Canada’s housing market faces a ‘big test’ as interest rates are set to rise

Canada’s housing market has been on a remarkable rebound since the pandemic-induced slump in 2022. However, this recovery may not last long, as the Bank of Canada is expected to resume its interest rate hikes in the second half of 2023, which will pose a “big test” for the affordability and sustainability of the housing sector.

What’s driving the housing market revival?

One of the main factors behind the housing market revival is the Bank of Canada’s decision to pause its monetary policy tightening in March 2023, after raising its benchmark rate four times since October 2022. This move was motivated by the slowing global growth, the escalating trade tensions, and the weakening domestic economy.

The interest rate pause has made borrowing cheaper and stimulated the demand for housing, especially among first-time buyers and investors. According to the Canadian Real Estate Association, the national home sales rose by 6.2 per cent year-over-year in October 2023, while the national average price increased by 5.8 per cent to $632,000.

Another factor that supports the housing market is the high population growth, driven by immigration and non-permanent residents. Canada welcomed 321,065 immigrants in 2022, the highest level since 1913, and is on track to surpass its target of 350,000 newcomers in 2023. Moreover, the number of non-permanent residents, such as students and workers, reached a record high of 1.6 million in 2022, and is expected to grow further in 2023.

These newcomers have contributed to the demand for housing, especially in the major urban areas, where the rental vacancy rates are low and the rents are high. Many of them have also entered the labour market, which has been resilient despite the economic slowdown. The unemployment rate fell to 5.5 per cent in October 2023, the lowest level since 1976, while the wages grew by 4.4 per cent year-over-year, the fastest pace since 2009.

A third factor that supports the housing market is the high household savings accumulated during the pandemic. According to Statistics Canada, the household saving rate soared to 27.4 per cent in the second quarter of 2022, the highest level on record, as the government provided generous income support programs and the consumers reduced their spending on non-essential goods and services. Although the saving rate has declined since then, it remained at 13.5 per cent in the second quarter of 2023, well above the pre-pandemic average of 3.6 per cent.

These savings have provided a cushion for many households to cope with the rising debt burden and the higher cost of living. They have also enabled some households to increase their down payments or to purchase more expensive properties.

What’s the downside of the housing market strength?

The downside of the housing market strength is that it reduces the affordability for many potential buyers, especially in the major urban areas, where the prices have skyrocketed. According to the National Bank of Canada, the national composite house price index rose by 9.5 per cent year-over-year in October 2023, the highest increase since 2017. The index for Toronto jumped by 12.6 per cent, while the index for Vancouver surged by 14.3 per cent.

A report by Desjardins Group that says the housing market will remain strong and put more pressure on affordability. The report estimates that the ratio of the average house price to the median household income will reach 6.7 in 2023, up from 6.1 in 2022 and 5.6 in 2021. This means that the average house price will be 6.7 times higher than the median household income, which is considered a very high level of unaffordability.

The report also warns that the high house prices could pose a risk to the financial stability of the country, as they increase the vulnerability of the households to a negative shock, such as a loss of income, a rise in interest rates, or a decline in house values. The report notes that the household debt-to-income ratio reached a record high of 177.6 per cent in the second quarter of 2023, while the household debt-to-asset ratio rose to 18.9 per cent, the highest level since 2010.

What’s the future outlook for the housing market?

The housing market rebound may not last long, as the Bank of Canada is expected to resume its rate-hike cycle in the second half of 2023, which will dampen the demand and cool down the prices. Chief economist of the Bank of Montreal, Douglas Porter, predicted that the Bank of Canada will raise its benchmark rate by 75 basis points in 2023, bringing it to 2.25 per cent by the end of the year.

There are also some risks and uncertainties that could affect the housing market, such as the ongoing trade disputes, the slowing global growth, and the potential for a recession. A survey by the Bank of Canada, shows that the business confidence has deteriorated in the fourth quarter of 2023, as the firms reported lower sales expectations, weaker investment intentions, and higher uncertainty.

Let's conclude by saying that the housing market faces a “big test” in 2023, as it will have to cope with the changing economic and financial conditions. The potential buyers and sellers are advised to be cautious and realistic, and to avoid taking on too much debt or paying too much for a property. The policymakers and regulators are also urged to monitor the housing market closely and to take appropriate measures to ensure its stability and affordability.

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Source: Yahoo Finance

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