Canada Facing Affordability Crisis in Housing

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Benjamin Tal, deputy chief economist, CIBC.

The question is what’s happening now with interest rates and inflation, and in mid-May, we got the CPI numbers for Canada. Stronger than expected. This means that the Bank of Canada will get a bit more nervous about inflation and therefore about interest rates. Quite frankly, the likelihood of the Bank of Canada raising interest rates, let’s say in July, has risen notably due to those inflation numbers and the fact that the labour market is relatively strong. So, the Bank of Canada was ready to pause already, and now new information is entering the market.

To me, this is the beginning of overshooting, if they’re actually going to go ahead with that. Every economic recession, in my opinion, was helped, if not caused, by monetary policy error in which central bankers raised interest rates way too much and killed the economy.

That’s because of the fact that inflation is a lagging indicator. Employment is a lagging indicator. But show me the central banker that will have the guts to stop raising interest rates when inflation is still elevated, and that’s exactly what we’re seeing now. So, unfortunately, the risk of the Bank of Canada starting a process of overshooting has risen. Still, our call is for the Bank of Canada to stop where it is now, but I admit that the risk of the Bank of Canada raising again has risen dramatically since mid-May.

Now, this also means that if you are overshooting, you are going to put some pain into the economic trajectory. Therefore, the risk of a more significant recession has risen as well. Again, we are not calling this kind of a recession, but the risk has risen. So, from an economic perspective, we have to realize that the environment is a bit different, the Bank of Canada is a bit more nervous, and the risk of overshooting and therefore a more significant decline in economic activity has risen over the past few weeks.

Regarding the housing market, one of the reasons why the Bank of Canada is talking or tweeting about the possibility of raising interest rates again is the housing market. Clearly, the housing market slowed down dramatically, but as all of you know, it’s stabilized already. We have seen some increase in prices lately, and that’s premature. That’s too early for the Bank of Canada. They want to see more pain not only in the housing market but also in the labour market, and we are not seeing it yet, and therefore, you need to raise interest rates, and therefore, the risk of overshooting has risen.

The housing market has seen significant volatility. We all know the story. Prices went down notably, but that’s a very healthy situation. After rising by 46% during COVID due to the fact that home buyers got the benefit of a recession vis-a-vis low interest rates without the cost of the recession vis-a-vis a broadly-based increase in the unemployment rate, we needed to see a significant decline in prices and activity. That’s exactly what we have seen.

However, we have to realize that one thing is happening. Supply is not rising. Not only new construction, but in resale. The resale market is not moving when it comes to supply. People are not listing, and when you don’t have listings, it means that prices are protected due to lack of supply. And that’s exactly what we are seeing now in the housing market, a very asymmetrical housing market. So, what we are witnessing now is some improvement in the relatively cheap segment of the market. Let’s say in places like Toronto, anything between 800K and 1.2 million go very fast. You go to $1.5, $2 million per unit, you don’t move at all. So, condo developers are unable to close, and clearly, in the detached market, very, very weak if the price is over 1.5 million. So clearly, this is a market that is still rewarding relatively cheap units because of affordability.

It’s not going to change anytime soon. And if the risk of higher interest rates is materializing, then we have an issue in which the housing market will go through another slowdown, because at this point people are counting on the Bank of Canada to pause, so the risk of the housing market is there.

The housing market has been very volatile. Prices went down dramatically. Sales went down dramatically. The only thing that saved the market in terms of prices is definitely the lack of supply, so people are not listing, and that’s something that we have to realize is going to continue to be a major force in the housing market. But clearly, we have seen a lot of volatility, and not a big surprise. In an environment in which interest rates rise by 400 basis points over the course of breakfast, clearly, a housing market will slow down, and that’s a very healthy environment.

Maybe this stabilization in the market is premature, but it’s clearly a positive signal. The Bank of Canada would like to see the housing market slowing down further before they start cutting interest rates, and that’s more or less where we are.

We have to realize that whatever we see in the housing market now, any slowdown is only a blip. This is a very tight housing market. Last year, we got no less than 950,000 new immigrants, non-permanent residents, people from the Ukraine, students. 950,000. This year, I estimate roughly 1.1 million. None of them, none of them, carries their house on their back. Clearly, we are going to see a major issue, a mismatch in the labour market between supply and demand. We have a lot of demand coming, especially in the rental market, and we have lack of supply in the recent market and, clearly, in the new construction market, and we need to wake up. This is an affordability crisis that we are facing.

So, whatever pause we are seeing now is only temporary. The long-term trajectory of this market is up if we don’t do something about supply. It’s urgent, and I think that the next elections, by the way, will be fought over housing, and I think that politicians are starting to realize that.

Well, when it comes to prices, depends what kind of prices we are talking about. At relatively cheap units, again, in Toronto, something between 800K and 1.2, prices are starting to rise because the demand is there, and we know we don’t have enough supply. For the rest, prices are stabilizing or even still falling. I do believe that if the Bank of Canada starts raising interest rates again, and we are going to slow down in the economic activity, moreso than we had predicted before, then we will see another wave of pressure in the housing market, and prices will continue to go down due to lack of demand.

This is a risk scenario at this point. This is not demand case scenario. So, I say prices will start rising from this point over the next six months, 12 months, for relatively affordable units while stabilizing for more expensive units and still going down for extremely expensive units.

Given all this, we know that we are in the midst of a major affordability crisis, and something has to be done. The slowdown in the housing market now is only temporary. It will not last. The fundamentals of this market are very strong, extremely tight. Vacancy rates in the rental market are approaching zero, and as I suggested, every year, we are getting close to 1 million people into this country, so we need solutions. And a rental solution must be a big part of this affordability solution.

It seems that for the first time, governments are realizing that. For many years, we basically used tools to fight supply issues. For the first time, governments at all levels are realizing that supply is the issue, and we are talking about all kinds of initiatives. Unfortunately, we are not moving fast enough. We have to provide incentives for purpose-built rental. Apartment buildings. Not condos, apartment buildings.

We have to provide the reduced development charges, the fair HST payments. Basically provide incentives to developers to build apartment buildings. That is a big part of the solution. We need to create an affordability issue in which you are a renter, and it’s okay. Nothing is wrong with that. We have to change the way we think about renting, and the only way to do it is to provide high-quality rental apartments. It’s possible. It was done in the past. What we need is incentives, and although people say you don’t want to support all those millionaire developers, you are not supporting them. What you are doing is basically providing incentives to build more units to increase the supply that is so lacking in this environment.