Andrew's Musings - September 2022

Fortune Favors the Brave

Yesterday, the Bank of Canada announced another rate hike of 75 bps, which met market expectations, but it will further soften Canadian real estate markets. Major banks are now taking an even more bearish view of housing prices, projecting a 20%-25% decline from the peak in February, and they are already down circa 15%. This sounds dramatic, and it’s a sharp correction, but it only retraces about half of the spectacular 46% run-up during the past two years; easy come, easy go.

Many who purchased at the peak will find themselves underwater for now, but so long as they’re able to weather the storm, and make their monthly payments, they’ll find themselves whole when prices recover. Unless things get nasty, and the slowing economy results in major job-loss, the vast majority will be able to weather the storm.

However, given our entrenched behaviors, and the relative size of real estate in the Canadian economy, there will be immediate knock-on effects, which may prove painful for many. The loss in equity of 25% is significant, and this loss curtails the ability to borrow against the equity in the home, typically via HELOC loans. These loans are commonly the vehicles to finance home renovations, and are also used for down-payments on investment rental properties, and recreational properties, like Muskoka cottages. When home prices were rising, these proved financially prudent moves, and banks would lend at will. A new kitchen was not mere indulgence, but a sound investment, a cottage property purchased in the past many years, was a sure winner, however, with declining prices, these choices become more complicated, at least in the short-term.

High inflation has had an immediate impact on consumer debt levels, as more than a quarter of Canadians report taking on debt to cover monthly expenses. The average Canadian has north of 21,000 in consumer debt, excluding mortgages, which is up 2.4% from last year, and this is worrisome. Blackstone has already earmarked $50 billion to buy-up Canadian real estate bargains, which they foresee in a recession over the next 36 months. This move is borrowed from the playbook of the US housing crash of 2008, where banks bought large tranches of homes for 30 cents on the dollar and prospered handsomely over the following two years in a quick recovery.

In terms of immediate housing affordability, little has changed; the declining prices have been offset by higher mortgage payments, and lower mortgage caps, and of course higher household expenses with inflation. As we saw last month, a lower purchase price reduces the size of the mortgage required, the down payment, and the land transfer tax; the upshot is that the monthly payments become about the same. A quick analysis finds that unless interest rates exceed circa 8-9% over the next five years, the affordability of a house purchased at the peak with lower interest rates, is about the same one purchased today, with higher rates.

What does all this mean?

It’s likely to result in fewer transactions, with sellers’ wishing to wait until prices recover before listing, and buyers electing to defer purchases amid uncertainty of further rate increases, and the overall state of the economy, not to mention significant and growing geopolitical risks of Russia in Ukraine, energy shortages in Europe, and China vs. Taiwan. But wait, there’s always a silver lining.

The Silver Lining

Fortunes are made by bold actions of contrarians, and volatility and turmoil bring about opportunity. In terms of residential real estate, for those wishing to upsize, there will be buying opportunities for interesting properties in the months ahead. Price recovery may take some time, but with immigration north of 400k per year, and limited attractive land available, Toronto, is a sure long-term bet. Even now, exceptional homes in desired areas, such as Rosedale, Toronto, remain highly sought-after, and continue to show price resilience; properties are still trading reasonably well. However, my guess is that luxury items such as Porsches and hot boats, which remain at a premium, will soon whipsaw, and become readily available, but only time will tell. In any case, we’ll keep our eyes peeled and ears to the ground to uncover exciting prospects. Please stay in touch, and contact me directly for discussion anytime.