Rising Interest Rates And The Toronto Real Estate Market

Real Estate, Tales From The Real Estate Trenches

Welcome to my blog on housing, culture, and design, where I explore all the facets of real estate, shelter, and home. I’m Steve Fudge, and I’ve been a realtor and housing consultant in Toronto, Ontario, Canada for over 30 years. Today I’m going to share some Tales From The Real Estate Trenches that provide some insights on what’s happening right now and where I’m anticipating the real estate market in the original City of Toronto is heading this Autumn.

 


 

**Note, I’ve added a couple of Addendums – made on November 3rd, 2022 , December 8th, 2022 & January 25th, 2023 –  updating this post with more recent interest rates since this was originally published on August 26th, 2022 to better serve you. As of this date, the Bank of Canada has been aggressive in its escalation of interest rates in an effort to control rampant inflation. The 8 interest rate increases to date in 2022 & 2023 have been as follows:

March 2nd, 2022 –> 25 basis points to a bank rate of 0.50%

April 13th, 2022 –> 50 basis points to a bank rate of 1.0%

June 1st, 2022 –> 50 basis points to a bank rate of 1.5%

July 13th, 2022 –> 100 basis points to a bank rate of 2.5%

September 7th, 2022 –> 75 basis points to 3.25%

October 26th, 2022 –> 50 basis points to 3.75%

December 7th, 2022 –> 50 basis points to 4.25%

January 25th, 2023 –> 5o basis points to 4.50%**

 


 

Hasn’t 2022 been quite the year for real estate, thus far? If you’re on the sidelines, you likely know that the year began with a bang, with real estate prices still riding the pandemic-fuelled highs. Meanwhile, inflation crept in, in part due to escalating housing and fuel prices, and we quickly went from ”let’s keep an eye on this” to sounding the “wtf” alarm! The Bank of Canada decided to get it under control by implementing a series of substantial increases in interest rates in order to bring the inflationary beast under control – and very quickly the real estate market turned.

Needless to say, the Canadian housing market is shifting downward. It’s stopped real estate speculators dead in their tracks effectively killing the bubble (which is a good thing, ultimately), and leaving people who want to buy shelter to sort out how much they can really afford now that rising interest costs are reducing their buying power. It sucks for dwell hunters, true, but it’s a horrific calamity for those who need to sell.

In a post I wrote prior to the pandemic, entitled, Dear Urbaneer: Should I Buy Property In A Climate Of Rising Interest Rates,  I counselled a reader who was nervous about taking on substantial debt in order to pay the high prices of Toronto housing, with the thought that this debt would become more costly in the near future. And fast forward years later, on the heels of a pandemic-driven housing boom and aggressive quantitative easing policies to sustain the economy, we are now facing the highest inflation seen in decades. And shouldering higher borrowing costs is now our reality and the primary culprit of the market slowdown, as outlined in the Toronto Sun’s piece “Housing Market Taking A Beating Thanks To Rising Interest Rates“.

In regards to interest rates and inflation, the writing is on the proverbial wall, so to speak; there was an important op-ed in the National Post from Bank of Canada Governor Tiff Macklem that received wide media attention. It was titled, “Tiff Macklem: We’re Determined To Eliminate High Inflation And Return To Our 2% Target“.

The timing of this op-ed is interesting; it came on the heels of the most recent Stats Canada data release, which showed that while inflation has tempered slightly, it is still overly high. Inflation in July dipped back to 7.6 per cent, after reaching a 40-year high in June – still well beyond the 2 per cent target! The slight decline is said to be driven mostly by falling fuel prices, but the cost of housing and food is extremely high.

Macklem suggests that inflation will stay high for some time, buoyed by global economic chaos in the form of supply chain disruptions, geopolitical tensions, and volatile commodity prices. With those aforementioned pressures on supply, plus the post-pandemic pressures on demand, broad-based inflation finds its perfect storm. But what’s particularly annoying – for me at least – is Bank of Canada Governor Tiff Macklem assured Canadian households and businesses that “interest rates are very low and they’re going to be there for a long time,” and then, just 21 months later (which is not a long time in my opinion) interest rates went up a lot. He should have been more cautious in his statement and has subsequently lost credibility with Canadians, while financially sinking those who took it to heart.

