Somedays it feels like we are years from the 2008 global financial crisis. Others, it feels like it was just yesterday that we watched asset prices free fall and waited with bated breath for central banks to come to the rescue. And they did – in the form of central bank easing. The Bank of Canada and its global counterparts came to the rescue with unprecedented global monetary policy easing by increasing bond purchases and lowering interest rates. In the years that followed, stock-, bond-, and housing prices all bounced back.
In the last few years in particular, the Canadian housing market has resurged, with some areas such as Toronto and Vancouver being subject to pundits’ cries for overvaluations and bubbles. These housing market bears argue that, once interest rates go up, home prices will fall precipitously as affordability becomes more challenging for more people. As it applies to many topics, generally, consensus opinions typically lack nuance, and no singular outcome is for certain. In particular, now that the Bank of Canada has begun to increase its key interest rate and therefore, push mortgage rates higher, the voices of so-called internet experts have screamed ‘bubble’ louder. Rather than suggest a singular outcome is inevitable, we think it’s more helpful to explore the relationship between interest rates and housing markets, as well as other factors that are in play.
Let’s first explore housing prices and interest rates in isolation. All else equal, it is true that higher interest rates push the cost of owning a home higher for prospective buyers. This is because a homebuyer will have to pay more in interest every single month, increasing his or her total mortgage payment. Alternatively, a buyer could the reduce the size of the mortgage in order to keep his or her overall monthly payment the same, i.e., be only able to afford a smaller house. Because this dynamic would cause houses to become less affordable, one could make the argument that it would reduce demand, causing home prices to decline.
But that’s not the only factor at play. Home prices could also rise. If people expect interest rates to increase slowly over the next few years, it may spur many people on the sidelines to preemptively purchase and home to avoid paying higher interest rates later on, causing demand to temporarily increase, creating home price appreciation. The fear of missing out could initially cause prices to rise, then either plateau or decline. In addition, if there are a number of buyers that have been sidelined for the last few years, a small dip in home prices could again stimulate demand.
So what does that mean for the average buyer, if they do not have a clear direction on which direction home prices will generate? Unlike real estate investors, who may have greater resources to research and invest or speculate on the direction of the housing market, what individual buyer should consider is their own current situation. One thing we can learn from the financial crisis is that we should not be buying homes with the expectation of exponential price appreciation, and with that, the ability to take out home equity lines or flip a home for profit on leverage. While it’s easy to get tempted to flip homes in a rising price environment, recall that this type of action caused the domino effect that was the 2008 global financial crisis.
Instead, focus on what size home you can afford. The Bank of Canada is likely to slowly raise interest rates, and at the end of the day, a buyer should probably not be so levered that a +/-0.50% change in mortgage rates will make or break their personal finances. Either sort out your finances or seek out professionals that can help you determine what monthly payment or mortgage size you can take on, in addition to having a buffer. This flexibility and buffer would allow you to potentially take advantage of opportunistic buying in the market, as well remain stable through life’s many surprises.
Furthermore, prospective buyers should do research on the specific markets they are looking to buy a house. For instance, the Calgary market is inevitable different than Vancouver and Toronto. Understanding the dynamics that impact these individual cities is key to understanding what other factors – beyond interest rates – that could impact housing prices. As one example, if a city benefits from greater economic growth, its population can likely afford higher prices, and therefore a small increase in interest rates will not deter price increases. As another example, if a city is losing its population over time, home prices may go nowhere even if interest rate fluctuate.
To summarize the above, there are many factors that influence home prices – economic growth, population changes, interest rates and city-specific factors – and not all of these things move in tandem. Any article that claims to forecast the outcome of the housing market following key interest rate increases may make some salient points, but would be speculating if they believe any singular outcome was set in stone. Rather than rely on any one forecast, prospective buyers should arm themselves with as much information as they can about their personal finances, the market they are looking to buy in and their time horizon in order to capture an attractive opportunity. Also consider that in some cities and for some would-be buyers, it may make sense to continue renting temporarily if the economics make sense, or if you don’t intend to stay in your home for a longer period of time. When considering the costs of purchasing, don’t just consider mortgage payments, but also sunk costs incurred: transaction costs associated with the purchase, moving costs, etc. The more you know, the better positioned you will be to make the best decision for your own personal circumstances.