Posthaste: Prices need to fall another 40% to make buying a home in these cities affordable

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Good morning!

You would think that falling home prices would make housing more affordable in Canada, but alas the opposite is happening, finds a new study.

That’s because the very thing that is cooling the housing market — rising interest rates — is in an “affordability tug-of-war” with falling home prices — and so far higher rates are winning, said Charles St-Arnaud, chief economist at Alberta Central.

Since the Bank of Canada began tightening in March, the policy rate has increased by 400 basis points, while home prices on the Canadian Real Estate Association’s index have declined 10 per cent.

Higher rates have homeowners paying significantly more interest, said St-Arnaud. The four-percentage-point increase means that a household is paying $24,200 more in interest a year on a national average home worth $756,000. In the higher-priced markets of Vancouver and Toronto, homeowners are paying $37,400 and $36,300 more, respectively.

Higher interest rates are also having an impact in markets where prices are lower, raising interest costs in Winnipeg by $10,900, Edmonton by $12,900, Montreal by $16,500 and Calgary by $16,700.

These forces have pushed Toronto affordability to the worst on record, said St-Arnaud. Montreal, Ottawa and Vancouver are the most unaffordable since 1981, a time when interest rates were around 20 per cent.

On average, the required income to purchase a benchmark house in Canada has increased by about $12,600 since February.

In Toronto, a family needs an income of $254,200 to afford the average house in the city, $15,400 more than in February. In Vancouver, the required income is $252,800, about $21,700 more than in February.

How much of their income Canadian households spend on mortgage payments is now on average 29.6 per cent, almost three percentage points higher than in February and the highest since 1990.

“The Canadian housing market remains overvalued by many metrics and the increase in interest rates over the past year has only made matters worse,” said St-Arnaud.

So how much would home prices have to fall to be affordable?

The calculations of St-Arnaud and his team estimate that home prices would need to fall another 35 to 40 per cent in Toronto, Vancouver, Ottawa and Montreal to restore affordability to where it stood over the past decade.

However, the question is complicated by where you set the bar, said St-Arnaud. If you use Vancouver’s long-term average as the measure, a city that has always been pricey, and assume that housing has become permanently more expensive in Canada, then only Vancouver and Toronto would need a drop in price to restore affordability.

The decline in affordability will have a big impact on the market, he says, because more potential buyers will be priced out or have to look at cheaper alternatives. With interest rates unlikely to decline over the coming year, St-Arnaud expects housing prices will fall further.

Another risk is a rise in unemployment if Canada, as expected, falls into recession in early 2023. The higher costs of owning a home mean many households rely on two incomes to stay afloat.

“The concern is that job losses would lead to households not being able to service their debt anymore,” said St-Arnaud.

A “wave of forced selling could exacerbate any price declines expected in 2023 and lead to an increase in defaults.”

 

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The Bank of Canada turned up the stress on homebuyers this past week when it raised its rate another 50 basis points. Canada’s biggest commercial lenders quickly followed suit hiking their prime rate by the same amount to 6.45 per cent. The mortgage stress test puts the qualifying rate at 5.25 per cent or the borrower’s offer rate plus two per cent.

Throughout the 2021 housing boom when variable rate mortgages were at about 1.5 per cent, qualifying rates didn’t even get near the ceiling. Now 400 basis points of tightening later, they have pushed past it, points out BMO senior economist Robert Kavcic who brings us today’s chart.

Bloomberg reports that major banks such as Royal Bank of Canada and Toronto-Dominion Bank have posted mortgage rates slightly below prime. With this latest hike, advertised variable mortgage rates are likely to move to the low 6 per cent range, pushing the stress-test rate to more than 8 percent.

“The key now will be how long rates stay at these levels. The longer we stay in 5.25-per-cent-plus mortgage rate territory, the more the pressure will build,” wrote Kavcic.

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Today’s Posthaste was written by Pamela Heaven, @pamheaven, with additional reporting from The Canadian Press, Thomson Reuters and Bloomberg.

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