Written by Christopher Liew, CFA at The Motley Fool Canada
Home prices are no longer bloated after four interest rate hikes by the Bank of Canada. This month’s full-percentage point increase by the central bank changed the dynamics of the once red-hot housing market. A sharp correction is happening right now, but this is not necessarily favourable for homebuyers.
While prices are dropping, many prospective buyers are extremely cautious due to the steep rise in borrowing costs. No one wants to be stretched thin because of higher mortgage payments. According to mortgage strategist Rob McLister of MortgageLogic.news, purchasing powers are under threat.
McLister said, “For a household earning $100,000 a year and putting 20% down on a new home, that cuts their maximum possible purchase price by almost $47,000, assuming a 30-year amortization and no other debts.” Another hurdle is the tougher mortgage stress test. Borrowers must prove they can handle mortgage payments.
Canadians are in an unfamiliar setting, if not uncharted territory, following a long low-interest-rate environment. A new era of high interest rates is here. Besides curbing inflation, the Bank of Canada believes the aggressive rate hikes will cool the housing market and correct the imbalance.
Commenting on housing prices, Garth Turner, a financial advisor, author, and former member of Parliament, said, “Things went up too far. They went up too fast.” He adds, “It was inevitable we would see the pendulum swing back. And here we are.” Meanwhile, sellers are also surprised by the sudden price drops and downward trend.
The Royal Bank of Canada’s recent report on what lies ahead for the housing market is telling. According to the bank’s economist, Robert Hogue, the correction that’s taking hold in the country could turn out to be its biggest in recent history. RBC predicts benchmark home prices will fall by more than 12% through early 2023 from the market’s peak.
On the sales side, RBC forecasts the slump to be 23% this year and 15% next year. Hogue said, “This will send more buyers to the sidelines. We expect the downturn will deepen in the coming months with both resale activity and home prices reaching lower levels than we previously anticipated.”
For real estate investors
Economist David Rosenberg, said, “Investors in residential real estate are typically what you would call ‘weak hands.’ The momentum could build on itself, where the lower prices beget even lower prices because of the forced selling by these leveraged weak hands.”
Buying real estate for investment purposes isn’t a good idea right now because prices could fall sharply. You’d be safer investing in a real estate investment trust (REIT) like Granite (TSX:GRT.UN). The cash outlay is smaller ($77.32 per share), while the handsome dividends (4.01% yield) can replace anticipated rental income from direct ownership. Historically, REITs have performed well compared to stocks, especially over longer periods. Unlike investing directly in real estate, REITs also offer transparency, liquidity, and diversification.
The $5.09 billion Granite REIT owns and manages a real estate portfolio that consists of industrial, logistics, and warehouse properties in North America and Europe. More importantly, it’s a dividend aristocrat owing to ten consecutive years of dividend increases.
Supply shortage myth
Economists at the Bank of Montreal said the previous supply shortage was a credit-driven and speculative bubble. Low interest rates stimulated demand and caused the unprecedented rise in home prices. But with rising interest rates, they believe the shortage narrative is collapsing.
The post Homebuyers: Your Maximum Possible Purchase Price to Drop by 47K appeared first on The Motley Fool Canada.
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Fool contributor Christopher Liew has no position in any of the stocks mentioned. The Motley Fool recommends GRANITE REAL ESTATE INVESTMENT TRUST.