The question of how rising interest rates could impact housing affordability worries many Canadians. An Ipsos poll shows that more than half of Canadians (55 percent) are concerned about the effect of interest rates on their ability to make ends meet. Yet, demand for housing is still insane and many are eager to get into the market despite rate increases.
In March, the Bank of Canada hiked the overnight interest and deposit rates to 0.5 percent. Finance experts believe there would be a series of rate increases as part of monetary policy tightening to tame inflation.
Why Raise Interest Rates?
Russia’s invasion of Ukraine is a major source of uncertainty. Commodity prices have increased sharply, including oil prices. As investor confidence has plummeted, inflationary pressures are felt across the world.
At the same time, Canada’s economic growth has been robust and actually stronger than the Bank of Canada’s projections. Imports and exports have already picked up, mainly driven by global recovery and demand. The rebound from the new Covid-19 variant is also evident, and household spending would further increase with the easing of restrictions.
Who Gets Affected When Rates Rise?
When interest rates increase, it becomes more expensive to borrow. Also, Canadians with home equity lines of credit and variable rate mortgages will face higher borrowing costs when interest rates increase. As a rule, rate hikes make it more difficult to pay down debt, and many Canadians will be faced with difficult financial decisions. As finance expert Rubina Ahmed-Haq put it, paying more toward servicing debt means Canadians will have less for their children’s education plans, retirement savings, travel, and entertainment. What is more, high debt levels can be an issue for people in every income bracket, including bankers, lawyers, and physicians.
Why Is Canada’s Market So Hot?
The housing market in Canada is influenced by a number of factors, including speculative demand, rate of construction, demographics, and immigration. Since the onset of the pandemic, real estate prices have increased between 25 percent and 200 percent. While the majority of Canadians were looking to buy larger properties for living, gyms, and offices in 2020, today, investors make for over 20 percent of real estate purchases. Speculative buying, coupled with a low housing supply, has sent prices soaring.
Can Interest Rate Increases Cool Canada’s Hot Housing Market?
According to the Bank of Canada, both strong investor demand and low interest rates drive up home prices. In theory, interest rate increases help cool the housing market by reducing buyer demand but the question is whether rate hikes alone can restore the balance. According to Carolyn Rogers, Senior Deputy Governor at the Bank of Canada, an effective solution would be to increase housing supply. Real estate experts also opine that rate hikes are unlikely to cool Canada’s hot housing market. Scarce supply, combined with a pent-up demand, means that an increase of 0.5 percent would not bring the desired effect. With past rate increases, more people were likely to be discouraged from buying but it is the opposite now. The fact is that mortgage rates are still lower than pre-pandemic levels, plus, homebuyers got used to price increases throughout the years.
Real estate boards report that for the most of the Covid-19 pandemic Canada saw a high volume of sales irrespective of rising prices. Buyers rushed to invest in real estate at a 0.25-percent interest rate. With a limited supply over the last couple of months, buyers and estate agents have been faced with a severe shortage of properties. As the same time, more people are eager to buy because there is a sense that rates already bottomed out and are going to only increase further. Some realtors report over 20 offers for a single property in a favorable location.
Many people are willing to give up other things but buy real estate. The fact is that during a prolonged pandemic, we have gotten used to sacrificing travel, entertainment, and many of the other good things in life. Plus, many are keen to buy while they still can as they are unlikely to get better offers until housing supply increases. According to realtors, even at double the inventory that Canada currently has, housing demand would still be an issue.
In fact, even before the onset of the pandemic, the real estate market was largely unbalanced, with housing demand far exceeding supply. Coupled with high inflation, demand is driving property prices high, especially when it comes to first-time homebuyers. To ensure availability and affordability, Canada needs to build a lot more housing, and there are signs that this is finally going to happen.
The government of Canada recently announced plans to build some 400,000 homes a year over the next decade. The first major challenge, however, is the shortage of skilled workers to build homes. Not only is Canada faced with a tight labor market and recruiting challenges but the construction sector is still hampered by supply chain bottlenecks and record high prices of raw materials. Also, the sector, which employs over 1.4 million workers across Canada, is already operating at full capacity. A record number of housing units is already being built but Canada’s housing stock is lower than any of the Group of Seven. This is mainly due to population growth and the fact that it took years getting into the current situation. The country’s immigration policy is partly to blame because it is primarily targeting white-color workers than those it needs. Adding to the hurdles are the shortage of available land to build new housing, coupled with provincial and municipal approval delays. And while Finance Minister Chrystia Freeland recently assured that the government is doing everything to meet housing needs, Canada’s immigration policy means significantly growing the housing supply.