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Canada's Real Estate Market: 5 Things You Need to Know - 2023-10-27

Throughout history, real estate has held a prominent place in the investment choices of Canadians. The steady increase in property values has made it a favorite among investors.

Rental property owners have also benefited from a robust rental market characterized by low vacancy rates and consistent annual rent hikes. The Canadian real estate market has played a pivotal role in helping families build wealth and improve their financial prospects. However, a significant transformation is currently in progress due to unsustainable price hikes and the escalation of interest rates.

1. An Overview of the Housing Market:

Prices, Demand, and Rent - Price Decreases: Except for the 2008 global financial crisis and a brief period in 2018, Canadian real estate prices have steadily climbed over the past two decades. The most rapid growth occurred during the COVID-19 pandemic, with a record 29% increase in prices within the year ending in February 2022. However, this meteoric rise in prices proved unsustainable, far outpacing income growth and challenging housing affordability for Canadian families. Recent data indicates a decline, with a 9% decrease in the benchmark price of a Canadian home from February 2022 to September 2022. Further price declines of potentially 20% or more are anticipated for the Canadian housing market in 2023.

- Softening Demand: Canadian home sales have significantly dropped over the past year, with fewer sellers listing their properties, resulting in longer times on the market. As of September 2022, housing sales have seen a 32% year-over-year decline. Although this is a significant decrease, it still places the volume of Canadian real estate sales moderately below historical averages over the last two decades. Buyers expecting future price reductions may delay their property purchases, anticipating lower prices.

- Rising Rent: Despite the declining house prices, the cost of renting in Canada continues to increase due to low rental vacancy rates and annual government-approved rent increases. This trend mainly affects younger families and immigrants who tend to rent with aspirations of homeownership in the future. Families who own rental properties as part of their investment portfolio stand to benefit from rising rent prices, as low vacancy rates and annual rent increases provide a stable and predictable cash flow for wealth growth.

2. Impact of Higher Interest Rates and Inflation on Home Buyers

- Weakening Canadian Economy: The Canadian economy is showing signs of weakness, with the looming risk of a recession in the coming year. Inflation and higher interest rates are key contributing factors to this economic downturn, affecting the cost of living, house prices, and the affordability of homes, particularly for recent graduates and young families. By late October 2022, the overnight lending rate in Canada had increased six times, from 0.25% at the start of the year to 3.75%, elevating the cost of owning Canadian real estate. Further interest rate hikes by the Bank of Canada are anticipated in the coming months, which will increase borrowing costs.

- Inflation Drivers: The past year has seen inflation driven by several factors, including global supply chain issues, high consumer demand for goods, increased gas and food prices, elevated household savings, and higher wages to attract and retain employees. The combination of higher interest costs and inflation has made it challenging for the average family to afford a home in Canada, and it has also made mortgage qualification more difficult.

- Variable Rate Mortgages: Variable rate mortgages, which provide significant interest savings in a low-rate environment, have seen increased interest costs as rates rise. With rising rates, a more significant portion of the mortgage payment goes toward interest, extending the mortgage's amortization period. Various options are available for managing variable-rate mortgages, such as increasing regular payments, making annual lump sum payments, or switching to a fixed-rate mortgage.

3. The Rental Market

- Contrasting Costs: While the costs of purchasing Canadian real estate are declining, rental costs continue to rise. Annual rent increases are advantageous for investors in residential rental real estate, helping offset ownership costs and potential increases in interest expenses for property acquisitions. However, this trend makes it challenging for young families and immigrants looking to rent or buy their own homes, as higher monthly rent and inflation exert pressure on their cash flows.

- Timing for Renters: The ideal time for renters to transition to homeownership is when the cost of owning a home is more affordable than renting. As the price of Canadian real estate falls, opportunities for renters to become homeowners will increase, but this transformation will take time.

4. The Housing Market Bubble and Its Impact on Homeowners

- Concerns of an Unsustainable Bubble: The substantial rise in Canadian home prices in recent years has raised concerns about the sustainability of a housing market bubble. Such bubbles can form when buyers drive prices upward, driven by strong beliefs in future price growth, low- interest rates, and available investment capital. Any change in these factors can lead to a rapid price decline or a burst of the bubble, negatively impacting recent buyers who may have paid top prices for properties now worth less than their purchase price.

- Home Equity Lines of Credit (HELOC): Established homeowners have used HELOCs for personal purposes, leveraging home equity for expenses like renovations. Unlike most mortgages with fixed interest rates, HELOC interest costs are typically tied to the prime lending rate. With the prime rate's increase, existing HELOC borrowers may experience higher borrowing costs, impacting overall cash flows and family budgets. Reducing this debt may be considered to manage cash flow concerns.

5. Impacts Across Canada

- Regional Variations: Canadian urban centers, particularly Toronto, experienced higher housing cost growth compared to the rest of the country. Cities that became telework hubs, like Brantford and Barrie, saw even more robust price growth. However, with the recent dip in Canadian real estate prices, cities like Kitchener-Waterloo, Cambridge, and London have witnessed the most significant price decreases. Provinces that were less affected by the housing boom, including Alberta, Manitoba, Saskatchewan, Newfoundland, and Labrador, experienced slower price increases and, as a result, remained relatively affordable.

While the Canadian real estate market is expected to continue its downturn into 2023, it is anticipated to regain its status as a significant source of wealth creation for Canadians and their families in the future, driven by solid immigration and housing demand.

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