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Canada’s once soaring house prices are now dropping after a wave of interest rate hikes, but will they fall even further? This episode, Scotiabank’s Head of Real Estate Secured Lending John Webster and economist Farah Omran joins us once again to break it all down and take us behind the headlines.

Key moments this episode:

2:01 — Brief catch up on what’s happened in the last six months 
3:50 — How the market’s been a bit of a roller coaster 
4:23 — How interest rate hikes have affected average selling prices 
5:46 — What does “balanced market” mean and are we seeing one? 
7:19 — Putting the COVID housing boom vs. current prices in perspective 
9:16 — Will prices go below pre pandemic levels? How low will they go? 
11:23 — What about people who bought at the peak and are seeing the price of their home go down? 
13:40 — Is this a good time to jump onto the market? 
15:11 — The big question: fixed or variable? 
16:32 — What factors that will continue to drive demand even as prices come down?
21:02 — What should someone be thinking about if they’re looking to buy or sell in the next six months?

Transcript:

Stephen Meurice: Whenever we talk about real estate, we usually lead off with some flashy headline about how wild the Canadian market’s doing. Hot, skyrocketing, shocking. Or as you might be reading in headlines lately – plunging.

John Webster: The media loves to talk about this housing market and why wouldn’t they? We love talking about it too, it’s one of the best shows in town, let’s face it.

SM: That’s John Webster- Scotiabank’s Head of Real Estate Secured Lending.

JW: But, I think it’s important to understand that the highs and lows we focus on. But the market—looking forward—is quite stable.

SM: John’s one of our guests this episode along with Scotiabank economist Farah Omran. They’re here again to take us behind the headlines and break down what’s really happening in the Canadian housing market. And where it might go from here. I’m Stephen Meurice and welcome back to a new season of Perspectives.

Farah, John welcome back. It’s always great to have you guys on the show.

Farah Omran: Thank you.

JW: Always great to be here, Stephen.

SM: So, we have lots to talk about. But I wanted to ask you one question first, you guys spend most of your professional time thinking about real estate and the housing market. Are you like everybody else where you're looking at the ‘what they sold for’ stories in the newspapers? Are you as obsessed about real estate outside of your professional lives or do you prefer to forget about it once you get off the clock?

FO: Well, I mean, whenever my friends see me for the weekend, they ask me, what do I think is going to happen? And I say, I'm sorry, I don't know anything about housing on the weekend. So, I think that answers my preferences.

SM: [laughs] How about you, John? Are you a real estate obsessive?

JW: I would say, yes. I mean, it's part of my daily ritual. I look at listings every day, I'm not too proud to admit it.

SM: Okay, we can get into the details shortly, but last time we were talking, which was way back in March — super hot market. Of course, that was just as interest rates started to rise. And now, some six months later, not exactly the same situation as it was back then. So, very briefly can you just catch us up on what happened? Maybe you, Farah?

FO: The last six months saw the housing market slow down from the unsustainable pace that we saw during the pandemic. So, we saw sales fall in response to a bunch of factors, including higher interest rates and worsening economic conditions, such as the falling stock market and the worsening sentiments. However, with the decline in sales and the fall in prices that we've seen, prices are still above their pre-pandemic levels.

SM: How about you, John? Was it a hair-raising summer watching the ups and downs of the market?

JW: Well, I think we were expecting the increases in interest rates. So, we've been calling for that. Certainly, Farah's department has and so, you know, we're at 3.25% right now with the BoC rate and that's exactly where we thought we would be. So, I knew what the impact of rising interest rates would do and let's all remember that we still have the qualifying rate. So, it's more severe than you would expect. It's not just the increase in the absolute rate, but you're qualifying at two points above the contract rate. So, it's been, on the five-year term in particular, very challenging because you're qualifying people at over 7% as their rate to underwrite and that's made for a whole group of potential purchasers that either they had to step back from the market or they had to pay less, come up with a greater down payment. So, we knew that was going to be challenging. We've fallen off about 30% year-over-year, in terms of mortgage origination. So that's a very big material move and as Farah mentioned, there has been some adjustment to the housing prices and that obviously varies. The regions where they saw the steepest increases are having the steepest declines. The ones that were a little more moderate are in that range that we expected. But it has been a bit of a roller coaster in terms of purchasers who had been competing in a very heated contest, now have a little bit more breathing room, a little bit better balanced market. Sellers are all upset that they may have missed the high-water mark in terms of pricing. And so that dynamic continues. But I think that the demand will be very strong as we move in, particularly into the back half of ‘23.

