A growing number of economic forecasts see Canadian house prices falling in the near term, with some suggesting declines of around 25% or more.
The latest such report came from Capital Economics, which outlined how the coming surge in interest rates poses a key risk to housing.
With bond markets forecasting the Bank of Canada’s policy rate to reach 2.50% by next year, Capital Economics economist Stephen Brown asked, “can the housing market withstand a return to pre-pandemic mortgage rates, even though prices have risen by more than 50% in the interim? The answer is a firm ‘no,’” he answered.
If the overnight lending rate, which influences prime rate and, in turn, variable mortgage rates, reached 2%, Brown said house price increases should slow to “little more than zero” next year, while a higher policy rate would trigger a decline in house prices.
“We shouldn’t assume that the Bank wants to avoid house price declines at any cost,” he added. “House prices are a key driver of shelter inflation, so moderate declines would help to get consumer price inflation under control without seriously jeopardizing the economy.”
But with prices currently so high versus traditional valuation metrics, Brown said the risk is that an initial decline could trigger a “downward spiral” of lower house prices and lower house price expectations.
Oxford Economics expects a 24% decline
Meanwhile, the latest forecast from Oxford Economics has home prices falling 24% by mid-2024.
One of the triggers is expected to be house prices themselves, according to report author Tony Stillo, director of Canada Economics at Oxford.
He noted that prices were 19% above the borrowing capacity of median-income households as of late 2021, and are expected to reach 38% above what the average household can afford by the middle of this year.
“We believe this will cause the housing market to reach a breaking point and crash under the weight of its own success before year-end,” Stillo wrote.
Another factor is higher borrowing rates, with the Bank of Canada’s policy rate expected to reach at least 2% by 2024. Oxford also expects average 5-year fixed rates will reach 4.25% by the end of this year and 5% towards the end of the decade.
Oxford says the third factor that could send house prices lower is the introduction of government policies that have already been promised during the last election, including a house-flipping tax, a tax on non-resident-owned vacant homes and a temporary ban on foreign ownership.
While a 24% decline sounds significant—and usually is—Oxford noted that after the recent run-up in prices, a 24% decline would still leave prices roughly 15% higher than pre-pandemic levels.
However, should there be no pull-back and if prices continue to rise higher, Oxford says the likelihood of a more substantial decline grows.
“Although unlikely, a crash could see home prices plummet by 40% or more, with dire consequences for the broader economy and financial system,” the report noted. “The fallout from a housing crash would look a lot like the U.S. housing meltdown during the global financial crisis, despite a minimal role for subprime lending in Canada.”
Not all forecasts involve price declines
Not everyone thinks home prices are about to turn negative, at least not yet.
In its most recent forecast, RBC Economics said prices are likely to grow by 6.2%, which would be a drop from the 17.8% gain seen in 2021, based on house price data from RPS.
“Plenty of unmet demand remains and will continue to fuel tremendous activity across the country,” reads the report by RBC economist Robert Hogue. “Still, we expect the Bank of Canada’s rate liftoff to turn down the market’s heat in 2022 as deteriorating affordability sends buyers to the sidelines.”
Earlier this month, the Canadian Real Estate Association also released an updated housing market forecast where it revised up its expectations.
CREA expects an annual average sale price of $786,000—a nearly $47,000 increase from its initial forecast released in December—which would represent an annual gain of 14.3% over 2021 prices. It expects the pace of price growth to slow further in 2023 to an annual rate of 3.2%.