I’m not sure how best to describe 2017 – crazy, ridiculous, heart-wrenching, exhilarating? We started with an astronomical price increase of near 30% in the first few months of the year. In other words, a home worth $1,000,000 January 1st was worth $1,300,000 by March 30th. After that craziness, the market swiftly corrected in late April after the Ontario government implemented measures to cool off the market (namely a foreign resident tax). The shift in sentiment from extreme optimism to extreme pessimism was quick and real as many who bought and sold this year can attest.
Buying and selling is emotional for many at the best of times but emotions this year were at all time highs. First time and move-up buyers felt a lot of pressure to buy quickly or be priced out of the market, investors continued to flood the market after years of astronomical returns and downsizers were resistant to sell with prices soaring. With low interest rates, low unemployment and high levels of immigration, it was a perfect storm for rising prices. When the government announced changes in the spring, sentiment quickly reversed and all of a sudden those very buyers worried about being priced out of the market, were now worried about buying too high, investors started cashing out and baby boomers came around to the idea of moving on from their family homes. The government changes were aimed at a relatively small group of buyers and yet the perception of a market shift was enough to reverse the market literally in the span of a week. Clearly perception was the biggest influencer here.
Now, 7 months on, we see that despite a huge drop in price and sales activity from April-November, prices are still up 15.5% year to date. This is over and above the 2016 average sale price which was a phenomenal year of +26%. The market has slowed so homes are now taking longer to sell and buyers are being pickier. In August/September, prices were up slightly before falling slightly in October/November. I suspect many buyers and sellers are taking a wait and see approach as further mortgage rule changes take effect in January.
Aside from mortgage qualifications, fundamentals haven’t really changed. Oakville consistently ranks a top place to live, unemployment levels are at all time lows, immigration levels are high, interest rates are low and land is limited. I suspect January will be slower than most but I hope that in time people’s confidence levels will be restored (perhaps without quite as much exuberance as Q1 2017) and real estate will churn out sustainable positive increases.
October continued the trend of slower sales volumes (down 27% YTD) with prices up from June/July/August levels but down slightly from September. Average prices for the month were $1,202,000 (October) vs $1,215,000 (September). While prices are relatively flat from September, much of this price stability was generated from some high valued sales in October. We know this from looking at Median sales values which are down to $950,000 (October) from $1,070,000 (September). Overall, values are still up +11.7% vs the 2016 Average.
In October much media attention was given to OSFI tightening lending restrictions for uninsured mortgages (impacting borrowers with ≥20% down). Borrowers will now have to qualify on 200 basis points above their rate hold or at the bank’s 5 year posted rate for those with a <5 year rate. Most lenders are implementing these rule changes ahead of the January 1, 2018 cutoff. We are currently seeing the last of the borrowers buying under the old requirements. Many expect these lending changes will further dampen the market, but many debate the length and size of the impact. Anecdotally, I have found most buyers are being more cautious and many are sitting on the sidelines to see the impact of the changes on home values.
This article is about interest rates...everyone's favourite topic right? I know it's a boring subject but it's relevant so here's my take on how it will impact home values.
As a recap...the Bank of Canada makes 8 announcements every year, roughly once every 6 weeks. Stephen Poloz, the Governor of the Bank of Canada, announced this week that the overnight lending rate is going up 0.25%. Variable rates are tied to the overnight lending rates so when the Bank of Canada raises rates, anyone with a variable rate mortgage is impacted by the change. Anyone shopping for a variable rate mortgage is also impacted as variable rates are usually offered at the prime lending rate give or take a certain percentage. If you are a homeowner with a fixed rate mortgage, your monthly mortgage payment is unaffected by the recent announcement however, anyone who is shopping for a home IS affected. Here's where it gets a bit more complicated. Unlike variable rates, fixed rates are not directly linked to overnight lending rates. Instead, fixed rates are linked to government bond yields so as bond yields go up, fixed rate offers (for anyone needing a new mortgage) go up as well. A number of factors impact bond yields, including overnight lending rates, economic policy, investor sentiment of the health of the Canadian economy, etc. In summary: when the Bank of Canada increases their overnight lending rate, variable rates will almost certainly go up (usually by the same amount) but fixed rates won't necessarily follow. This is why some banks chose to increase their fixed rates ahead of last weeks announcements.
Most home buyers have "rate holds" from their bank when they get pre-approved for a mortgage. In essence, the lender will typically say, "a rate of X% will be honoured should you buy and close on a property within the next XX days" (I think most banks offer to hold rates for 90 days but some may be longer or shorter). We are now in a situation where a number of buyers have an opportunity to buy a home with a better interest rate IF they can buy (and take possession) before their rate hold expires. This is a short window of opportunity for anyone luck enough to have a lower rate hold in place.
And Now Some Math
Historically the Bank of Canada hasn't raised the overnight lending rate by more than 0.25% at any given announcement. To put that in perspective, someone with a $300,000 25 year mortgage with a variable rate of 2.25% would have to pay an extra $37 a month if the rate increased to 2.5%. This doesn't seem like a big deal, right? For most it won't be. If you have a $900,000 mortgage, your rate would only go up $111/month. The point is that while no one likes higher interest rates, 0.25% is hardly going to break most people's budgets.
The Psychology of Real Estate
So if it only minimally increases mortgage amounts, what's the big deal? Well, from my experience real estate is based on a combination of fundamentals and market sentiment. I would argue that market sentiment was responsible for much of the price increases during the first few months of this year and has been subsequently responsible for the cooling off period that followed.
Before this week's announcement, the overnight lending rate had not been raised in 7 years. This is an amazing run. It has been so long lived that many of us haven't owned a home through a period of high interest rates, certainly not the rates of the early 80's when 17-18% interest was the norm. In mid April the Ontario government released an action plan to curb real estate price increases and a flurry of negative press on "overheated" markets was published. All of this has people questioning real estate values and is making them more hesitant to buy.
I believe that underlying economic fundamentals are still as strong as they were at the start of the year. If anything, rising rates means that our economy is picking up steam which is generally a good thing. It's the market sentiment that is really the big question mark at the moment.
Buyers and Sellers are adjusting to a rapidly changing market. Assuming there are no more unexpected changes looming in the short term, people should start to adjust to the new realities of the market, prices will stabilize and people will be less hesitant to buy and sell. In the near term, we may see a slight lift of buyers who are incentivized to buy before their rate holds expire. Unlike other investment vehicles, real estate isn't just bought to make a profit. People continue to move for work, expand their family, get married, get divorced, downsize, etc. Once things settle in the market, I think people will feel more secure about housing values. Life will go on as it always does to the point that the buyers who have hit pause will start to look once again.