemic. Canada’s real estate market has spread from stagnant to explosive in the past two years, with record rates and high demand. The hot market has resulted in real estate agents and mortgage brokers reporting historical revenues, topping $17.3 billion in 2020 alone. Home sales volumes were also up 11.4% from the previous year, the highest growth rate since 2016.
As the pandemic forced fundamental changes in how Canadians lived, they also shifted where they chose to live. While cities and urban areas have historically been in demand, Canadian homebuyers adjusted their focus to rural and suburban markets. Living outside the city suddenly became attractive as working from home became the norm, and commuting into brick-and-mortar offices was no longer necessary.
But, just as quickly came a lack of inventory and runaway prices in these areas, forcing homebuyers to choose bigger loans and cheaper, variable interest rates to qualify for their mortgages.
Fast forward to today, when the real estate landscape has changed again. Homebuyers are now grappling with rising interest rates, falling prices, and a looming recession. So, what should home buyers, sellers and homeowners know to ensure they’re in a good position financially? Let’s talk about it.
Demand, Changing Markets, and Interest Rates Driving Home Prices
Until the first quarter of 2022, the real estate market and the economy were hot. Then, the Bank of Canada began a policy interest rate hiking schedule, following the lead of the US Federal Reserve, the central banking system in the United States, which started to raise interest rates in early 2022. These interest rate increases intend to curb record-high inflation, but they also made the cost of borrowing money, including mortgages, more expensive.
These climbing interest rates increased household debt — causing average debt loads to grow faster than during the famous 21% interest rate hikes of the 1980s. Throughout that period, five-year fixed mortgage rates stayed at 10% and above for 18 years. Today, although mortgage rates aren’t nearly as high, an affordability crisis for the average homebuyer is already taking shape.
So, what’s impacting Canada’s real estate market today? The main factors are:
1. High Demand for Homes
Who is buying homes in Canada is changing. While you might imagine that the average homebuyer is a Canadian family, an increasing number of homes are purchased by real estate investors.
As of 2021, this Bank of Canada housing report found that investors accounted for over 20% of home purchases in Canada. In contrast, the same report found that first-time homebuyers’ share of purchases has been steadily declining since 2015 (53%) and hit a new low in 2021 (47%). They feel homeownership costs have increased quicker than most Canadians’ disposable income. This may account for the decline in homeownership amongst first-time homebuyers.
2. Changing From a Seller’s Market
Canada’s real estate market runs in cycles, where either the sellers have the power (a seller’s market) or the buyers do (a buyer’s market), or, sometimes, the power is perfectly balanced between the two.
In a seller’s market, more buyers are looking to purchase than there are homes for sale. This means buyers will have to compete with one another for the limited number of homes for sale, resulting in high selling prices.
A buyer’s market is the opposite. In a buyer’s market, more homes are available for sale than buyers. In this market, sellers will have to attract buyers to their homes, and buyers have the power to negotiate the price with the seller. A balanced market is in the middle — where supply and demand are relatively equal.
Experts use the sales-to-new-listings ratio (SNLR) to determine what market we’re in. Here are the classifications:
- Above 40% is a buyer’s market
- Between 40% to 60% is a balanced market
- Above 60% is a seller’s market
According to the Canadian Real Estate Association (CREA), in January 2020, the SNLR was 54.5%, and just two years later, in January 2022, the SNLR was 90.2%. So as of July 2022, we’re back to 51.7% in a balanced market.
3. Increased Cost of Borrowing
With rising interest rates comes a rising cost of borrowing. Whether you have a fixed-rate or variable-rate mortgage, you may have been more or less impacted than others. If you have a fixed-rate mortgage, your monthly payment will stay the same through the mortgage term. A variable-rate mortgage will change with the prime lending rate, which is dictated by the Bank of Canada and your lender.
Somewhere in the middle are static-payment variable-rate mortgages. These mortgages have interest rates that change with prime, but the monthly payment stays the same. As the interest rate increases, the borrower pays less principal on the mortgage, meaning they pay the home off slower.
In February 2020, less than 10% of new mortgages had variable rates. However, by 2022, over 50% of new mortgages were variable, making the housing market dependent and responsive to the Bank of Canada’s overnight rate fluctuations. Typically, Canadians may choose a variable-rate mortgage because the interest rates are lower, allowing them to carry a more substantial mortgage.
