Welcome to Mortgage Rundown, a quick take on Canada’s home financing landscape from mortgage strategist Robert McLister.
Inflation is doing a moonshot and that can’t be good for home prices. Or can it?
If you’re sitting on the edge of your seat, wondering if your windfall home equity will go up in smoke, know this. Real estate is a strong inflation hedge historically, and people believe that it will continue to be. But there’s a “goal.”
Let’s break it all down.
What’s good for home prices?
The stagflation-stained 1970s were a posterchild for inflation.
Canada’s consumer price index rocketed 109 per cent between the first oil embargo of October, 1973, and September, 1981, the month mortgage rates set an all-time record.
During that very same period, home prices gave inflation the bird and shot up 146 per cent.
Now, think about that for a minute. In one of the most devastating economic eras since the 1800s, people took refuge in real estate.
Stanford University research concludes that prices rose because “the Great Inflation led to a portfolio shift … making housing more attractive than [stocks].” Whatever the case, real estate is a scarce hard asset that’s proven itself when the cost of living spirals higher. It’ll likely prove itself again.
And despite all the bubble-talk, which shouldn’t be dismissed, there’s more that could support home values, including:
1. A refusal to list: Resale housing supply is at record lows, leaving homeowners too scared to list before they can secure a new home. Millions of Canadians would love to cash in on their equity bonanza. The problem is, most people don’t want to downsize or move far away. That majority are resigned to not sell at all unless they have to, and that doesn’t help supply.
2. Employment momentum: Canada’s labor market is on fire. More jobs and higher incomes mean more homebuying demand. And free-spending politicians could continue fueling job growth.
3. Net migration: Statistics Canada doesn’t have current net migration forecasts, but the Minister of Immigration plans to admit more than 1.3 million new permanent residents through 2024, and they all need a roof.
4. Equity windfall: Soaring rates make qualifying for a mortgage tougher, but not if you can bag a bigger down payment. Skyrocketing home values have armed parents with gobs of equity. They’re all too willing to gift or loan that equity to reduce their kid’s mortgage balance. This will soften the rate blow to some degree.
5. New-home building: If builders slow home construction as rates soar, like they did in the late 1970s, that, too, could limit supply and support prices. So could the fact that building costs keep rising. That pulls up resale prices, too, given they’re a new-home substitute.
6. Debt assessment: As inflation soars, incomes rise. But most mortgage payments stay relatively fixed. So not only does your mortgage balance drop, your relative debt expense drops, all while you build tax-free equity on your primary residence – a compelling reason to hold for the long run.
What’s bad for home prices
1. Rate increases: Mortgage rates are still cheap versus inflation, but five-year fixed rates under 2 per cent are long gone and won’t be back for years. People now worry that everyone who said rates could never go up a lot may be wrong. In March, 1988, the prime rate surged five percentage points in two years. If today’s Bank of Canada moved even half that much, as the market now forecasts, it would slash people’s home-buying power almost 20 per cent.
2. Unemployment: It usually takes a job to buy a home and recessions don’t help with that. Following Canada’s late 1980s rate increases, unemployment surged almost five points, coinciding with Toronto’s famous housing crash. With the rate hikes we’re facing, a recession within 18 to 36 months is now a serious risk.
3. Weak-handed investors: Most smart rental property investors invest primarily for cash flow. Looking back at history could make them nervous. Data from the Organization for Economic Co-operation and Development show that average rents rose 54 per cent in the above-mentioned 1973 to 1981 period, for example. That’s about half as much as the cost of living. That and more costly leverage aren’t great news for income-generating assets, a worrisome prospect for investors who’ve fueled Canada’s skyscraper-high valuations.
4. Policy “fixes”: Our government has proposed everything from banning foreign buyers, to vacant home taxes, to house-flipping taxes. Who knows what bearish ideas they’ll come up with next.
The values most in danger
If home prices eventually get hammered, it won’t happen everywhere. Despite Toronto prices crashing from 1989 to 1996, for example, prices in most other regions remained relatively stable.
Cities with scarce inventory, stable economies, positive net migration, fast-rising rents and low vacancy could noticeably outperform. Halifax, Gatineau and the Niagara region are just a few such examples.
Home type matters, too. Materials, wages, machinery, land and cost overruns are incentivizing builders to construct more expensive homes. But higher rates, worsening consumer debt ratios and a weakening economy make competition and demand fiercest for lower-priced homes, which could also outperform.
The rabbit hole of price forecasting
If Canada’s housing agency can’t consistently predict home prices, I won’t pretend to. But the fact is, inflation has been bullish for home values, at least until high rates hurt mortgage qualifying and joblessness soars. At that point, borrowing costs and unemployment become poison for real estate.
But, while nominal home prices may keep rising this year, real (ie, inflation adjusted) home prices are a different story. They’ve typically flatlined or trended lower for at least five years following inflation spikes that led to rate spikes.
Market timing is always a gamble but if you want to gauge the health of the market, keep an eye on housing inventory as measured by the months of supply figure that the Canadian Real Estate Association puts out. Until that key metric shoots up by more than a month, there is no correction.
That said, history is not the future. Given real estate valuations now resemble 1720 share values in the South Sea Company, we may be in for a different outcome. I sure wouldn’t run out and start flipping houses right now.
Real estate has made automatic millionaires of millions of thousands of Canadians. Inflation could keep boosting their net worth, for now.
But, let’s talk again once surging rates and unemployment break up the party. Buyers won’t be as vivacious 12 to 24 months. And if inflation does push prices higher in the next 12 to 18 months, the correction may be all the more unpleasant.
The rate pain continues
Fixed mortgage rates continued north this week, with the best five-year climbing another 25 basis points. I’ll be a broken record and say it again: If you need a mortgage in the next four months and don’t have a rate hold already, get on that.
Rates in the accompanying chart are as of Wednesday from providers that advertise rates online and lend in at least nine provinces. Insured rates apply to those buying with less than a 20-per-cent down payment, or those switching a pre-existing insured mortgage to a new lender. Uninsured rates apply to refinances and purchases over $1-million and may include applicable lender rate premiums. For providers whose rates vary by province, their highest rate is shown.
Robert McLister is an interest rate analyst, mortgage strategist and columnist. You can follow him on Twitter at @RobMcLister.