Home prices dropping occur when the number of homes for sale exceeds the number of qualified buyers for more than a few months. In 2023, the combination of high and rising home prices, elevated mortgage rates, sluggish income growth and tightened lending criteria have decreased housing affordability, reduced the number of buyers, and forced some sellers to home price reductions in order to sell.
Home prices are dropping. But will housing prices drop more? Let us dissect the factors playing out in the market.
Mortgage Rates and Monetary Policy
Both the Bank of Canada and the US Federal Reserve are demonstrating unprecedented resolve in their desire to control inflation. Their primary tool is the use of higher interest rates to curb demand, thereby reducing price inflation.
House prices are so high these days that even a one percent increase in rates can add hundreds of dollars to monthly payments. And we have faced an increase of nearly 5% in mortgage rates! Many homeowners renewing their mortgages are facing payments thousands of dollars higher. Many will not be able to afford those higher payments, forcing them to consider selling their property — if they can. Of course, buyers are finding it much more difficult to afford the payments, so many are reluctant to purchase until the rates come down.
Central banks are also applying quantitative tightening, leading to home prices dropping. Quantitative tightening is the Government’s term for reducing the supply of money available for banks to lend. Banks respond by only lending to the most credit worthy customers, and by not offering significant discounts to the posted mortgage rates. This is huge, actually: credit worthy individuals often get 1% or more off the posted rates on 5 year mortgages. By no longer providing this discount, banks effectively raised mortgage rates by another percent for many customers, while simultaneously decreasing the number of buyers.
Mortgage rates and the Central Bank’s monetary policy are designed so home prices drop.
Massive Immigration
The Federal Government is proudly touting that Canada welcomed over 430,000 new permanent residents in 2022 (Canadian Immigration Press Release), with plans for even greater levels of immigration in the following years. Over 1/4 of net migration arrived in BC – most to the Lower Mainland! While immigration can bring many social and economic benefits, the absence of a coordinated housing policy raises obvious questions: how will these migrants be housed? And what will be the impact on house prices dropping?
Federal immigration policy favours highly educated and wealthy immigrants, many of whom can afford high house prices. This influx of money will create a new pool of buyers with different criteria of what constitutes “unaffordable”, and tend to put a floor under how much house prices can drop.
Tightening rental markets and Investor Activity
The rental market is experiencing increased pressure due to the ongoing affordability issues in the home ownership market. As more people find it challenging to purchase homes, the demand for rental units rises significantly. This surge in demand will, in turn, drive up rental prices, making them even less affordable for tenants.
Canada’s most expensive housing markets, particularly Vancouver and Toronto, will be hit the hardest by this situation, as rents soar and the supply of available housing remains limited. Will home prices drop more in 2023? The rising rental prices means that investors will increasingly snap up rental housing stock, helping put a floor under price drops.
Looking ahead to 2024 and 2025, factors such as economic recovery and immigration will further contribute to the demand for housing. Unfortunately, the lack of affordable housing options and a shortage of new supply will persist, posing ongoing challenges for individuals seeking suitable accommodations.
Addressing this pressing issue calls for innovative solutions from various stakeholders within the housing industry. Collaborative efforts are needed to increase the supply of affordable rental housing to alleviate the burden on tenants and ensure a healthier rental market.
Slow Pace of Construction
The pace of construction slowed dramatically in 2022 and 2023, with new housing starts reaching the lowest levels in years. Developers hate uncertainty, and rapid changes in mortgage rates and affordability bring lots of uncertainty! Nonetheless, the slow pace of construction means that the current shortage of housing supply will persist for years to come.
Making Predictions is unusually risky
Predictions about future trends in the housing market are particularly fraught with risk at the moment because of the titanic opposing forces currently at work in the market. Moreover, governments are unusually active in setting monetary policy. For all these reasons, take predictions – by anyone – with a large grain of salt!
Recovery projected some time in 2024 — and onward
Are home prices going down? Economists at CMHC (CMHC- Housing Market Outlook Report) and most banks anticipate a robust recovery in the housing market starting in 2024. They forecast rising home prices and sales once again. The same economists also expect inflation to reach its target rate of 2% by the end of 2025.
Furthermore, mortgage rates are expected to become more affordable after 2023. This development is likely to make home ownership more accessible for potential buyers.
Renewed growth in income and employment will also support the recovery of the housing market. An improving economy fosters more demand for housing, and developers are expected to step up the pace of construction to meet this demand.
Overall, the projected recovery is expected to create a more favourable housing market environment with increased affordability and better opportunities for both buyers and sellers. However, it is essential to closely monitor economic trends and developments to ensure the sustainability and stability of this recovery.
In the short term, do expect some market volatility as homeowners in financial distress exit the market. However, the buying opportunities that are created by home price reductions will likely be short lived, as investors and new immigrants replace the more traditional Canadian home buyer. If you are looking to purchase, you should be actively looking for deals now!