 

 

Rising Interest Rates & The Impact On The Housing Market

As Macklem covered in his op-ed piece in the National Post, one of the most immediate impacts of interest rate increases is seen in housing. With increased borrowing costs, the market moderates – and it certainly has over the last several months. He also points out the secondary effects of a housing market slowdown: spending on housing-related goods like appliances, furniture, and renovations will also slow down.

In a piece earlier this summer from the Financial Post – “Canada Risks Housing-Related Recession If Interest Rate Hikes Get Too Aggressive“- economist Stephen Brown cautions that the BoC may miss the mark when setting new interest rates, warning of the significant and strong downward pressure they have housing prices. In the article Brown estimates that a rate of 3.5 per cent (which is where current estimates for rate hikes sit for the coming months) would lift the average five-year fixed rate mortgage rate to 4.5 per cent and the average variable rate to 4.9 per cent. Brown predicts that rates such as this would reduce home buyer purchasing power by 23 per cent, which has an impact four times greater than the three previous tightening cycles.

That’s a big bite.

 

 

A Recession Looming?

In July, the Bank of Canada predicted that, although there are signs that inflation is easing, it is expected to be a slow process, with targets not likely achieved until 2024. With rate hikes, the BoC is attempting to create a “soft landing” for the economy – that is walk the line between reining in inflation and avoiding knocking the economy into full recession.

Because of the interest rate hikes, housing prices will continue to retreat, some saying by as much as 20 per cent by February next year, a year after the peak, according to this Globe and Mail article “Canadian Home Prices Down 6 Percent In July From February Peak, The Largest Five-Month Decline Since 2009“. Truth be told, from the real estate trenches I can tell you I’m already seeing instances where property values have declined at least this much in the suburbs and the exurbs. As we’ve seen in the past, the closer you are to the urban centre the less likely your property value will be dropping. But that isn’t a certainty because the most desperate of Sellers for any housing type can quickly erode your value if you live nearby in a similar product.

Incidentally, there are still more Bank Of Canada rate announcements to come in 2023 with every hike eroding a Buyer’s purchasing power further.

 

 

 

Higher Interest Rates & Affordability

In the op-ed Macklem addresses this question: If the cost of everything – from housing to gas to food – is so high, how does creating another expense by making debt so costly with higher interest rates help cash-strapped Canadians? Macklem acknowledges the short-term pain that higher interest rates place on borrowers – particularly homeowners, but that it is ultimately to the benefit of everyone to bring inflation down. Why? Because inflation erodes purchasing power substantially – which has a number of collateral economic effects.

And as much as people don’t like more expensive debt payments, they hate overall inflation more, as they are pinched in every way- at the grocery store, at the fuel pumps, buying consumer goods, and so on. And inflation stretches across all sectors and social strata with negative impacts when it runs too high, so higher rates are the lesser of two evils. Read this article from the Globe and Mail, “Canadians Are Understandably Angry At The Bank Of Canada. Here’s What It Can Do“.

But at the end of the day, higher interest rates don’t help with affordability, even if they effectively bring housing prices down. Basically, Buyers are still purchasing what they can afford (the amount of money they can borrow has simply been reduced with the interest rate increases) which means they’re just securing dwellings at a lower purchase price in order to pay the highest monthly carrying cost they can afford.

Although housing prices are falling, the size of mortgage debt most Canadians have to take on consumes a substantial amount of household income. That’s the real issue with housing affordability: shelter costs have grown out of wack with earning power. Although interest rates were sky-high in the 1980s, there was a much smaller gap between housing prices and incomes. So, while interest rates were high (when I first started selling in 1990 one was thrilled if one could get a mortgage for around 12.75%), it was easier for the middle class to buy. I wrote about this in my past post –> Dear Urbaneer: Interest Rates In The 1980s And Now. However, today “house prices have been growing at a rate 41.9% faster than incomes since 2015, creating an overvalued real estate market. And even further back, house prices have more than doubled the pace of income growth since 2000” as explained in this March 2022 Canadian Mortgage Professional piece called “Canada Is Second Only To One Country For Highest House Price-To-Income Ratio“.

