Canada’s housing market downturn threats affecting not only prices, but the overall economy as well

If extremely low interest rates were the reason for the real estate market overheating, as one famous economist noted in 2020, some may believe that the recent sharp rate increases will cool down the markets. However, we need to focus on more than only home prices.

According to the latest Goldman Sachs Group Inc. report, a housing slowdown is expected in Australia, Canada and New Zealand. Researchers say Canada will face a 13% home prices decrease by the end of 2023, while Australia and New Zealand will report much larger drops of 18% and 21%, respectively.

In addition to it, Canadian banks are also expecting housing price declines to continue in 2023. For instance, Desjardins Group believes the prices will go down by 23% by the end of 2023 compared to a February’s peak. TD Economics predicts a 19% drop.

Such possible declines are not surprising, as the real estate prices have already fallen from their peak numbers in Q1. Nevertheless, let’s not forget that they were up by as much as 27% in 2021 alone.

There are two important lessons we should understand from last year’s price increase. First of all, home prices can never continue annual growth of more than 20% for a long time. This anomalous hike would have changed its direction eventually without the BoC’s help.

Second, even a 23% drop brings the prices to approximately 2020 levels. However, housing prices have been growing for much longer. If most Canadians thought home prices were too high in 2020, a return to that level will hardly improve the affordability.

The deal is that housing affordability may have even worsened since prices began to go down. How so?  The affordability depends not only on the prices, but also on a household’s ability to afford the monthly mortgage payments. A sharp increase in interest rates will raise the borrowing costs even more significantly.

But as the real estate has become a more important component of the national economy, a downturn in housing markets can affect the overall economic activity. According to the Goldman Sachs report, because of a “negative outlook for housing prices, and the importance of residential investment, we believe the housing downturn brings stronger downside risks to GDP in New Zealand, Australia and Canada.”

In a 2018 report by economist Taylor Webley, the central bank also expressed concerns about real estate increasing its influence on the economy. The BoC found that the level of resale activity was “supported by fundamentals — full-time employment, housing affordability and migration flow.” Nevertheless, it also noted that deviations from a stable relationship between sales and economic fundamentals supported the home prices increase.

Webley’s paper pointed to the risk to GDP growth coming from fluctuating resale housing markets. Growing interest rates will keep reducing housing sales and prices, and will probably contribute to a slowdown in the entire economy. The main difficulty for central bankers is to find the moment to ease the policy before not only real estate markets, but also the overall economy begins shrinking.