Is Canada's Housing Market Finally Cooling?

Summer is here and housing prices are falling in previously scorching-hot markets across Canada. The question on everyone's mind now: is our seemingly unstoppable housing market hitting a brick wall?

What happened: The average selling price of a home in Canada dropped in April for the second month in a row, falling to $746,146 from an all-time high of $816,592 in February 2022. Toronto, and particularly the GTA, hosted the largest drop in prices (about $80,000) and saw a 26.2% decline in the total number of units sold. The long-standing prophecy of a “market cool-down” thus seems to be coming to fruition at last.

But why now? Doesn’t Canada have a housing supply issue? And just how Cool is this cool-down? 

Not that cool...yet! 

Like a teenager coughing up their first pull of a marshmallow vape, the housing market has only had a preliminary, scandalous taste of the cool life; cooler days, we are told, are still on the horizon.

By the numbers: The total number of residential sales across Canada fell from 751,500 in the first quarter of 2021 to 661,880 in the same quarter of 2022; this ~12% national decrease was vastly outpaced by the 41.4% drop in sales in Toronto/the GTA during that same period.  

The first quarter of 2021, however, was itself marked by an unprecedented amount of activity in the housing market. The number of sales across Canada in the first quarter of 2019–our most recent record of pre-pandemic first-quarter sales– was 446,156. In those two years, the number of houses sold in Canada increased by 68.5%; the drop in sales between 2021 and 2022 still leaves us with a 48.4% increase from pre-pandemic levels. Despite the drop, April 2022 still marked the third-highest number of sales ever behind April 2021 and April 2016.

Zoom out: The recent ‘cooling’ is relative to a period of sales activity that has been uncharacteristically ‘hot’. Considered independently of the fever which gripped the market this past year, total housing sales in both Toronto and the rest of Canada bear a closer resemblance to your uncle’s Steely Dan cover band, in that neither are particularly cool.

What it means for first-time buyers: Also, for the optimistic renters amongst you, the recent cooling of sales has not yet led to any significant drop in selling price: despite the fall in total sales, the average selling price of a home in Toronto was $1,254,400 in April 2022 and $746,146 in Canada, representing, respectively, a 15% and 7.4% increase from home prices a year ago. 

But why did this happen, and what comes next? To understand recent trends and the estimations currently being floated about what the market has in store this coming year, we turn now to the notoriously cool topic of interest rates and their impact on the housing market.  

Hiking the Rate

As was widely predicted, the Bank of Canada’s increase in its overnight lending rate (or policy rate) has had a sizable and immediate impact on the housing market. 

Why rates are rising: The Bank of Canada aims to keep inflation at (or around) 2% annually. Because cutting into corporate profits is not considered an option, and hacking away at wages is generally frowned upon, the recent increase in commodity prices–driven by the pandemic and Russia’s invasion of Ukraine–has resulted in a rate of inflation far surpassing the BoC’s sought after figure. The inflation rate in April 2022, was 6.8%—the highest since January of 1991.

The primary tool at the BoC’s disposal for influencing inflation is the overnight lending rate, sometimes referred to as the policy rate. The policy rate sets the interest rate at which banks can borrow money from each other, which in turn determines the interest rates they can offer for all other types of loans, including mortgages. Both businesses and consumers tend to spend less when the cost of borrowing rises, thereby decreasing the demand for commodities and, in turn, the yearly inflation of their general value.   

The policy rate was set to 0.25% in March 2020 to offset economic stagnation stemming from the pandemic. This March, it was raised to 0.5% and in April to 1.00%; it is expected that it will be raised to 2.25% by the end of the year. This will shift 5-year variable mortgage rates from the record-setting 1.5%  reached during 2021–a rate made possible by the 0.25% policy rate–to somewhere between 3.75% and 4.5%

Why it matters: These actual and anticipated increases in mortgage rates are directly responsible for the recent decline in activity in the housing market. Mortgage rates play a huge role in determining who has the capacity to participate in the housing market. A mortgage rate determines the amount of interest that must be paid yearly on what is still owed—it determines how expensive the loan is. For single-residence homeowners, taking out a mortgage at a higher rate requires more equity and/or income given the increased costs of servicing the loan. For real estate investors, mortgage rates determine both the costs and profitability of expanding their portfolios.

What about supply?

The policy rate and mortgage rates have directly impacted the demand for housing. The fact that the policy rate has had such an immediate and dramatic impact on the market challenges the fairly ubiquitous idea that the solution to Canada’s affordability crisis is to be found in increasing our supply of housing.

Although housing sales and prices remain high relative to pre-pandemic levels, the decline in activity seen since the raising of policy rates in March 2022 still represents one of the largest two-month drops in housing sales on record. The fact that sales and prices remain extremely high compared to pre-pandemic levels is likewise tied to the fact that the policy rate (and mortgage rates) still stand far below their level at the end of 2019. 

However, until recently, it was also fairly accepted that the most effective way of reining in the cost of housing would be to build more units. If there was really such a problem with the supply of housing, some have wondered, why did this single adjustment to demand have such an immediate and far-reaching effect? The impact of the policy rate on the market, which will presumably be felt to an even greater extent as it continues to rise through the end of the year, suggests that Canada’s skyrocketing housing prices are also being driven by supercharged demand.

The vast majority of homebuyers in Canada are not first-time buyers. Over two-thirds of Canadians purchasing a home are previous homeowners. The rapid increase in the value of housing over the past decade has provided homeowners with a large amount of equity; the median (not mean!) income of Canadian couple-families (the predominant homebuyers) has also steadily increased. When this greater equity and increased income are combined with low mortgage rates, Canadians in this particular economic bracket are granted an enormous amount of purchasing power in the housing market.

Additionally, the number of investors taking part in the Canadian housing market also increased dramatically during the pandemic. The number of Canadians buying homes for the first time increased by 40% in 2021 and the number of repeat home buyers increased by 60%; the number of Canadians buying an investment property (i.e., one they did not intend to use as a primary residence), increased by a staggering 100%. 

These two factors – the increase in investor activity, and incentivizing Canadians to “move up” (or around) in the real estate market – helped to drive the housing market into a frenzied state of supercharged demand. The impact of the policy rate on the bottom line of investors and the purchasing power of repeat homeowners has been significant and swift, causing a historical dip in activity that cannot be explained by a change in supply or related market fundamentals.

What’s cooler than cool? 

We can’t predict the future of the housing market, and this is by no means an exhaustive analysis of the various factors that influence its activity. However, in trying to form an opinion of what the coming years might hold for the new or aspiring home-owner, we recommend paying attention to policies that would affect purchasing power and, thereby, demand; likewise, be critical of narratives that focus exclusively on housing supply, as they grossly oversimplify the issue, despite serving as great fodder for some good ole’ mudslinging.