The Bank of Canada says it’s too early to talk about a significant correction in housing prices.
And as sales have started to cool, one of the things that bear watching is how investors are going to behave.
How deep prices could fall may depend partly on how these Canadian property buyers will react to rising interest rates and other market conditions.
As the central bank stated in a recent report, investors can “amplify house price cycles”.
Are investors going to head for the exits in face of softening prices?
“A sudden reversal of the influx of housing investors seen during the pandemic could amplify downward pressure on prices,” the BoC said.
The central bank’s report on June 9 covered the broader subject of the overall state of the country’s financial system.
In it, the bank identified six key vulnerabilities, of which two relate to household debt and house prices.
A discussion about housing investors formed part of these two vulnerabilities.
“The share of Canadians buying homes as investment properties grew in 2021,” the central bank noted.
The BoC defines investors as “existing mortgage holders who obtain an additional mortgage to purchase a property”.
They can “play an important role in the housing market if they make their property available to renters on a long-term basis”.
Investors accounted for over 22 percent of mortgaged purchases in the fourth quarter of 2021.
That’s up from 19 percent in 2019.
“In 2021, they made purchases at a faster pace than first-time or repeat homebuyers,” the bank related.
With this come added risks in the housing market.
“The increased presence of investors in the real estate market can amplify the vulnerability associated with elevated house prices,” the BoC noted.
“During housing booms, greater demand from investors can add to bidding pressures and intensify price increases,” the bank explained.
When the Canadian housing market isn’t doing well, the increased presence of investors poses an added risk.
“When prices are stable or declining or mortgage carrying costs are rising, holding real estate as an investment becomes less attractive. The incentive to sell may be greater for investors who risk falling into a negative equity position on one or more properties, also known as being ‘underwater’.”
The BoC noted that investors typically earn more income than non-investors.
However, they “tend to have higher loan-to-income ratios, once all the mortgages they hold are accounted for, and higher debt servicing costs”.
“If an income shock occurs—whether a reduction in employment or rental income because, for example, some tenants become unemployed—highly leveraged investors may need to sell one or more of their properties to recover some liquid assets,” the central bank explained.
It continued, “Although investors may not be considered as financially vulnerable as non-investor households given the amount of equity they have tied up in real estate, investors could intensify the effect of an economic slowdown by adding downward pressure on housing demand and prices.”
The Canadian home price index fell month-over-month by 0.6 percent in April 2022, the first monthly decline since April 2020.
This came in the face of a rapidly cooling market brought about by rising interest rates that have dampened sales.
However, the price index managed to climb 23.8 percent year-over-year in April.
The annual price increase happened even though the number of transactions in April 2022 fell 25.7 percent below sales in the same month last year.
A huge drop in home prices may not cause significant losses for long-time homeowners who have built a huge equity.
However, a rapid downturn in the Canadian housing market could affect those who have purchased lately.
“While the sharp increase in house prices over the past year has resulted in significant equity gains for many households, those who entered the housing market in the last year or so would be more exposed in the event of a significant price correction,” the BoC stated.
Is the Canadian housing market seeing the start of a significant correction in prices?
“It is too early to tell whether the recently observed decrease in resale activity and prices will be temporary or is the start of a deeper, lasting decline,” the central bank stated.
The BoC has raised interest rates three times so far this year.
It has indicated that further increases are needed in order to contain inflation.
The bank’s key rate has risen from the pandemic-low of 0.25 percent in March 2022 to 1.5 percent as of June 1.
It is expected to hike its rate to 2.75 by October this year.
In its report, the bank stated that it is “paying particular attention to the fact that a greater number of Canadian households are carrying high levels of mortgage debt”.
“These households are more vulnerable to declines in income and rising interest rates,” the bank noted.
As for the overall health of the country’s financial system, the BoC has no cause for too much worry.
It stated, “The Canadian financial system has proved resilient throughout the COVID‑19 pandemic, and the balance sheets of businesses and households are generally in good shape.”