With the sharp rise in interest rates over the past 6-months, we thought it would be a good time to check in on the Canadian housing market. RBC Economics has done some solid work on this front, so we will lean heavily into their analysis, while sprinkling in a bit of our own.

Let’s first start with the increase in interest rates that we have seen since the beginning of 2022 and the impact on mortgage rates. The Bank of Canada has raised its benchmark overnight rate from 0.25% at the start of 2022 to 2.5% today. Further, RBC Economics expects the BoC to raise rates by another 1% by year-end 2022, which would bring the benchmark rate to 3.5%. The impact of these hikes and the market’s expectation of future hikes has driven mortgage rates to levels not seen since early 2009:

Now, in the chart above, which looks at 5-year fixed rate mortgages since the beginning of 2017 (note that we have included a 1% discount from the benchmark rate as banks will typically discount by this amount), we have highlighted three data points – July 2017, January 2022 and the current rate. As you can see, since the start of 2022, the interest rate on a 5-year mortgage has risen by more than 2%. Putting numbers to this, a $500k mortgage would cost ~$500 more per month today than it would have at the start of 2022.

Similarly, a $500,000 5-year mortgage that was secured in July of 2017 and would thus now be maturing and need to be renewed would cost ~$200 more per month at current rates, despite the fact that the principal on that mortgage would have been reduced by ~$60k over those 5-years.

With the backdrop of rising rates, we have seen housing demand fall-off quite sharply over the past couple of months:

Here, we would note that while resales are down ~30% since March, they are actually only back to levels seen before the pandemic. In other words, while the rise in mortgage rates has taken the froth out of sales, it has yet to drive resales below longer-term averages. This is, perhaps, best illustrated when looking at the ratio of sales to new listings, which has fallen back into “balanced” territory, meaning that while it is no longer a “seller’s market” it is not, as of yet, a “buyer’s market”:

The decline in resales coupled with rising rates has led to a back-up in prices of about 7% nationwide:

In the Greater Toronto area, declines have been more acute:

Now, we would note in both cases – nationwide and Greater Toronto – while the declines over the past few months have been steep, prices have essentially dropped to where they were in October/November 2021. In other words, we had a brief “frothy period” ahead of the interest rate hikes and we have since seen that froth come out of the market as rates have risen.

Where does housing go from here? While the housing market has already taken a hit, the more important question is – where does it go from here? RBC Economics sees sales declining by 23% in 2022 and a further 15% in 2023, which should be enough to push the market from balanced to a buyer’s market. Further, RBC Economics sees prices, which as we mentioned are already down 7% nationwide and 9% in Toronto, declining 12% and 14% respectively from the peak’s seen earlier in 2022.

To put these prices declines in perspective, let’s look at the following:

So, while RBC Economics forecasts another 5% decline in nationwide prices and another 6% decline in Toronto prices, these declines would only act to bring prices back to where they were in September of 2021. This sort of thing is important because one of the things we worry about with a housing correction is the number of people that are underwater on the value of their homes vs. where they purchased them as this can often be a leading indicator of defaults. RBC Economics’ forecast would suggest that while there are some risks to the market, considering we would be looking at less than one-year of gains that would be lost, the number of homeowners in this “negative equity” group should be relatively low.

Why is RBC Economics not more negative? One question that may stem from this relatively sanguine forecast is – why not bigger losses? That is – considering the rise in rates and the slowing economy, shouldn’t home prices fall more?

While there are always risks of a bigger downturn, RBC Economics points out that Canada enjoys two powerful tailwinds that should help to support house prices. The first is a decline in household sizes, which has helped to increase household formation by ~30k/year over the last 5-years. While declining household size is often associated with declining birthrates, in the case of Canada, the much bigger driver has been a sharp increase in the number of single person households with ~30% of Canadians now living alone. RBC Economics expects this trend to continue with declining household sizes expected to add ~90k new households by 2024.

Second and much more importantly, RBC Economics points out that Canada’s immigration policy will be a powerful driver of household formation in the coming years, which in turn will be a driver of demand for housing units. Ottawa is targeting 1.3mn new permanent residents by 2024 and RBC Economics expects this to increase household formation by 550,000 over this period.

that a normally functioning housing market annualizes to between 500k and 600k units per year, the addition of ~640k new households just from decreasing household sizes and immigration over the next 3-years will be a powerful counterforce to falling home prices.

Thus, while the outlook for housing over the next 12-months likely includes further declines in prices, the risks of a more pronounced downturn remains relatively low.