Will housing prices fall after today's interest rate hike?

The myth that increased interest rates in Canada will magically lead to more affordable housing needs to be busted.

This morning, the Bank of Canada hiked interest rates to 5%, the highest rate in 22 years. 

So what impact will this have on Canadian housing prices?

Some analysts still believe that housing prices will fall as interest rates in Canada rapidly rise. The thinking behind this theory goes something like this. When borrowing money costs a lot more, people can't afford to pay as much for housing because more of their monthly payments have go towards paying interest. Housing prices then fall because fewer consumers have the wherewithal to drive up prices.

The problem with this line of thinking in Canada is that the country is facing a nationwide, massive housing supply shortage of every type of housing imaginable. Spring 2023 estimates suggest Canada needs to build an additional 3.5 million units by 2030 to address the growing delta between supply and demand. And, these figures may not adequately account for increases in Canada's immigration levels, particularly in fungible immigration streams, like international students or temporary workers.

This problem becomes even more evident when we think about housing from the perspective that it is a necessity, not a luxury. While it's true that certain types of accommodation are more luxurious than others, at the end of the day, Canadians still require some form of a roof over their heads. And the problem with Canada's housing supply shortage is that it affects every type of housing. This deficit includes purpose-built rental stock, condominiums, and other types of multi-family dwellings.

So, as interest rates rise in Canada, it's not like Canadians who need housing can easily downgrade their expectations and purchase or rent a home in a class of housing that may provide less space or amenities but may be more affordable. And Canadians who may not be able to afford their current home as rates rise can't easily downsize or sell and rent to save money because that class of affordable (or rentable) stock doesn't exist either. 

In but one example of this phenomenon, putting further pressure on Canada’s more affordable housing stock is a growing number of older Canadians looking to downsize their homes. Even if they can find a condominium to move into out of a larger single-family dwelling, they may be less inclined to sell if their retirement savings are locked into their home's equity and if they have to pay far more than they thought they'd have to for a smaller dwelling.

And ugly whispers of high interest rates leading to a wave of potential mortgage defaults are also emerging. While the International Monetary Fund has warned that Canada is a country most at risk for a wave of defaults, if housing prices do begin to fall in Canada due to defaults, it would be a sign of an epic wave of homelessness in Canada, the like of which have never before been seen, given the country’s extreme housing shortage. Again, that’s because it’s becoming equally as impossible for Canadians to move into a more affordable style of accommodation as it is for Canadians to find a place to live to begin with. 

Said another way, if someone defaults on a mortgage in Canada right now, the housing shortage means there are few places for them to go. More and more Canadians are locked out of the housing or rental market entirely or trapped in a home they can't afford. 

To lower housing prices, what Canada needs is a massive increase in housing supply.

However, new data shows that Canada's rapid interest rate increases are making it harder for homebuilders to start new builds. Indeed, new housing starts have slowed, with the Canada Mortgage Housing Corporation suggesting that there could be a further chill as the number of people who had financing for a new build under lower interest rate conditions diminish.

Prices fall when supply outstrips demand. For housing, that scenario is laughably impossible in Canada right now, and Bank of Canada interest rate increases will only worsen the situation. 

The myth of increased interest rates in Canada magically reducing housing prices, particularly without widespread negative social consequences, must be immediately busted.