SM: Okay, let’s get into the details here a bit. Farah, you maybe you can elaborate on where the market has gone over the last six months?

FO: Yes. So, since the (central) bank started hiking, the average selling price fell by around 17% from its peak in February of this year. But that still leaves it over 20% above its pre-pandemic levels. And of course, the average house price can overestimate the movements and house prices in the market because it doesn't take into account the size of or type of house. So as more people shift to smaller, more affordable units as they get priced out of more expensive ones, the decline in the average selling price can be exaggerated. So, when we look at the MLS house price index, which does take into account differences in house type and size, it actually has only fallen by 6% from its peak early this year. And it's still around 40% above pre-pandemic levels. Just to kind of put that in context. So, prices now are close to where they were in February 2021 and that was a month in which we were already all concerned about the increase in prices and how far prices have diverged from incomes and fundamentals, and what this means for affordability for first time homebuyers. So that is all to say that historically, prices remain very elevated with the declines that we're seeing.

SM: Mmmm. I’ve heard the term balanced market used when it comes to housing. In fact, John just used it just a few minutes ago. What does that mean and is that what we’re seeing? Because that seems like a far cry from a housing crash.

FO: Yes, we are in a balanced market territory now. So, when we say balanced market, we are referring to the sales to new listings ratio. That's a ratio that is used as an indicator for how tight supply/demand conditions are in the market. So, if it's one standard deviation above its long-term average, then we are in a seller's territory. We've got high sales and demand, low listings and supply, and therefore this is a seller's market. If it's one standard deviation below its long-term average, then this is a buyer's market, whereby buyers have more price-setting power. And it's also a leading indicator which means, say, today, it is in seller's market territory. This indicates future upward pressure on prices. So, when we say the market is in balanced territory, we're just saying that the ratio of sales to new listings is in line with historical levels, nothing more. And that's definitely not a bad thing and most definitely doesn't equate to a crash to have the housing market in a more balanced territory. And that's not across the board. We still have some cities in seller’s market, we still have some cities in balanced and we still have some cities in buyer’s market.

JW: Yeah. I'm not sure how reliable a measure sellers versus buyers is, but we speak to it that way. I think Farah’s pointed out — it's a bit of a rough measure. I think that we have to put this into perspective, the pandemic boom in housing is over. We're not in an ultra-low interest rate environment. In fact, it's the contrast now, so we've seen significant increases and we anticipate there will be more increases in the interest rates. So that obviously influences you as a borrower or a purchaser in terms of trying to plan for what you can afford and what you can sustain, also that's a reflection of the economy. But remember in the pandemic we had a number of things going on; working remotely, people looking further afield, people wanting to have a different kind of experience in their dwelling. So, you know, we had the rise and increase in people moving further away from their existing market where they might be employed. We had overwhelming demand for recreational property. All those things happened at once during an ultra-low interest rate environment. So, I think most people in the industry look at it as a return to sort of 2019 as the base case in terms of looking at pre-pandemic levels. Certainly, from our perspective, we were growing at a year-over-year rate of anywhere from 14 to 16%, which is unheard of, to have that kind of double-digit growth. So, we see the adjustment both in prices as stabilizing. Affordability though will continue to be an issue because that is a function of demand. And we still have overwhelming levels of new households being formed through immigration. And we have a lot of millennials out there, as the Royal LePage recent survey indicated, that want to get into the market and are determined to get into the market. So that demand will continue to exceed our capacity to produce housing.