This is really the crux of the issue. Increasing interest rates are pushing Buyers who want to purchase a principal residence into lower price points. It’s similar to when the stress test was introduced a few years ago and it effectively pushed Buyers out of the freehold market and into the condo market – or simply further out of the city. A survey recently showed that many would rather rent indefinitely – or live in a shoebox – than move to the suburbs. But that wasn’t always the sentiment when the Covid19 Pandemic spawned what I called ‘The New Space Race’ and prompted an urban exodus as I wrote in –> The Season Of COVID-19 & Canadian Real Estate.

 

 

Two Examples Of How Higher Interest Rates Reduce Buying Power 

You may be wondering, from a Buyer’s perspective, what are the impacts of having to pay higher interest rates, and how much less of a property purchase does this translate into? This example from mortgage broker Joe Sammut with Mortgage Architects demonstrates how higher rates have a tremendous impact at the time of first posting on August 26th, 2022. See below for more recent calculations.

A Freehold Purchase: Most qualifying Buyers in February 2022 could purchase a dwelling for $1,500,000 and, after their down payment of 20%, secure a mortgage for the balance of $1,200,000 at a rate of 3.24% for a 5-year term compounded semi-annually with a 25-year amortization for monthly payments of $5827.75.

Today (August 26th, 2022), for monthly payments of $5829.78, they can only purchase a house for $1,195,000 (yup, $305,000 less) and, after placing 20% down, pay the balance of $956,000 at a mortgage rate of 5.49% (for the same 5-year term compounded semi-annually with a 25-year amortization rate).

A Condo Purchase: In February 2022 a buyer could purchase a condo for $700,000 and, after their down payment of 20%, secure a mortgage for the balance of $560,000 at a rate of 3.24% for a 5-year term compounded semi-annually with a 25-year amortization for monthly payments of $2719.62.

Today (August 26th, 2022), for monthly payments of $2719.75, they can only purchase a condo for $558,000 (yup, $142,000 less) and, after placing 20% down, pay the balance of $446,000 at a mortgage rate of 5.49% (for the same 5-year term compounded semi-annually with a 25-year amortization rate).

 


**Addendum 2 – November 3rd, 2022 – To demonstrate how much smaller a mortgage one can arrange today compared to February 2022, the calculations below show the same monthly payments based on the different interest rates in February 2022 versus October 2022’s:

A Freehold Purchase: Most qualifying Buyers in February 2022 could purchase a dwelling for $1,500,000 and, after their down payment of 20%, secure a mortgage for the balance of $1,200,000 at a rate of 3.24% for a 5-year term compounded semi-annually with a 25-year amortization for monthly payments of $5827.75.

Today (November 3rd, 2022), for monthly payments of $5828.34, they can only purchase a house for $1,161,250 (yup, $338,750 less) and, after placing 20% down, pay the balance of $929,000 at a mortgage rate of 5.79% (for the same 5-year term compounded semi-annually with a 25-year amortization rate).

A Condo Purchase: In February 2022 a buyer could purchase a condo for $700,000 and, after their down payment of 20% could secure a mortgage for the balance of $560,000 at a rate of 3.24% for a 5-year term compounded semi-annually with a 25-year amortization for monthly payments of $2719.62.

Today (November 3rd, 2022), for monthly payments of $2,719.68, they can only purchase a condo for $554,000 (yup, $146,000 less) and, after placing 20% down, pay the balance of $443,500 at a mortgage rate of 5.79% (for the same 5-year term compounded semi-annually with a 25-year amortization rate).

 


**Addendum 3 – January 25th, 2023 – To demonstrate how much smaller a mortgage one can arrange today compared to February 2022, the calculations below show the same monthly payments based on the different interest rates in February 2022 versus January 2023:

A Freehold Purchase: Most qualifying Buyers in February 2022 could purchase a dwelling for $1,500,000 and, after their down payment of 20%, secure a mortgage for the balance of $1,200,000 at a rate of 3.24% for a 5-year term compounded semi-annually with a 25-year amortization for monthly payments of $5827.75.

Today (January 25th, 2023), for monthly payments of $5828.40, they can only purchase a house for $1,223,750 (yup, $276,250 less!) and, after placing 20% down, pay the balance of $979,000 at a mortgage rate of 5.24% (for the same 5-year term compounded semi-annually with a 25-year amortization rate).

A Condo Purchase: In February 2022 a buyer could purchase a condo for $700,000 and, after their down payment of 20% could secure a mortgage for the balance of $560,000 at a rate of 3.24% for a 5-year term compounded semi-annually with a 25-year amortization for monthly payments of $2719.62.

