When the Bank of Canada finally decided to cut its policy rate, it expressed concern that such cuts could lead to an overheated housing market. Some real estate industry experts are also forecasting a “material lift” in sales and “accelerated home price appreciation.”
Despite these predictions, significant changes in major markets like Toronto are unlikely this year. While there is pent up demand, affordability remains a concern. A rate cut of 25 or even 50 basis points is hardly going to move the needle on interest rates.
Furthermore, while rate cuts will benefit variable rate borrowers, longer-term rates are dependent on bond market movements. A five-year bond rate is made up of a series of implied forward interest rates plus a term premium. Until there is more clarity on the pace of future policy adjustments, bond rates will be primarily determined by movements in the US market.
We are also seeing housing market adjustments driven by several other factors. At the end of May, the Toronto area had 9,951 units listed for sale, the highest number for any month in recent history. The sharp rise in vacant units suggests that investors are looking to sell, as they typically put units on the market when they are unoccupied.
Despite the rapid rise in rents, higher interest rates have made it difficult for the average investor to cover operating costs such as mortgage payments, taxes, maintenance, and condo fees. Investors have been banking on ongoing property appreciation to offset negative cash flow. However, with a record number of completions expected in the next year and the federal government’s plan to reduce the number of non-permanent residents, there is uncertainty about the likelihood of future price growth in the Toronto condo market.
Compounding this challenge is the presale market. Historically, buyers would put down a deposit, wait several years for their building to be completed, and then have the option to sell at a gain. Now, completed units are worth less than the agreed-upon purchase price. Some buyers may walk away, but those who proceed will need to cover the difference in value when obtaining a mortgage. The last time we saw a similar situation was during the financial crisis when condo prices declined for about six months as the market adjusted.
Why don’t buyers step in? The issue is that builders must have 70% of units presold to secure financing. This has led to builders creating units targeted to mom-and-pop investors with lower-price points, typically around $500,000. However, to meet this price point, particularly amid rising development charges, builders have been constructing shoe box-sized units. While these units may appeal to a buyer who is looking for a rental unit, they are not appealing to buyers looking for a home.
Given the lack of supply and population growth, we don’t see this as a long-term problem. However, there will be an adjustment period until the market absorbs the oversupply of smaller condo units.
Housing Affordability Watch
CMI monitors the latest developments and offers insights on solutions to Canada’s housing affordability crisis
One of the major hurdles in addressing Canada’s rental housing crisis is the lack of new affordable housing units being built. Despite initiatives under the National Housing Strategy, only 17,000 units have been completed in four years, which is only a modest improvement compared to the past three decades. In contrast, the U.S. has successfully built 3.5 million subsidized rental units since 1987 – an average of roughly 95,000 units per year – largely due to the Low-Income Housing Tax Credit (LIHTC).
Adopting a similar tax credit in Canada could harness private sector expertise to dramatically increase the development of affordable housing. In the latest Housing Affordability Monitor, we explore how this potential solution could revolutionize Canada’s affordable housing landscape. Read it here: Is a Tax Credit a Better Way to Support Social Housing?
Independent Opinion
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