SM: Right. So, a lot of volatility for all those factors that you just mentioned over the last couple of years. But in some sense, we're kind of getting back to somewhat along the lines of what we were at just pre-pandemic. But do you still see — and I think other experts are saying — we're likely to continue to see a decline in housing prices as interest rates continue to rise? What's your view on that, John will go below those levels that we saw in 2019? How low can it go?

JW: Well, there's been a number of prognosticators that have said anywhere from 18 to 20% decrease overall in the average price of a home. I don't think we've seen that so far where we are, we're still at higher levels of household pricing from  pre-pandemic. So, they have gone down from the peak in last March when we spoke, but they're not below where they were pre-pandemic. So, I don't think we'll see that. I see this more as an adjustment and a rational one than a fall. And I think it's, you know, encouraging for consumers, but we still are challenged in affordability because we just don't have enough supply. And then as well, the costs of construction have gone up significantly materially. The supply chain has had a major impact on that. So unfortunately, if you are in the market and want to buy a home, it's still going to be very challenging, particularly in our major urban markets.

FO: Yes, absolutely, prices are predicted to continue to fall, but that won't bring them back to historical levels, that they will remain elevated. And as John said, this kind of decline is just reversing some of the irrational increases that we've seen over the past two years. And when they were happening in the past two years, we were talking about how unreasonable they were and we were, you know, wanting them to stop and now that we are reversing some of it, you see the conversation immediately shifting to, oh my God, prices are falling as the world's crashing. And I do think it's important to just kind of zoom out and not focus on monthly or high frequency data points and just look at the overall trend and levels and how we compare to household incomes and demand.

SM: It's true, you know, we have to look at it sort of from 10,000 feet, from the larger scale macroeconomic perspective. But for those people who bought during that period, whether it was reasonable or unreasonable, those people are looking at the value of their house decline. What do you say to those people who bought at the peak and are now seeing the value of their investment? I mean whether you look at it as an investment or not…

FO: I was gonna say ideally, those people, you know, purchased a home to provide a roof over their heads rather than an investment that they now are rushing to sell and feeling like they bought at the peak. And another thing is that those people bought at the lowest borrowing rates, so they locked in the lowest rates, particularly if they got a fixed mortgage rate. As John said, a part of the equation is also the qualifying rate. They were able to qualify at much lower rates.

SM: Right.

JW: Yeah, market sentiment turns really quickly. So, you know, in March, we would have been talking about how can we maintain this outsized growth? Bank analysts are obsessed with the housing market because the mortgage portfolio’s such a large share of the balance sheet of any of the banks, right? So, they are always moving very quickly to see what the trends are. The reality is that it's a very small percentage of our portfolio that involves purchasers that did buy at the top of the market if you will. And as Farah said, they were locking in into low rates and they know what their payments are. Typically, if you're in a 5-year. I think industry participants are more concerned that if we get to the 5.7, which I agree we will as a 5-year fixed rate, we're pretty close to it now. What has to happen is, I think at the end of the year, OSFI and Peter Routledge has undertaken to review that qualifying rate. Because underwriting people at 8% is not going to work and it's not fair. And so, I think people are hoping that the need for the qualifying rate that worked out really well to provide an interest-rate cushion during those ultra-low interest rate times is no longer necessary and that will provide some relief. Also, employment, you know, we're at what most people would have described as full employment. We're looking to see has inflation peaked? Is there a strong economic rebound if we are going into a recession? How deep? I think when all of those issues become more known and stable, you'll see a return to a typical pattern that is really driven by demand, household formation, immigration, millennials. Those are the things, along with employment, obviously, that will drive it. Even with rates high, it seems as if consumers want to get into the housing market. I think they have a long-term belief that prices will continue to rise and waiting is not a solution.

SM: So, what are you telling people now? Is this a good time to jump into the market? Obviously depends on people's individual circumstances, but prices are down, interest rates are up. What kind of questions are people asking you?

