BoC Raises Rates, May Pause But Real Estate Holding Power Is WEAK (Variable Mortgages Triggered Again!)
This month’s rate hike was a coin toss and forecasters couldn’t agree on whether we would see a 25 or 50 basis point hike. What actually happened was a 50 basis point hike which now takes our Canada target rate from 3.75% to 4.25% as of Dec 7.
In this video, let’s dive into what the BoC said at this month’s meeting and how this latest hike might actually trigger a new a forced sale theme for real estate for next year.
Why did we go up 50 basis points?
If we saw a 25 bps hike this month, that would have allowed the BoC to fine tune things better and prevents overshooting and mort than necessary downsides. But the thing is, the US Fed is already 25 bps ahead of the BoC rates and their market is expecting a 50 basis point hike next week.
So if we only went up 25 basis points this month, we would end up 50 bps behind the Americans. That would make the loonie even weaker, our imports more expensive and ultimately give us higher inflation. And that’s probably why we had to be in lockstep with the US with a 50 basis point hike this month.
Are We Done With Rate Hikes?
At the last BoC meeting, they mentioned they’ll still be raising rates. Two weeks ago, they mentioned we’re getting close to the end of rate hikes. But we’re not done and the BoC is weighting the risks of over tightening. And now today, we don’t hear anything about rates going further anymore so it’s likely that we’re probably peaking for the next while as we wait to see lagging results.
Impact on Fixed Rate Mortgage Holders
Here’s the thing: even with our major jumps in interest rates this year, and even though we have come down in price from the peak, the overall GTA market still hasn’t seen much of price change compared to the average from last year yet. It looks like the full impacts of interest rate hikes haven’t really been priced into the overall market yet which means there’s probably still room for prices to come down.
Some people think the change in monthly payments from fixed rates will see the biggest downside impact on renewal so let’s see what the damage is here. If someone was on a 3% 5 year fixed rate mortgage with a $800,000 starting loan balance, they were paying $3,400 per month and would end their 5 year term with a balance of closer to $700,000.
Now let’s say they renew at 5.5% with a smaller mortgage balance now because of the principal pay down over the past 5 years, so the monthly payment goes to $4,000, and that translates to a $650 increase per month. It’s not insignificant at all but it turns out the bigger effect does come from variable mortgage holders.
Impact on Variable Rate Mortgage Holders
Let’s assume someone else also has a similar $800,000 mortgage getting at 1.75% variable rate a year ago. That mortgage first got triggered in September, which means that’s the first time their mortgage payments started going up. But it was still manageable at $230 per month more for a few months.
Now after this month with even higher interest rates, this increase goes up close to $900 per month. And at that point, it will make things a lot harder to carry if rates stay this way for another year.
Real Estate Outlook For 2023
Either way, these mortgage holders can’t make their payments anymore because of these big increases that’s expected to stay this way for a year, forced sales might be the real estate theme for next year.
We still stand firm on the fact that freehold investments will be the most resilient real estate asset class. Many freehold investors saw a few hundred dollars of positive cash flow before rate hikes which helps pay for the mortgage payment increase. And if they managed to turn over tenants and got a few hundred dollars more in rent this year because of that, then they’re in an even safer position.
We also know that the current price of starter investment freeholds in Toronto are close to the right price nowadays because prices have come down a lot more than the overall GTA market. And because of that, new purchases can cash flow positive even at today’s higher prices. But for the rest of the GTA, prices are still more or less the same as last year and that’s the worrying for those who were already stretched before rate hikes.
We think the most vulnerable markets next year would be the starter freeholds in the suburbs where buyers barely saved enough for the downpayment and is at max leverage. GTA detached home prices are still 39% above Jan 2020 levels, which is a lot higher than in the 416, and so there’s a lot of room to come down there. Condos are another weak market because investors there were negative cash flowing before rate hikes and once you stack on much higher mortgage payments, holding power would get much weaker.
And once any of these groups have trouble paying for their mortgages, they might be forced to sell even if it’s at a loss. And from number crunching, the price of a GTA house would need to come down by 25% before monthly house expenses get back to 2021 average levels again so there’s still a lot of room to go.
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