Given the current market conditions, many Canadians believe that a recession is imminent. For some, the word “recession” brings up memories of the 2008 financial crisis, for others, the sharp downturn in the economy that followed the COVID-19 lockdowns. In reality, recessions do not come in just one shape or form; a recession is simply defined as two, or more, consecutive quarters of negative GDP growth. The impact of a recessionary economy can range from very mild to financially debilitating— depending on the market conditions.
In this guide, we examine the market headwinds that led us to where we are in 2023, we also examine the possibility of an economic downturn, and explore the potential impacts a recession could have on the Canadian real estate market.
2022: An Overview of Canada’s Real Estate Economy
In 2022, the Bank of Canada hiked interest rates a total of seven times in an effort to control inflation. By the end of the year, the overnight lending rate had reached 4.25%, representing a 400-basis point increase since the 0.25% rates established during the COVID-19 lockdowns. Despite this, inflation remained steady around 8%— not increasing, but not decreasing either.
How Do Rate Hikes Fight Inflation?
In a free market economy, the prices of goods and services are determined by what consumers are willing to pay— in other words, their perceived value. When demand increases for a particular product, but supply does not, consumers are typically willing to pay more to acquire it. Over time, as demand increases, the prices of products can start to trend upwards. This is what is known as inflation.
Within the housing market, this trend can be examined through the COVID-19 case study. Following the economic shutdown that occurred at the start of the 2020 lockdowns, the Bank of Canada lowered the overnight rate to 0.25%. By tanking interest rates, the BoC hoped to revive the failing Canadian economy through a capital injection. Remote working structures, as well as in-store shopping bans, led to an increase in savings amongst Canadians during the pandemic. The combination of these factors made qualifying for a mortgage easier than ever. This ease of access increased the demand for home buying without increasing the supply of available homes. This then led to bidding wars becoming commonplace, leading to an eventual explosion of home prices across the Canadian market.
The goal of rate hikes is to help curb inflation by reducing the demand for goods. In a real estate context, the higher the rates rise, the harder it is for Canadians to pass the stress test needed to qualify for a mortgage. The fewer Canadians qualify for a mortgage, the fewer Canadians can buy a home— leading to decreased competition for properties, and thereby, lower prices.
Have Rate Hikes Been Working?
While inflation has been slowing down, this may not be entirely due to interest rates. While the recent rate hikes have successfully decreased demand for non-commodity goods, some experts argue that the lack of supply is a much bigger driver of inflated prices. Just as companies were beginning to recover from the supply chain crisis of 2021, the Russian-Ukrainian conflict reintroduced pressure onto an already stressed global supply chain.
In the world of housing, rising input costs (labour, lumber, steel, etc.) have led to a slowdown of contract execution, leaving a massive gap between the amount of housing that is demanded by Canadians, and the number of houses available.
How Recessions Impact the Real Estate Market
Recessions are, put simply, an extended downturn in the economy. During past economic downturns (e.g. 2008, 2020), the Bank of Canada slashed interest rates to encourage spending— with the goal of reviving the economy. Unfortunately, even if we do enter a recession in the near future, the BoC has implied that rates will remain relatively high for the next two years.
Canadian homeowners, who are coming up to the end of their terms, will be in for a rude awakening when they refinance or renew their mortgages. In Canada, a 5-year fixed term has been the most common mortgage product, which means that millions of Canadians will be impacted by the high interest rates in the near future. The most troubling consideration is that some Canadians who were previously able to afford their mortgage payments may no longer be able to do so following their mortgage renewal.
As building materials continue to cost a fortune while house prices are dropping, many home builders have elected to hold off on new construction projects for the moment. While this is a sound decision from a business perspective, it does unfortunately worsen the supply-demand gap that is currently plaguing the Canadian real estate market. While rising rates will curb housing prices to an extent, the cost of borrowing will remain high, making it difficult to take advantage of the low prices in the market.
Preparing for a Real Estate Recession
Whether or not we enter a recession in the next few months, it never hurts to be prepared. Limiting excessive spending, keeping up with debt repayments, and setting up a rainy day fund are just a few steps you can take to maintain a stable financial position. If you are looking to buy a home, it is a good idea to avoid taking on other types of debt alongside your mortgage. Given the high rates in place, even something as benign as an extra car payment, could deeply cut into your savings. Additionally, if you cannot meet the qualification requirements of the big banks, you may want to consider working with alternative lenders, who often have simpler approval criteria.
Clover Mortgage can help you secure a low rate despite market conditions. Our team has experience working with a large variety of lenders— both traditional and alternative— and can connect you with the best terms and rates available to you. You should not let the current market stand between you and your home. Contact Clover Mortgage to book your free consultation today!