Bubble burst risk: Canadian home prices predicted to fall by 24%

If the forecast of Oxford Economics holds true, home prices in Canada could fall significantly over the next two years, essentially erasing much of the skyrocketing gains made throughout the pandemic to date.

A recent analysis by the UK-based international research group states home prices could drop by 24% between Fall 2022 and Summer 2024.

The accumulated gains made over the last few years — the years leading up to the pandemic, and especially during the pandemic — have not been sustainable and have essentially created bubble-like conditions, but these are still dissimilar to the harsh conditions that led to the crash in the US housing market in the late 2000s.

As of the end of 2021, Canadian home prices were 19% above the borrowing capacity of median-income households in Canada. And so far in 2022, this upward unsustainable trend has continued, with home prices by Summer 2022 expected to reach a level that is 38% higher than what most borrowers can afford.

Last month’s national housing market update by the Canadian Real Estate Association (CREA) showed the country’s average home price was up by 21% year-over-year, hitting a new record of $748,450.

“We believe this will cause the housing market to reach a breaking point, and crash under the weight of its own success before year end,” reads the report.

Canadian home prices expected to fall 24% by 2024, realgin with household borrowing capacity by 2028. (Oxford Economics)

Other factors that are driving Oxford Economics’ forecast of a home price downturn include the continued expectation that the Bank of Canada (BOC) will raise interest rates. This began early in March 2022, when the BOC raised its key interest rate from 0.25% to 0.5%, the first time the bank has increased its rate since 2018.

Oxford believes the key interest rate will be increased three more times within the remainder of 2022, followed by more incremental increases through 2024 that will bring the rate to 2% by Summer 2024. Fixed-rate, five-year mortgage rates are forecast to go up by about one percentage point to 4.25% by the end of 2020 and eventually reach a ceiling of up to 5% by 2023.

All of this has the effect of shrinking the borrowing capacity of households, which would put a downward pressure on demand.

Other factors considered by the analysis include the federal government’s forthcoming new interventionist policies on housing demand, specifically the tax on house flipping, a ban on foreign home ownership, and a tax on vacant homes owned by non-residents.

But even with a 24% drop, home prices in Canada would still be about 15% higher than before the pandemic, and it would lead to healthier market conditions that pair home prices closer to the reality of what Canadians can afford. Currently, this kind of drop is not expected to lead to a recession.

But the analysis also outlines a possible worst-case scenario of a 40% home price drop over the same period, resulting in a crash similar to what the US housing market experienced in 2008. They emphasize that while this scenario is a possibility that would generate conditions for a potential financial crisis, it is highly unlikely.

“The fallout from a housing crash would look a lot like the US housing meltdown during the global financial crisis, despite a minimal role for subprime lending in Canada,” reads the report.

The forecast currently expects home prices to be in better alignment with the borrowing capacity of households by 2028, but the impact is likely to be uneven across the country. It should also be noted that Canada’s ambitious immigration targets — welcoming over 1.2 million immigrants over three years — are beginning to contribute to the country’s tight housing market, especially in the major urban centers of Vancouver and Toronto.

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