Today (November 3rd, 2022), for monthly payments of $2,720.71, they can only purchase a condo for $571,250 (yup, $128,750 less!) and, after placing 20% down, pay the balance of $457,000 at a mortgage rate of 5.24% (for the same 5-year term compounded semi-annually with a 25-year amortization rate).

 


 

 

 

From The Real Estate Trenches

Just after Ontario’s Fair Housing Plan took full effect in 2017, we saw some weird and wild stuff in the Toronto real estate market like swings in value, shifts in Buyer and Seller behaviour, and a growing gap between low-rise and high-rise dwelling type values. I wrote about it in this post: The Wackadoodle Toronto Real Estate Market. What’s interesting for me, as a realtor, is that when government interventions (and the arrival of a global pandemic as I wrote in my series called Covid19 & Toronto Real Estate) impact our real estate market, how each buying and selling market segment responds contributes to a reshaping of the housing market as it oscillates.

Today – with the interest rate jumps – there are a huge number of Buyers watching from the sidelines; albeit for different reasons. First-time Buyers are understandably nervous and are waiting to see what the market will do before making a move, unless they’re under the wise guidance of the Bank of Mom & Dad who, playing an active role with their children, see this market shift as an opportunity right now. Speculators are out completely, as they tend to be highly leveraged and want to be certain profit is in their near future whereas investors with deep pockets are on the hunt ‘for a deal’ so they’re looking for the most desperate of sellers (here’s my 2017 blog called –> Are You Investing Or Speculating?).

Boomers who own urban freehold dwellings with substantial equity wanting to downsize into smaller houses or larger condos hold the reins because the demand for their Forever Homes remains strong, continues to exceed the limited supply available, and isn’t difficult to sell. And those Buyers who want to climb the property ladder are still keen if they can make the numbers work. However, until Sellers are willing to accept an Offer conditional on the sale of the Buyer’s property they’re not willing to proceed, as it’s really risky, especially if the Buyer owns a condo and wants to trade up to a freehold dwelling. Because first-time Buyers and investors/speculators constitute a big portion of the condo market, there are fewer Buyers actively looking at condos right now. In fact, we had one stellar listing in a Triple AAA location on the market for 10 days recently and only one Buyer viewed it. Fortunately, they submitted an offer which our clients accepted, for 8.5% less than the amount an identical suite garnered 90 days earlier.

Many freehold and condominium dwellings in the original City of Toronto are now selling for discounts that reflect the change in interest rates. And Buyers are being very upfront about it by submitting offers to Seller disclosing they’re still willing to pay the most they can per month as qualified by their lenders, but that because of higher interest rates it means they’re having to submit offers that are $100,000 less than what similar 1bed units in downtown condo buildings sold for in March in the $700,000 to $750,000 price range. This is also the case for freehold dwellings. Because Buyers looking for a starter family home often want to spend under $1,000,000 because the down payment requirement increases to 20 percent above $1million, dropping prices means that there is more housing stock available for those prepared to buy-and-hold should prices continue to decline for the foreseeable future.

In this Globe & Mail Article “The Frustrated Home Buyer’s Guide To Real Estate” realtor John Pasalis shared “In the first three months of this year, only 7 per cent of all low-rise home sales in the GTA were three-bedroom homes that sold for under $1-million. Over the past three months, just over 25 per cent of sales were three-bedroom homes that sold for under $1-million. While home prices are still expensive, it’s encouraging to see far more homes selling for under $1-million again”. I can attest that on the central east side I’ve seen a few instances of move-in dwellings that previously sold in the $1,050,000 range in 2020 are now selling for sums in the low to mid $900s. It’s bittersweet for Sellers, but these Buyers are still maxing out their mortgage debt to secure these purchases. The upside for these Buyers is that 6 months ago they couldn’t afford to buy a house on The Danforth.

In this regard, we’re going to see Buyers still buying as the Fall Market unfolds. But those Buyers who are financially limited will only be able to stretch financially to a lower max than they previously did, while Sellers reconcile that we’re on a new playing field where sale prices are much lower than in the Spring. The demand by end-users is certainly there. And, as I wrote in The Number Of Owners With Multiple Properties Is Increasing In Toronto. Here’s Why! so are the ‘investors’ – mostly because who an ‘investor’ has been labelled include those who purchase another property beyond their principal residence to shelter ageing parents; to assist one’s adult children onto the property ladder or, as we saw during the pandemic, purchase a recreational property to telework from.

