In the run-up to the Bank of Canada’s first rate cut in June 2024, every real estate office in Canada was buzzing with talk of an impending mortgage “renewal shock” or “renewal cliff.”
Words went into turmoil in October 2023, when Darko Mihelic, an analyst at RBC Capital Markets, estimated that about six in 10 bank loans would be extended until 2026, with payments rising by as much as 48 percent.
Fortunately, a spiral of defaults did not occur, thanks to a convenient mix of falling interest rates, rising incomes, government mortgage restrictions, accumulated home equity (some of which later evaporated), and government-sponsored lender forbearance.
All of this helped stabilize Canadian real estate values ​​after a painful decline since the winter 2022 highs.
In the end, almost everyone survived the 2022-23 real estate earthquake, albeit with a loss in their home equity.
But what if this quake wasn’t the only one? What if it was just a foreshock for the next quake – one building beneath our feet today?
And for the record, I’m not an apartment guy who likes to write dramas for people to watch. I also don’t like being the Debbie Downer on a day when data from the Canadian Real Estate Association (CREA) shows average home prices rose twice as much last month as usual in April. (CREA’s main price measure, the MLS Home Price Index, fell 0.1 percent in April from the previous month.)
But it’s also nice to be realistic. Aside from improving affordability and pent-up demand, most fundamentals looked decidedly poor:
- Shrinking population (mainly due to the expulsion of Canada’s temporary residents – who typically rent, although rental demand also increases the value of homes)
- Well-known weakness of condominiums
- Government supply initiatives (which admittedly have not yet borne much fruit in the home market)
- High household debts and oppressive living costs
- Full-time employment that seems to have reached its peak
- Increase in housing completions (mainly rents, which affect house values ​​due to the substitution effect)
- General economic uncertainty
But all of this takes a back seat to the heavyweight cyclical driver of price movements: interest rates. Nothing is causing demand for real estate to fall faster than rising mortgage rates.
And interest rates answer one master above all: inflation.
Most key inflation metrics have pointed straight upward in the past two months, reflecting Iran’s stranglehold on oil shipping through the Strait of Hormuz.
Central bankers are hoping (praying?) that Iran will give in and allow oil to flow again soon. But after U.S. producer prices hit nearly three times estimates on Wednesday, that prayer appears to be unanswered.
Inflation in Canada has so far responded more slowly to the global energy shock than in the U.S., but could recover somewhat according to next Tuesday’s CPI reading.
Growth from fiscal stimulus and AI investments is also driving interest rates higher, as is cross-border upside as investors demand higher term premiums on U.S. bonds to offset rising risk. These premiums are now at multi-year highs for five-year Treasury bonds. Even Canadian term premiums have recently traded near 10-year highs.
What is at stake
If the Bank of Canada actually pulled the trigger and raised interest rates, housing would immediately feel the pinch. For example, an increase in mortgage interest rates by 100 basis points reduces purchasing power by around 8.5 percent. That immediately limits the amount most people can pay for houses.
Additionally, other things being equal, higher mortgage rates on renewals typically mean higher default rates, more home listings, and somewhat larger systemic losses when home prices hit new lows.
Worst of all, successive cycles of rate hikes, if one actually occurs, would deplete the resources of some of the 36 percent of homeowners who say they are already struggling to make mortgage payments. And by my calculations, almost a quarter of this group has a renewal date in the next 12 months.
And let’s not forget the head of the Office of the Superintendent of Financial Institutions (OSFI), Peter Routledge, who estimated this year that up to 30,000 to 150,000 households could be particularly vulnerable to a renewal.
Most of them wouldn’t default, but only 13,749 bank mortgage holders are in default today, so it doesn’t take much to noticeably increase the default rate.
What I’m saying is that this humble author wouldn’t bet the children’s college fund on housing prices going up in 2026. And no one should be borrowing that much money to buy something at this moment.
For all anyone knows, the green shoots sprouting in Canada’s real estate garden may turn out to be weeds in disguise.
In perspective
Ultimately, sinking into the housing crisis is a fool’s errand and certainly not wise in the long run.
Longer term, the fundamentals are still in the housing corner for several reasons:
- Sooner or later Ottawa will turn the immigration tap back on to a normal flow. (There is no real option as Canadians are not producing children at a sustainable rate.)
- New arrivals tend to settle in urban centers, which only drives up prices in major markets.
- The current shortage of homes is likely to come back to us in a few years.
- The number of older people continues to increase and an ever-increasing proportion want to age in place, taking supply away from the market.
- Construction costs are not exactly declining.
- Restrictive land use regulations/zoning will not provide significant improvements, and most importantly…
- As soon as a recession is likely, interest rates will fall again.
With all that’s on the table, there may be another quake before Canada’s real estate dust settles.
This is particularly likely if inflation expectations become unanchored and/or average core inflation is well above three percent, at which point the Bank of Canada is almost contractually obligated to raise them.
Robert McLister is a mortgage strategist, interest rate analyst and editor of MortgageLogic.news. You can follow him on X at @RobMcLister.
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