JW: I always tell people there's always another train leaving the station. You know, this is the largest financial transaction that most Canadians make in their lifetime. So, you want to approach this and be, I think, cautious about how much you want to spend, what can you afford in terms of debt service and you know, how does that fit into your lifestyle? So, I think what you said is very representative of most people I talk to, it depends on their circumstances. Where they are in their life stage, what their need for housing is. You know, there was a big prediction there'd be a lot of downsizing. There was some activity where people were selling their single-family residence and buying into multi-unit condominiums, for example. That hasn't happened at the rate that they thought for boomers, people are staying in their houses longer. You know, you have the phenomena of reverse mortgages, things like that. People have not left and we just haven't added to the supply. And I know lots of young people that talk to me on a regular basis about getting into the market. Their concern is not about the price point, it is, how do I manage? How do I develop a financial plan that will sustain me? Because affordability is a real issue, I would say, for the majority of people that I talk to that are contemplating buying their home, particularly their first home.

SM: Right. I want to come back to the demand side of things and I’ll come back to you in a moment, Farah. But I have to ask the question, cause I'm sure people are asking you: fixed or variable?

JW: People do ask that question, it’s the obvious question and it's really a function of the delta between the variable current rate and the fixed rate. And what happened as rates were rising. The variable was still so overwhelmingly attractive, more than a percentage point cheaper. So, I think that it depends on your circumstances. That's why you need to get advice. Talk to a home financing advisor, you've got to look at what can you afford? The certainty about the payment amount. Do you want to gamble on variable going up or down? That's a risk factor. If you're going into your first-time home, you've got to be concerned with your debt service, but people always forget about ongoing maintenance issues, furnaces that go, roofs that leak. Those are all the things that I talk to people about having a more holistic financial plan. How long do you want to pay off your mortgage? You know, Canadians are obsessed with reducing their 25-year or 30-year amortization down to something like 10 or 15. They're very responsible about paying down household debt. The majority of homeowners don't have a mortgage. The media loves to talk about this housing market and why wouldn't they? We love talking about it too. It's one of the best shows in town, let's face it. But it's not without its risks or consequences. And as I said, you're making a major financial decision for you and your family and it's an emotional decision. It's not just about the interest rate.

SM: I want to come back to you Farah to talk about the demand side of things. Prices have gone down, it's a bit more of a buyer's market than it is a seller's market as a result. But there are a bunch of factors—and you both mentioned them in passing—a bunch of factors that are going to contribute to demand being steady, that there's going to be continued demand in Canada. Can you talk a little bit about what those factors are that are going to continue to drive demand even as prices are coming down?

FO: Yes. Well, you know, we talk about a reduction in sales, but we still have large volumes of sales happening every month that we're discussing the decline, the reversal, we still have a good chunk of people participating in the market because they need a home and that will never change. People will either be buying or renting and the units that are rented are bought by somebody else. So, the demand will always be there. In terms of moving forward, when prices fall, you've got affordability improving. Home prices, as they decline, become more affordable. Now, of course, that is partly offset by the increase in borrowing rates. But on net, the increased affordability from the decline in houses for some buyers where the net effect has increased affordability, we're going to see an increased demand from there. You know, investors initially are quick to drop out of the market when rates increase because they have higher debt-servicing ratios and their demand is more sensitive to profitability and business costs. So, we might see some of those come back to the market as they get used to the current state of affairs and to kind of respond to heightened rental demand as you know, people who shifted from the ownership market go into the rental market. Some investors would want to respond to that market signal and prop up demand. And of course, we've got immigration and that's a big part of it because we've got a federal government that announced higher targets of immigration for this year and next. But the reason why it's important this year relative to last year is, we met our immigration target last year. It was lower than this year's, but, you know, it wasn't zero and we still met it. But the way that we met it is by mostly accelerating the status of people who were already landed in Canada and we made these temporary residents, permanent residents. And we met the target. So, it didn't really translate to an increase in population. But when we look at the share of the PR admissions this year, that are not from people who were already in Canada, but are from people actually coming to the country. We're seeing that share increase this year. And we're seeing a shift to actually bringing more people in. So, these new higher immigration targets this year and next and the one following will actually translate to more population growth, more demand.

SM: Okay.

