Canadians: Don’t Rush To Buy a House

A few key factors need to settle down before you decide to buy a new home.

Yan Barcelo 21 February, 2023 | 1:48AM
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House in Banff 

Since its peak in May 2022, the Teranet-National Bank House Price Index dropped a total of 10% up to mid-January 2023, the “largest contraction in the index ever recorded” since it began in 1999.

“In mid-2022, we saw a dramatic pull back in transactions, close to 23%, and in many markets, it was 40%,” recalls John Lusink, President of Right at Home Realty. In some higher-demand neighbourhoods, price drops have been more subdued and activity is still brisk. “On buyers’ side in Toronto, he continues, we still get two or three simultaneous offers, but it’s not 20 or 30 as we saw a year ago. People will no longer pay excessive amounts over the asking price.” 

As we argued in a previous article, the present slump is not a catastrophe, but a welcome adjustment of prices.

Bank of Canada’s Rate Hikes Play a Role

The Bank of Canada’s rate hikes that started in March 2022 are the main impetus for the turn in the housing market, but the hikes didn’t really bite until the BoC pushed them by one full percentage point in July, then again by 75 basis points in September. All through 2022 and in January 2023, the BoC pumped up its overnight rate by a total of 4.25 percentage points from .25% up to 4.5%.

Of course, it’s not the Bank’s rates per se that did the damage but how mortgage rates responded. Five-year fixed rates went up to 6.05% in 2022, going back up to the level they reached in 2005, according to Super Brokers. For the time being, house listings are somewhat normal, “just a bit higher than a year ago in our network, and still higher than what we would normally see,” notes Lusink.

Also, credit quality has not yet deteriorated significantly, observes Carl De Souza, Senior Vice-President, Canadian Banking, North American Financial Institutions at DBRS Morningstar. “In time, borrowers and mortgage owners will continue to face increased pressure, he says. The impact from higher interest rates and inflation on consumer disposable income should negatively affect credit quality. But credit quality is still quite strong, residential mortgage credit quality remains extremely strong. Also, jobs are still very healthy.”

Stay Patient for Better Deals

Prices in the greater Toronto area fell by 19% between February and July 2022, recalls John Pasalis, President of Realosophy Realty, much more than the Teranet-National-Bank index average. But since July, prices have remained flat. Pasalis believes that many buyers moved to the sidelines, expecting prices to fall further, but now, “some buyers are starting to think: I won’t wait anymore. The market is busier than what most people expected, and it doesn’t seem to panic as they expected.” 

The Canadian housing market is still quite resilient, which means that buyers hoping to purchase a house at bargain prices still need to be patient. “I would wait, especially if I were a first-time buyer, to see what effects the rate increases will have, advises Ian Provost, Senior Consultant in Wealth Management and Portfolio Manager at National Bank Financial – Wealth Management. It’s still too early. Usually, these effects need 12 to 18 months to pan out. Since the hikes have been steep only in the second half of 2022, it means holding out to 2024.”

Four other specialists interviewed for this story agree. “The right moment should present itself only in 2024,” confirms Fabien Major, Financial Planner and Wealth Management Advisor at Assante Capital Management, Major Team.

Pasalis also agrees. “There are still risks pressing on prices, he warns. We haven’t yet felt the full weight of rate hikes on the market and on the economy in general.” However, he notes that many buyers don’t really care to wait any longer because they are buying for the long term, and any bargains in prices won’t really make that much of a difference in the long run.

However, buyers who wait shouldn’t expect a rout. “Prices could still fall by another 15%,” ventures to predict Lusink. Yes, on the one hand, conditions are pressing down on prices: interest and mortgage rates, deteriorating household credit conditions, inflation, all factors that could be exacerbated by an eventual recession and its negative impact on the job market, De Souza points out. But, on the other hand, he recalls, “strong immigration and strong demand for housing and low inventories” contribute to hold the market up “and make predictions more difficult”.

For Pasalis, immigration is definitely a major driver of the rise in house prices. “Over the previous decade, he points out, Canada admitted roughly 275,000 new immigrants each year. In 2022, Canada saw a record 431,645 new permanent residents and this number is expected to reach 500,000 annually by 2025.” Trying to increase the number of housing starts is a route fraught with countless obstacles: municipal, regulatory, worker shortages, etc., “but changing our population numbers is the easiest path to follow,” he argues. However, until Canada’s immigration policies are changed, the rise in immigration will definitely supply a support platform for higher house prices.