Since the beginning of 2022, those with a variable rate mortgage have seen 300 basis points (+3.00%) added to their interest rates:
- +0.25 on March 2, 2022
- +0.50 on April 13, 2022
- +0.50 on June 1, 2022
- +1.00 on July 13, 2022
- +0.75 on September 6, 2022
These increases directly impact the “prime” interest rate of variable lenders, stressing existing homeowners with variable-rate mortgages and homebuyers hoping to use a variable interest rate mortgage to increase their budget by qualifying at a lower stress-test rate. The stress test ensures that homeowners can still afford their mortgage should interest rates rise.
What does this mean for variable-rate mortgage holders?
- They are more exposed to benchmark interest rates increases
- Decrease in purchasing power due to stress test
- Borrowers are closer to (or already at) their ‘trigger rates’ — the interest rate level that causes your monthly mortgage payments to increase if you have a static-payment variable rate mortgage
What Might Happen to Canadian House Prices?
As interest rates increase, the market proves to be highly impacted by these rises. Nationally, house prices have fallen 9.9%, according to the CREAs House Price Index (HPI), but that doesn’t mean every real estate market in Canada dropped 9.9%. Also, real estate markets that grew more slowly and sustainably have been slower to “recoil” or decrease in price. As a result, some real estate markets are still seeing prices rise.
Markets Still Increasing During Rate Hikes
Change CREA HPI February 2022 to August 2022:
- Prince Edward Island + 13.1%
- New Brunswick +12.8%
- Newfoundland & Labrador +7.9%
- Nova Scotia +4.0%
- Saskatchewan +3.6%
Markets That Dropped the Most Since Rate Hikes Began
Markets that “ran up” faster during COVID-19 (areas that experienced high price growth) have experienced similarly steep price declines.
Change in CREA HPI February 2022 to August 2022:
- Mississauga -18%
- Cambridge -18.7%
- Oakville Milton -20.5%
- Kitchener Waterloo -21.7%
- London St. Thomas -22.5%
What to Look For When Buying or Selling a Home in 2022
We’re still seeing a lack of homes for sale, but demand has now dropped in line with supply. Earlier this year and in 2020, buyers in Canada’s real estate market felt a sense of urgency because prices rapidly increased. However, it seems buyers have set that urgency aside and are becoming more patient. Seeing others rewarded for patience, buyers seem to have adopted a “wait and see” mentality towards their searches. This has caused a nearly 50% contraction in the total value of all transactions from February 2022 to August 2022 in specific markets, like the Greater Toronto Area (GTA).
When it comes to home listings, two critical things are happening. First, fewer houses are selling (a decrease in the sales-to-new-listings ratio). Second, homes are taking longer to sell (a decrease in absorption or an increase in days on the market). This impacts a vital metric called months of inventory. Inventory is the amount of active supply of homes available on the market.
Two factors can impact the months of inventory:
- The number of active listings this month (the numerator)
- The number of sold listings last month (the denominator)
As fewer homes sell less frequently, we will gradually see inventory begin to “pile up” — pushing the market from a seller’s market (less than three months of inventory) towards a balanced market (four to six months of inventory). If this situation persists, we could ultimately see a buyer’s market (over six months of inventory).
Although news organizations are heavily reporting that housing markets are seeing record low inventory, in my opinion, that metric doesn’t guarantee we’ll stay in a seller’s market. The months of inventory calculation is why it doesn’t matter that we see “record low inventory.” If that inventory is not selling quickly, then months of inventory will continue to rise, and we could still reach a buyer’s market.
Only time will tell how these metrics evolve, but we know this: prices rise in a seller’s market, and prices fall in a buyer’s market. In a balanced market, prices are relatively unchanged.
TL;DR
As a buyer, paying attention to the total number of homes for sale and the number of listings sold each month is essential. These metrics will tell you what is happening in your local market and whether you are in a seller’s or buyer’s market. Another great indication of absorption is days on the market, which tells you how long properties take to sell. If you are a seller, remember that receiving an offer may take longer than you might have anticipated.
Canadians Still Optimistic About Real Estate
While working from home was hugely popular during the pandemic, today, many businesses have begun to reevaluate work-from-home and remote positions, which causes demand to move away from markets that favoured rural or ‘staycation’ destinations as choice communities to live. As a result, suburban markets seem to suffer from housing price declines first, while urban markets are proving relatively resilient.
A lot is happening in real estate markets across Canada right now. Despite all of this, there is still the general, overarching theme and opinion that Canada will always need more homes, and there will always be buyers. We expect the market to level out and continue its long-term growth trend in the long term. But, the factors we went over will cause some turbulence in the short term for both buyers and sellers.
