New Forecasts Suggest Home Prices May Decline

New economic forecasts suggest that home prices may decline in the near future with some economist suggesting a decline of 25% or more in housing prices. Capital Economics published their latest report and outlined that the coming increase in interest rates presents an important risk to housing.

As the bond markets forecasts that the Bank of Canada policy rate will reach 2.50% by next year, Stephen Brown, economist of Capital Economics said, “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’”.

Brown discussed that should the overnight lending rate, that has an influence on the prime rate, and consequently, on variable mortgage rates, reached to 2%, the house price surge should slow down to a little more than zero by next year and the higher policy rate would trigger a decline in house prices.

“We shouldn’t assume that the Bank wants to avoid house prices decline at any cost. House prices are a key drive of shelter inflation, so moderate declines would help to get consumer price inflation under control without seriously jeopardizing the economy.” he spoke. However, because the current house prices are extremely high as compared to traditional valuation metrics, the encountered risk is that an initial decline would trigger a ‘downward spiral’ of lower house prices and decrease expectations related to lower house prices.

Another economist argued that home prices would fall by 24% by 2024 and the key trigger to decreasing prices would be the house prices themselves. It was contended that current prices were 19% above the borrowing capacity of a median-income household in 2021 and are expected to reach 38% above what the average household can afford by the middle of this year. Tony Stillo elucidated, “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,”.

Another factor that would play a role in decreasing house prices is the borrowing rate because Bank of Canada’s policy rate is assumed to reach at least 2% by 2024. Moreover, the 5-year average fixed rate will also increase to 4.25% at the end of 2022 and 5% towards the end of the decade. The third factor that would decrease prices in the housing market is the government’s introduction of policies that were promised during the last election include a house-flipping tax, a tax on non-resident-owned vacant homes and a temporary ban on foreign ownership.

Albeit a 24% decline in housing price sounds significant, and in normal circumstances such would be the case, however, this percentage of decline would still leave prices roughly 15% higher than pre-pandemic levels. The report published by Capital Economics highlighted, “Although unlikely, a crash could see home prices plummet by 40% or more, with dire consequences for the broader economy and financial system. 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.”.