Without question, many Buyers are chagrined at now only being able to afford a smaller dwell or different housing type, while others are feeling defeated because they’re now priced out of the market. The effect of fewer folks going up and down the property ladder is detrimental to the property market overall, as this filtering of housing stock keeps neighbourhoods and the economy vibrant. When this stops, it impacts the flow of capital and it also exacerbates the rental market; all of those would-be-buyer bystanders are now competing for a scarcity of rental properties.

This shift in market segments and dynamics is squeezing vacancy rates hard,  as well as driving rents way up. This is true in a number of cities in Canada but is particularly pronounced here in Toronto. In fact, rents in the city have increased by 20 percent year-over-year. The title of this article from the Financial Post says it all: “Great For Landlords, Horrible For Renters’: How A Runaway Rental Market Has Become Toronto’s Latest Housing Nightmare“. The condo and freehold housing markets in Toronto have long been characterized by bidding wars, but stiff competition is now plaguing the rental market too, where the gap between supply and demand is widening.

Ironically, the higher rents being paid will help the investors who need higher revenues to offset their higher borrowing costs. This, in turn, may provide just enough financial security to investors to hang on and not unload their properties, stemming what could be a substantial crash in prices as condos get listed under financial duress. It will be interesting to see how it lands.

 

 

A Shifting Market

There are many mitigating factors that influence a property’s value based on the market dynamics and conditions oscillating at any given time like economic headwinds, political stability, and demographics. There is also seasonality, as I wrote some years ago in –>The Seasons To Real Estate. In Toronto, other drivers of the market include the flow of global capital; our current and anticipated government policies that foster and tax homeownership; foreign buyer restrictions & the vacancy tax; the opportunities and constraints of the property type itself based on its location, size, condition, zoning and highest and best use within the current supply and demand framework.

There is also the mechanics of supply and demand – and the shifting expectations and behaviours of both Buyers and Sellers as the market cools. For Sellers – who have long held the cards of control in the selling process – many are having to reassess how truly financially secure or indebted they are, and determine whether they hang on or cash out now before it gets worse.

Plus, let’s not forget we’re also operating amidst several ‘wild cards’: a global pandemic that persists, the Ukraine invasion by Russia, and don’t forget climate crisis! All of these add a heightened level of unpredictability to our real estate market. This is in part why we rely more heavily on real-time data, Buyer feedback, and the opinions of our peers to illustrate current market conditions.

 

**Addendum 2 of 4 – November 3rd, 2022 – A 5-year fixed mortgage is about 2.5% to 3% higher than it was in February 2022 – landing at around 5.65% for a conventional mortgage with Scotiabank**.

**Addendum 4 0f 5 – January 25th, 2023 – A 5-year fixed mortgage is about 2.5% to 3% higher than it was in February 2022 – landing at around 5.24% for a conventional mortgage with Scotiabank**.

 

Do rising interest rates and cooling housing prices have you rethinking your dwell hunt strategy? Success lies in prudent planning and fully understanding the mechanics of the market. With decades of experience in guiding clients toward their housing dreams in all sorts of market conditions, I – and The Urbaneer Team – are here to help!

 


 

If you found this post helpful, check out these other Urbaneer.com posts:

When Dreams Of Domesticity Became Nightmares: A Recollection Of The 1989 Toronto Housing Market Crash

Dear Urbaneer: Is It Time For Us To Climb The Property Ladder?

How Canada’s 3 Levels Of Government Shape Housing Policy & Programs

Dear Urbaneer: What’s Being Done To Create Affordable Housing In Toronto?

Why Does Homeownership Remain A Priority For Canadians, Despite The High Costs?

The Role Of Fiscal Stimulus During COVID-19 And Toronto Real Estate

 


 

Thanks for reading!

 

– Steve & The Urbaneer Team

 

 

The Urbaneer Team

Steven Fudge, Sales Representative
& The Innovative Urbaneer Team
Bosley Real Estate Ltd., Brokerage – (416) 322-8000

– we’re here to earn your trust, then your business –

 

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