Canada’s real estate bubble is growing as mortgage rates stifle credit

Canada’s real estate bubble is growing as mortgage rates stifle credit

Canada’s real estate bubble got a big boost from low rates, and prices are correcting as rates rise. House prices rose aggressively as cheap credit flooded the mortgage market until March. As rates rose, credit was cut, and the opposite effect began to appear. Home prices have fallen significantly now and are likely to rise further as rates rise.

Canadian real estate prices are down 15% since their peak

Canadian real estate prices took a big plunge as market psychology collapsed. The price of a typical home fell to $735,400 in October, down from a peak of $868,300 in March 2022. The 15.3% drop erased almost half of the gains made since interest rates were cut in March 2020.

Canadian real estate price growth

Price change for a typical home across Canada as of March 2020.

Source: CREA; Better housing.

Canada’s mortgage lending has been aggressive due to standardization

Canadian mortgage rates have also risen since housing prices peaked. A borrower saw a 32.2% drop in borrowing capacity today, compared to the February 2022 low. Lower mortgage leverage and lower house prices are no coincidence.

Assets are worth what they can be liquidated for. This means that a regular flow of buyers must be willing and able to pay the current price. As credit becomes cheaper, leverage rises, making it easier to absorb rising prices. As credit becomes more expensive, leverage is reduced, making it harder to pay high prices. To ensure the flow, prices have to fall or buyers have to get rich.

Canada is seeing the exact opposite mechanics that boosted demand. Mortgage rates fell, and creditworthiness increased by 17% at the peak of the cycle. Predictably, this led to a gold rush as investors replaced household end-users. Price growth got a second boost by driving cheap credit to deep-pocketed investors. As rates go up, this should be corrected a lot.

Higher Interest Rates Slant House Price Growth Lower

Higher rates have led to a collapse in demand, and rates are expected to rise further. A hike of at least 50 basis points (bps) is expected this month. This would reduce the capacity of the credit service by another 5%. A reasonable assumption is that house prices see more downside risk in the short term.

How much further down is up for debate. Mortgage rates at this level make housing less attractive, creating more demand for fixed income products. If investor demand shifts to more sustainable areas, demand falls to end-users, who have much smaller budgets and less leverage to compete against each other’s supply.

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