Should one wait for the BoC’s pivot, when it starts to lower rates if it perceives it has tamed inflation? Beware such a moment, warns De Souza. “It could be a signal, provided that inflation comes down toward the 2% target. But the timing will depend on the economy, if there’s a recession, if unemployment grows. Lowering rates could mean a downturn in the economy.” He proposes rather to wait for the moment rates are peaking, which “could get buyers to come back into the market if prices are good and credit conditions are lightening up.”

A House is More an Expense Than an Investment

House owners often consider their purchase as an investment. Such a proposition needs many qualifiers. If you intend to “flip” your purchase and make a quick profit from a fast resale, it could work. But some buyers who expected to execute such a plan over the last year came in for an unhappy surprise. Some people Major knows were quite disappointed with their plan: “They can’t even meet their payments, even with revenues from rents,” he says.

“A main residence can be an investment if held over the long term, asserts Provost. But then, one needs to calculate how much this ‘investment’ has cost.” Indeed, many would find that when they add up all the mortgage costs, repairs, renovations and taxes, their house has cost them more than what they got out of it.

“A house is first and foremost a consumer item, agrees Major, it can become an investment only after many years.” Major warns that, once the share of residential real estate starts to exceed 50% of one’s assets, it ceases to be an asset and tends rather to become a liability because the expense of keeping up the real estate part of the portfolio becomes a drag on revenues from the other part.

A house becomes an investment essentially when you change its mission to produce rents, Major claims. And then, you find yourself with real estate which, for most investors, should represent between 5% and 15% of one’s portfolio.

Is a REIT a Better Real Estate Option?

Investors may consider a real estate investment trust, or a REIT, as a way to invest in real estate without the costs of owning a physical space. Is that a better idea? Jeremy Pagan is a NEXT research analyst at Morningstar, and he leveraged different personas to guide investors toward the right choice.

A Successful and Busy Professional: Property ownership could be costly or infeasible if you don’t have time to deal with tenants or maintenance, so passively investing is likely the right choice, as REITs minimize time and effort while improving risk-adjusted returns in a mixed-asset portfolio.

  • Sophisticated or wealthy investors could consider becoming a silent partner to an active investor, which could generate higher returns but comes with substantial risk.

A Flexible Professional: Early careerists or those with flexible jobs may consider making real estate into a part-time job or hobby. Risk appetite, liquidity needs, and your willingness to earn sweat equity will inform the appropriate choice.

  • Purchasing a rental property could make sense if you’ve already built a traditional investment nest egg and have excess savings. Your spare time and capital can be invested into a specific asset in the right market, and you can leverage real estate’s tax treatment to boost your after tax returns. Choosing tenants and working with maintenance providers is the time cost of actively investing in real estate.
  • Active investors have a wide range of opportunities to pursue. For example, if an investor has an appetite for remodeling, a fixer-upper could be an option. Between the tax benefits and leveraged nature of housing, this approach can compound returns quickly.
  • However, purchasing an illiquid asset could be a costly mistake if you don’t have an adequate financial cushion or suddenly need cash. On the other hand, buying shares of a diversified REIT at the right price could provide the diversification benefits you’re looking for without limiting portfolio liquidity.

Retired or Self-Employed: Professionals planning for retirement or without guaranteed income may lean toward real estate for steady income. Depending on the investor’s willingness to get hands-on, either a traditional investment or a REIT may be appropriate.

  • Empty nesters who plan to downsize or those who want to relocate may benefit from turning their current home into a rental property, especially if property prices are soft. If you purchase a home with a low interest rate and transition it into a rental, your investment property retains this perk and increases your positive cash flow. In addition, since a rental property is not treated as earned income, it is exempt from self-employment tax, or FICA tax. If time is a factor, then hiring a property manager for day-to-day decision-making could be right for you but will offset returns and may still take some of your time.
  • Shifting your investment strategy to REITs might be appropriate if free time is important to you but you desire a steady income. Perhaps you already have a passive income stream or a sizable investment portfolio. Taking advantage of diversified REITs is a strong choice for keeping your real estate assets liquid and easily investing in properties in various markets.


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About Author

Yan Barcelo  is a veteran financial and economic journalist with more than 30 years of experience, Yan writes for many publications in Toronto and in Montreal, including CPA MagazineLes Affaires and Commerce.

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