CDPYF - Can The Canadian Housing Market Handle More Rate Hikes?

2023-08-21 11:55:00 ET

Summary

• Housing market holding up despite rate hikes.
• Some weakness in Greater Toronto Area.
• Immigration to outstrip housing supply.

Interest rates have been on the rise, but it hasn’t been enough to dampen the housing market. MoneyTalk’s Greg Bonnell discusses with Rishi Sondhi, Economist, TD.

Greg Bonnell: Canada's housing market appeared to be on the rebound earlier this year, but then the Bank of Canada resumed hiking interest rates. That's, of course, weighing on activity. Joining us now to discuss the health of the housing market, where things may go from here, is Rishi Sondhi, economist with TD. Rishi, great to have you back on the program.

Rishi Sondhi: Well, thanks for having me, Greg.

Greg Bonnell: So things have changed since the last time we were on pause at the Bank of Canada. You're seeing people take that as a sign of, perhaps, it's time to come off the sidelines, get in the housing market. We've had hikes since then. How are you reading this market?

Rishi Sondhi: Well, we've had a couple of months of hikes in June and July, and we've had housing data in June and July. I would say, on balance, it points to some resilience in demand that we're seeing. I mean, sales are actually up a little bit over that time period across Canada. And you're seeing sales rise in almost all provinces across the country over that time period, with the exception of Ontario and New Brunswick, where sales are down since the bank started hiking rates.

So I would say that there's been sort of an element of resilience that we've seen come through in response to the rate hikes. And we're seeing that in sales. I mean, average prices are down, but those can be influenced by the type of home that sold in a given month.

Benchmark prices, which give a truer indication of the underlying trend, are up over those two months. So the market is still quite tight when you look at measures of the month's supply of inventory and the like. So again, resilience, I would say, is sort of an underlying theme that comes through when you look at the data.

Greg Bonnell: Yeah. When the Canadian Real Estate Association came out with a report earlier this week where they sort of gathered all the regional reports, put it all together for us in one picture, it was notable that there were several markets -- Calgary, I think, Edmonton, and others that were actually showing some robust activity. And then it was Toronto that was weighing down the overall sales number. Is that a function of the fact that Toronto is already a very expensive market, maybe a little more sensitive to interest rates?

Rishi Sondhi: Yes, definitely. I would say that's, for sure, the case. We're seeing the intended impact of interest-rate hikes, really, in Toronto's market. Sales are down about 15% since May. Prices are down for two straight months in Toronto in the GTA market. So that's really where the negative impact of the rate hikes really looks like it's coming through. But as you say, Calgary, Calgary is sort of on the opposite end of the spectrum with respect to how it's performing. Sales are actually up 10% since the Bank of Canada started hiking rates.

And there's a couple of other things that I would point to that sort of explain that. I mean, one, they're having this robust inter-provincial migration. So there are people coming from primarily Ontario into Alberta to boost the market.

And you got to remember that heading into the pandemic, prices were falling in Alberta. And they didn't go up over the course of the pandemic run up that we saw. They didn't go up by as much in Alberta and Calgary as they did in other jurisdictions. So the market is still relatively well positioned to handle higher interest rates, and we're certainly seeing that come through.

Greg Bonnell: Calgary having its moment right now in the cycle. When we talk about these higher rates and people are trying to figure out what the Bank of Canada is going to do next, what about builders? I mean, we keep hearing the need that we need more housing supply. If builders are facing a higher cost of financing, are they going to start putting some projects on hold until they figure out what's going on?

Rishi Sondhi: You hear about that on the margin, I would say. You do hear that some groups are having some difficulty completing projects because of financing-cost issues. But I would say, on balance, housing construction is still quite robust. When you look at housing services -- got that data yesterday. Housing starts were about 250,000 or so annualized units, which is a huge number and well above pre-pandemic trends.

So we're really still breaking ground on a significant amount of properties, near multi-decade highs with respect to building. So I would say that, perhaps, on the margin, it's having an impact, but builders are still doing their thing with respect to breaking ground on projects. Part of that, I think, has to do with the fact that the price level-- the level of price is so high. So the bottom lines are getting insulated to a degree by the fact that prices are so high.

Greg Bonnell: I know that you co-authored a report with some of your colleagues at TD Economics that came out near the end of July talking about the robust population growth we're seeing in the country. On the headline, a lot of people worry about what that means for housing demand. And that supports the housing market, but where are we going to get the units from? But I found it fascinating.

You really started digging into the demand side of it. More people in the country are going to pull some demand out of the economy. Might mean that interest rates have to stay higher for longer. If that's what happens, what does the housing market look like longer term? The question I get from a lot of people when I do some stuff outside of the show is like, so when are the cuts coming? When are the cuts coming? I say, I don't know.

Rishi Sondhi: Yeah. Yeah. Well, you hit the nail on the head, right? If population growth continues to be robust -- like last year, we saw over a million people come to the country -- population growth continues to be strong like that, just obviously the impacts will be felt in housing. We estimate that on sort of our baseline scenario, we could be short 200,000 units or so, 200,000 to 250,000 units so over the next three years.

That number could swell to 500,000 if population growth is extremely robust. So that's one impact on housing. And now with respect to interest rates, yes, because, population growth is, as the report calls, sort of a textbook demand shock. That's putting upward pressure on demand. And in that environment of robust population growth versus a situation where population growth is, say, closer to its long-run average, interest rates would have to be higher to weigh against that demand and keep inflation in check.

Greg Bonnell: Almost take us to a place where there's a higher, I guess, neutral rate, that place where central bank feels like we're not stimulating the economy. We're not trying to tamp it down. I think people have an idea in their head what they've lived through for the past 10 years or 20 years about where interest rates are going to settle out. Maybe that's not the reality going forward.

Rishi Sondhi: Yeah, I would say so, as I mentioned before, because of this robust population. If it were to be maintained, again, interest rates would have to be higher than relative to a situation where we saw population growth more in line with historical norms. I would say our neutral rate forecast, I believe, is around 2 and 1/2%. I'd have to check, but I believe it's around 2 and 1/2%. So we think the policy rate over the long run could settle around that level. And again, that's boosted by the fact that population levels, population numbers have been strong.

Greg Bonnell: So these are some of the longer-term things we need to take a look at as we, sadly, in the next couple of weeks, several weeks, say goodbye to summer, head into the fall season. What is the housing market look like? Is it all going to be dependent on what the Bank of Canada does next?

Rishi Sondhi: Yeah. Well, the bank but also, more broadly, bond yields, right? So that's a function of the Federal Reserve, the economic outlook. So there's lots of things that influence bonds. Bank can, of course. They've hiked rates. They've done their 50 basis points of tightening. We think they'll remain on hold for the remainder of the year, but those hikes are baked into the system, and they're having some impact on demand.

Prior to this, demand was going quite robustly, and it has sort of petered out a little bit. So certainly, we're seeing some impacts. Also, we've seen bond yields grind higher. And that's likely to put some upward pressure on mortgage rates, which, of course, would slow demand. So in our forecast, we have, in the second half of the year, sales falling a little bit and prices flattening out overall, at least in markets like the GTA, for example, and then in the third quarter and then actually dropping a little bit in the fourth quarter.

Across Canada, we see average prices falling in both the third and fourth quarter of this year. So in the near term, we do think that rates will have some impact on the market to the downside.

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