JW: Well, just to pick up on a couple of things that Farah said, I think they're important to point out. There were a number of comments made about the impact of investors in housing and that they were also sucking up the necessary supply. And so, regulators and commentators were concerned about the number of investors. Because as Farah mentioned, the ultra-low interest rates made it very possible to buy investment properties. So, if you are concerned about that being a real issue, that is going away, because the negative carry with these high rates doesn't inspire investors. And also, as you mentioned, the psychology around, ‘maybe I should wait and it's going to be a lower price.’ So that factors into it as well. So that's an important distinction to draw because investors as well as foreign purchasers have been viewed a little bit as the boogeyman, soaking up the supply. But as Farah mentioned, like if you're going to invite 500,000 new Canadians, I think as a society and as a government, it's irresponsible not to look at this and meet this supply challenge. And for tenants and renters, it's also been a problem. So, what's happened in the markets recently is rentals are all at high water marks because of the lack of supply. So, investors, particularly in condos, were providing as Farah said a lot of that rental stock and now that's gone away. So, there are challenges. There has been some movement at all levels of government. I just don't think it's enough. It's not dramatic enough. It can't be fast enough. We can't build enough to keep up with the demand.

SM: Okay, I think we’re about ready to wrap it up. I just want to get one more final thought from each of you. What would you say to someone who is looking to get into the market? Or somebody who is looking at moving or selling or buying. What should they be thinking about over the course of the next six months to a year? Farah?

FO: Yes. Well, overall for the market, I will just say that to make sure that one is zooming out. Not focusing on short-term headlines and remembering that the market is just recalibrating and correcting. Which has been a reasonably orderly and welcome process and it is not a signal of a distressed labour market. It might seem alarming right now, given the speed of the slowdown and how much media is focusing on it. The speed is related to many factors that I won't get into right now. But once those kind of settle in, we can expect a more comfortable pace of adjustment. In fact, July’s decline was the fifth monthly one in a row. But the declines have been getting smaller each month. And in the longer term, as we said, fundamentals including the acceleration of immigration and the challenge to increasing supply will kind of put a floor on the adjustment.

SM: John?

JW: I think it's important to understand that the highs and lows we focus on, but the market looking forward is quite stable. So, we'll get through this little blip of the balance of ‘22 and I think that you'll see real estate is a long cycle. Even in residential real estate, you've got to think about it. Because, as in the United States where they actually sign long-term contracts, here, you know, you're signing up, Stephen, on a mortgage that's typically going to amortize over 25 years for you to completely pay back the principal and interest. So, you got to play the long game. And as Farah said, you're buying a home, you're buying a home for yourself, for your loved one, for your children, for your extended family. And we all know what is involved in that, in terms of we all have disappointments with where we live and a number of the features and people focus on kitchens and bathrooms and the typical stuff. But I don't know anybody that doesn't look out, whether it's landscaping or improvements that they like to make that doesn't say, ‘housing is really important to me because it's not just about my livelihood, it's where I live and how I unwind and I want a pleasant space.’ Right? So that's a decision that isn't about picking a point in time and saying, are interest rates at the right moment? Is pricing at the right moment? You're looking and taking a more long-term view. And if you've taken a long-term view, I think you're better off to make the decision to be a homeowner if it's possible. If you can come up with a down payment. I advise people that looking back from 20 years later, you'll be pleased with the decision you make. I don't meet many people who say to me, you know, I really regret stretching to buy that first one or the second residence. In fact, they say it's given me comfort in my own personal net worth, it's given me some security for my retirement or the golden years that approach you, Stephen, you want to know that you've built equity in your home. And we're here to help you do that.

SM: We’ll leave it there. John, Farah, I want to thank you again for coming. It’s always such a great conversation.

JW: Thanks for having us.

FO: Thank you.

SM: I've been speaking with Scotiabank Economist, Farah Omran. And John Webster, Scotiabank’s Head of Real Estate Secured Lending. And hey, if you haven’t yet, be sure to follow us on your favourite podcast app. We’re on Apple Podcasts, Spotify, Amazon Music or wherever you listen. For a transcript of this episode visit scotiabank.com/perspectives. See ya next time.