REAL ESTATE CONFIDENTIAL Do House Prices Always Go Up?

Chris Kapches, President & CEO of Chestnut Park Real Estate Limited, Brokerage, is a lawyer with an extensive career working within real estate organizations. Chris has served as Executive VP for the Toronto Real Estate Board (TREB), as well as roles on numerous TREB committees. Chris has been the Chairman of the Real Estate Council of Ontario’s Discipline and Appeals Committee for more than fifteen years.

Do House Prices Always Go Up?

House prices are driven by a number of economic factors. The two most important are mortgage interest rates and household income.

As long as buyers can pay more, which they were able to between 2019 and mid-May 2021, prices will increase, as they did. There is no question that going forward demand will exceed supply, and that’s before immigration to the greater Toronto area resumes.

The simple answer is both yes and no. This is not a facetious statement. It’s ambiguous because house prices are driven by a number of economic factors. The two most important are mortgage interest rates, and household income. The question related to rising home prices has been front and centre for some time but has become more urgent during the Covid-19 pandemic. This analysis is primarily focused on house prices in the Greater Toronto Area. Other factors have come to play in secondary markets which are beyond the scope of this article. During the pandemic, average home prices have skyrocketed. Until we dig deeper into the economic factors at play, this seems counterintuitive. So, what has happened during the pandemic to cause prices to increase to the stunning heights that they have reached? To answer this question, it is necessary to look at what was happening in the housing market even before the pandemic. Two developments were occurring simultaneously. The housing shortage in the Greater Toronto Area had become critical, and mortgage interest rates were falling. The number of available properties for sale was simply not enough to meet demand. Consequently, there was always a buyer or two, or more, for every property that became available. But demand alone will have a marginal impact on rising prices. Households, for the most part, have fixed house-buying ability. Basically, this means they can only buy what they can afford, so no matter how many buyers there are for a property, its sale price will ultimately reach a number that aligns with the purchasing power of the buyers – not counting outliers who are funded by parents, relatives, trust accounts, or foreign buyers. Canada Mortgage and Housing Corporation indicates that the average household income for Toronto in 2019 was $109,480. Not taking into account the effect of the pandemic on wages, (many have lost jobs and household incomes have declined for some households), applying an annual three percent increase to household incomes since 2019, roughly the increase in the cost of living, the purchasing power of households should have increased and should have the effect of increasing average sale prices by a similar percentage.

Buyers have had more purchasing power, and since there were a lot of them, they drove prices to the limits of their purchasing power.

In 2019, the average sale price for homes sold in the Greater Toronto Area was $819,057. Applying the compounded increase in household income over the same period, the average sale price by mid-2021 should be approximately $895,000, an increase of a little over nine percent.

However, the Toronto Regional Real Estate Board reports that in April 2021 the average sale price for all properties sold was $1,090,992. This represents an increase of over 30 percent. So, what happened, and why did house prices increase so dramatically? The answer is mortgage interest rates.

In 2019, five year posted mortgage interest rates were 4.29 percent. Since 2019, interest rates declined to 3.49 percent. The decline appears to be small, a mere 0.8 points. In percentage terms, however, this decline is closer to 20 percent. Based on my assumption, in that three-year period, the average household income increased by more than nine percent while at the same time mortgage interest rates decreased by almost 20 percent. It’s not surprising that the increase in average sale prices over this period jumped by the combined increase in household incomes and the decline in mortgage interest rates.

As I mentioned above, there was massive pent-up demand even before the pandemic. That demand exploded in the latter half of 2020 and continues on to the middle of 2021. Through this period, buyers have had more purchasing power and since there were a lot of them, they drove prices to the limits of their purchasing power and prices reached record levels.

Returning to the question “do house prices always go up?” the answer is that as long as buyers can pay more, which they were able to between 2019 and mid-May 2021, prices will increase, as they did. There is no question that going forward demand will exceed supply, and that’s before immigration to the Greater Toronto Area resumes. The federal government is hoping to attract 400,000 immigrants to Canada in 2022, a large number of whom will end up in the Greater Toronto Area. Even with more supply coming to the market, the increase in immigration will mean more demand and continued pressure on prices.

Interest rates are expected to increase, even though this is not welcomed by the federal and provincial governments – they are, after all, massive debtors. Other economic forces will drive the increases. If rates increase by a single percentage point, that is a 28 percent increase. In June, 2021, the increase in the threshold for mortgage qualification will increase as a result of higher levels of stress testing. That means buyers will have to consider lesser-priced properties, and since they will have less purchasing power, prices are not likely to rise, and, in certain instances, will moderately decline.

This has been the story of rising house prices since 1996 when mortgage rates first began their decline. In 1995, posted mortgage interest rates were 8.95 percent, 157 percent higher than they are today, with average sale prices correspondingly lower. Rates had fallen constantly since 1990 when the mortgage rates were an eyepopping 13.25 percent. Prices did not begin to rise until 1997 when the rates fell to seven percent.

Setting aside any possibility of government intervention or legislative micro-management, prices will rise if people can pay more – more accurately, service more debt. If rates rise, buyers will have less purchasing power and will have to lower their expectations. Either way it will modify house prices. So, can house prices decline? Yes, but that is not likely given that rates are not about to rise dramatically. Rather, we are likely to see prices stabilizing because of slowly rising household income and more costly debt service.

The Toronto Regional Real Estate Board reports that in April 2021 the average sale price for all properties sold was $1,090,992. This represents an increase of over 30 percent since 2019.