Turbulence Ahead: How Changing Interest Rate Expectations Reshape Toronto’s Real Estate Market

Turbulence Ahead: How Changing Interest Rate Expectations Reshape Toronto's Real Estate Market


The interest rate uncertainty is back and so is the uncertainty around where real estate is going. If you’re trying to figure out where things might be going with Toronto real estate, you’re in the right place. 

In this video, we’ll share insights into where interest rates might be headed and then follow up with how this might affect Toronto real estate. Let’s dive in.

Relationship between real estate and interest rates

Most people might think that real estate follows where rate hikes go. That’s not wrong, but not entirely right either. I’d say Toronto real estate reacts more so interest rate expectations as opposed to when the Bank of Canada actually increases rates, and that’s where the bond market comes in. 

In simple terms, for a 3 year bond yield, the bond market looks at where rates are expected to be over the next 3 years, averages it out, and that’s the yield is derived. So as you can see, once bond yields start to stabilize, you’ll know that rate expectations are stabilizing too and that’s when confidence in real estate also starts to come back.

Bond yields affect the market psychologically but also on a practical level too because mortgage fixed rates area also derived from government bond yields plus a spread. And for the past year, it’s bene the safest choice since rates are locked in for the most uncertain period and recently, it’s even more favourable because it offers the cheapest rates too.

If you head over to this chart, you’ll see it. Once bond yields started to stabilize, Toronto real estate prices also started to bottom in the middle of last year. And once fixed rates started to come down earlier this year, real estate prices also came back up. 

There was better actually buying power from slightly lower rates, plus confidence came back and when you combine this with improved wages and higher market rents too, real estate prices had a pretty big upswing in the spring.

Interest rate forecasts

But that all came to an end when the Bank of Canada hiked rates in June – and this wasn’t previously priced into the market. 

The BoC is also hinting at more hikes, the Fed is hinting the same, and even announced that rate cuts are probably going to be a couple of years out. 

Now, take a look at this chart comparing the bank forecasts from April to June. As you can see, economists are readjusting their interest rate expectations, and you can clearly see the shift to higher expected rates and a higher period of time with higher rates now.

The impact of this is that bond yields are going up again, bringing fixed rates higher along with it. Right now, 2 and 3 year bond yields and fixed mortgage rates have come up around 120 basis points. The real estate numbers don’t show it yet since we only have May data at this point. 

But if everything else remains the same in terms of rents and wages, a 120 basis point price drop would equal to an 11% drop in purchase power based on tougher stress tests.

Toronto real estate forecast

So, what can we expect in the short term for Toronto real estate? 

If history repeats itself, the real estate market still needs to readjust to new interest rate expectations and we’ll need to see rate expectations stabilize before we get complete clarify on where prices will go. This will most likely get validated closer to Q3, once we see more data and future guidance from the BoC.

We know it’s a challenging time for home owners, especially with much tougher cash flows and renewals at much higher rates today. 

The good news is that fundamentals for real estate haven’t changed – supply is still limited and slow to create and demand is growing. We don’t know when actually things might stabilize – our best advice is the keep an eye out for fixed rates. Once those rates stabilize, that will likely signal more stability for real estate too.

If you’re looking to buy and missed the boat last summer, it might be your second chance. Even at higher rates these days, we’ve noticed that cash flows on new purchase with market rents might be just as strong if you snag a deal. Yes, it’s possible to get 6%+ cap rates today and very positive positive cash flows just because there is so much more variance in the market these days.

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