Are House Prices About to Fall?

// REAL ESTATE CONFIDENTIAL //

Are House Prices About to Fall? The answer requires a consideration of four factors.

The incredible increase in sale prices of homes, especially since the beginning of the pandemic, has generated skepticism about the sustainability of the residential real estate market. Prices in the greater Toronto area have increased by more than 30 percent since 2019. Similar and higher increases are being experienced in almost every community in southern Ontario, from Hamilton in the west, to Barrie and Southern Georgian Bay to the north, to Prince Edward County in the east. At the beginning of 2022 the average sale price of a single-family home in Toronto was almost $1,700,000.

The dramatic escalation in the price of homes is not restricted to southern Ontario. In fact, it has become a global phenomenon. This unprecedented increase in the price of homes has not gone unnoticed. The International Monetary Fund (IMF) announced that its global house price index has far exceeded the peak it reached before the 2007-2009 financial crisis. This assessment begs the question – is the real estate party about to end?

The IMF cites a number of legitimate concerns that it believes will negatively impact the market. As government and societies combat and cope with the corona virus, governments are beginning to wind down economic stimuli. Consumers are spending again

and no longer hoarding money. People are beginning to travel and taking long-postponed holidays. Monetary policy is being tightened. Inflation has reached levels not seen in decades making it an absolute certainty that mortgage interest rates will rise, probably by the end of the first quarter, and perhaps sooner. Canada’s inflation rate in January was almost five percent.

In the face of these changes and challenges, the IMF has pronounced that there is a significant downside risk to house prices and that the current level of house prices is unsustainable.

But is this really the case?

The economic and real estate landscape is very different today than it was before the financial crisis. There are fundamental factors at play today that explain why house prices are so high and that they are very likely to remain that way, notwithstanding the concerns of the IMF. There are four forces at play that will not only cause houses to remain high, but to continue increasing. This is particularly true in southern Ontario.

Firstly, people are less financially vulnerable to rising interest rates, which are likely to be moderate in any event. Banks learned their lessons after the financial crisis and are substantially more stringent with their lending practices. Even Canadian Banks, already prudent lenders, have tightened their lending policies.

Since 2018 borrowers have had to qualify for mortgages at much higher interest rates than the actual rates which they will be paying. Mortgage stress testing requires borrowers to be approved at approximately 5.25 percent. Five-year mortgages are currently under three percent. Any renewal of mortgages that have been issued in the last few years will be at rates well within the borrower’s financial abilities to pay higher rates. As a result, it is most unlikely that banks will have to take collection action, which leads to distress sales which cause prices to decline.

Secondly, consumer and household preferences have changed dramatically in the last two years. More and more people are working remotely resulting in the need for home office space. People want open space, gardens, and less dense environments. Only single-family homes can meet these needs. This also explains the diaspora from dense urban markets to the communities that halo the greater Toronto area.

Thirdly, and very importantly, is the lack of supply. The supply of housing has simply not kept up with demand. Government policies and Byzantine regulations have made it difficult and expensive for builders to get shovels in the ground and for developers to build to fill the “missing middle.” This is particularly true at the local level where politicians are influenced by community nimbyism, and pander to vocal anti-development taxpayers.

In the greater Toronto area supply has diminished to shocking levels. This is best illustrated by looking at resale inventory levels today compared to inventory levels twenty-five years ago. It can be argued that in 1996 the market as we know it today began to emerge. That year, the Toronto Real Estate Board reported more than 55,000 sales, a new record at that time. The previous six years had seen real estate prices decline by more than 30 percent. By the end of 1996 that downward spiral was reversed. At that time the average sale price was $198,150.

A look at data provided by the Toronto Board reveals that as 1996 came to an end there were 16,964 active listings available to buyers in the greater Toronto area. Fast forward to December 2021 and, unbelievably, there were only 3,232 available properties – 80 percent fewer! Not only is this decline shocking, but it is even more unnerving when we consider that there are almost double the number of people living in the Greater Toronto Area today.

This brings us to the fourth factor that is driving the market and sale prices upward – immigration. Canada’s immigration target for 2021 was 401,000 people. In 2022 that number is expected to climb to 411,000 and even higher in 2023. In only three years Canada will be welcoming over 1,200,000 immigrants, many of whom will settle in the Greater Toronto Area, further increasing its current population which is currently approaching seven million.

A recent study by the Bank of Montreal looked at population growth and its impact on housing prices. The study analyzed 18 major economies throughout the world between the years 2010 and 2020. It concluded that those countries with faster and larger population growth have experienced dramatic growth in house prices. Conversely, countries with shrinking or static population growth saw house prices stagnate or even falling house prices.

The study cited Canada and New Zealand. In both countries the populations grew by one percent annually. Correspondingly, home prices in New Zealand grew by 7.9 percent annually while Canada’s prices grew by seven percent. At the other end of the population spectrum, over the same period, Japan’s population declined by 0.2 percent every year and, correspondingly, home prices were stagnant. Based on immigration alone Canada’s and the Greater Toronto Area’s population will continue to grow. The findings of the study point to higher house prices for southern Ontario, including communities outside of the Greater Toronto Area. The nature of the immigrants coming to Canada will further put pressure on housing prices. Canada’s immigration policies are more favourable to immigrants with wealth and job skills. Newcomers arriving with money and job skills quickly join the ranks of domestic buyers, increasing the demand for housing, and correspondingly driving prices higher.

These four factors are why house prices will remain high – households are financially sound, shifting household preferences, lack of housing supply, and immigration and population growth. There is little or no likelihood that any of these reasons for rising house prices will change in the next few years, especially supply and immigration. Rising mortgage interest rates may slow the increase in house prices, but their impact will be moderate, because in addition to the four factors currently driving the market, a mindset has developed amongst consumers that will continue to drive up demand. Buyers are now of the justifiable belief that it may not be possible to acquire wealth unless they are invested in real estate. Household incomes have simply not kept pace with rising house prices, particularly since the beginning of the pandemic. That is not going to change and as a result house prices will continue to remain at their lofty levels and even grow higher.

So, is the real estate party about to end? Unless some unexpected economic factor comes into play, the answer is a resounding No!