Focus

January 19, 2024 | 13:04

Housing Outlook: Laying the Floor

Economist

Robert Kavcic

Senior Economist and Director
Economics

Robert has been with BMO Capital Markets since 2006. He plays a key role... (Read more)

Benjamin Reitzes

Managing Director, Canadian Rates & Macro Strategist
Fixed Income Strategy

Benjamin has been with the Bank of Montreal nearly two decades. He is re-sponsible for the Canadian macro-econom... (Read more)

Scott Anderson , Ph.D.

Chief U.S. Economist and Managing Director
Economics

Scott Anderson is BMO’s Chief U.S. Economist and Managing Director. He analyzes and forecasts U.S. national and ... (Read more)

Michael Gregory , CFA

Deputy Chief Economist and Managing Director
Economics

Michael is part of the team responsible for forecasting and analyzing the North American economy and financial m... (Read more)

Sal Guatieri

Senior Economist and Director
Economics

Sal Guatieri is a Senior Economist and Director at BMO Capital Markets, with over two decades experience as a ma... (Read more)

Jennifer Lee

Senior Economist and Managing Director
Economics

Jennifer has been wi... (Read more)

Robert Kavcic

Senior Economist and Director
Economics

Robert has been with BMO Capital Markets since 2006. He plays a key role... (Read more)

Benjamin Reitzes

Managing Director, Canadian Rates & Macro Strategist
Fixed Income Strategy

Benjamin has been with the Bank of Montreal nearly two decades. He is re-sponsible for the Canadian macro-econom... (Read more)

Scott Anderson , Ph.D.

Chief U.S. Economist and Managing Director
Economics

Scott Anderson is BMO’s Chief U.S. Economist and Managing Director. He analyzes and forecasts U.S. national and ... (Read more)

Michael Gregory , CFA

Deputy Chief Economist and Managing Director
Economics

Michael is part of the team responsible for forecasting and analyzing the North American economy and financial m... (Read more)

Sal Guatieri

Senior Economist and Director
Economics

Sal Guatieri is a Senior Economist and Director at BMO Capital Markets, with over two decades experience as a ma... (Read more)

Jennifer Lee

Senior Economist and Managing Director
Economics

Jennifer has been wi... (Read more)

Feature

Housing Outlook: Laying the Floor

The Canadian housing market should enter a period of overall stability this year, with lower resale prices, easing mortgage rates and pent-up demand likely helping to set a floor for the market. But, a return to the rollicking price gains of recent years, and previous highs for some locations, is unlikely at this point. Our baseline forecasts for housing in 2024 are shown in Chart 1. Sales volumes are expected to rise about 6% for the year, with less egregious valuations and lower mortgage rates helping to clear the market. The benchmark home price looks to bottom in the spring on a national basis, but still post a modest calendar-year decline, while still-challenging affordability will likely temper the subsequent rebound. Finally, housing starts look to remain firm at around 240k units, but still miles below government supply goals. Here are some key market themes as we move into the 2024 selling season:

Market psychology improves

Psychology has played a major role in this housing cycle, from the days of “rates will remain low for a long time”, to the crushing reality of aggressive rate hikes. Surveyed expectations of home price gains have largely followed the path of BoC communication/rate changes since early in the pandemic (Chart 2). The latest turns have come as the Bank restarted the tightening cycle after an early-2023 pause (sentiment deteriorated with renewed rate hikes). Now, it is widely assumed that this tightening cycle is over which, from a behavioural perspective, is an important milestone—buyers know the ‘worst case scenario’ with respect to rates and can plan accordingly. At the same time, markets and the media are pricing in rate cuts this year, which would no doubt go an even more important step further toward improving market psychology.

Descending the mortgage-rate mountain

The Bank of Canada’s tightening cycle is likely complete, and the question now surrounds interest rate cuts in 2024—when, and by how much? We believe the Bank will be in position to cut rates around mid-year, with 100 bps of easing through 2024. As such, given the recent rally in the bond market, we’ve likely already seen peak Canadian mortgage rates for this cycle (Chart 3). With five-year fixed rates already down about 100 bps to around 5%, the market has been given some relief heading into the spring season (assuming it holds) even before the Bank of Canada itself moves variable rates down. Given the wide spread between those rates, Canadian borrowers will likely take up more fixed-rate (three-to-five years) in the coming months, but one should be mindful that we are at the peak of the rate cycle before locking in long term.

Prices find a floor

Downward pressure on prices continues in some markets (namely Ontario), and we expect that to persist through the spring. But, the combination of pent-up demand and easing borrowing costs could finally put a floor under the broad market. In real terms, Canadian home prices have now largely adjusted back to their long-term growth trend, suggesting that most froth has been cleaned out of many markets (Chart 4). That said, affordability remains strained, which will limit the scope of any rebound. We estimate that the current outlook for lower interest rates will go about halfway to restoring affordability to pre-pandemic levels, while the rest will require either further price declines or (more likely) stagnant prices and a catch-up in incomes. Meantime, there remains little forced selling in the market, particularly for single-detached homes. A wave of condo completions, much of which were purchased by investors, could lead to a softer market in that space versus much scarcer singles.

Location matters again

Market conditions vary significantly by region entering 2024. The correction in exurban markets, especially in Southern Ontario, has been well documented and remains ongoing, but even some of those areas (e.g., Barrie, Guelph and Windsor) have tightened back into more balanced territory (Chart 5). We continue to see underperformance in these peripheral markets in 2024. Meantime, recreational property remains under heaviest pressure, with markets such as Okanagan (B.C.) and the Kawarthas (Ontario) exhibiting the weakest balance (we don’t foresee recreational property improving much at this stage). On the flip side, Calgary is arguably the strongest market in the country, with favourable affordability and an influx of families/investors from other regions of Canada adding to already-strong population growth. Atlantic Canada, for similar reasons, also remains firmly a sellers’ market across most regions.

Investors remain cautious

The hurdle for investors to jump back into the market is probably higher than for end-users. With expectations of price growth now deflated, cash flow is king again for investors, but the economics still don’t quite make sense at current prices and interest rates. Setting aside the highly speculative presale/assignment market (which has been silenced), longer-term investors are watching valuations reset to reflect higher interest rates. Using Toronto as an example, residential cap rates (e.g., rental condos or multifamily properties) have historically traded roughly 1.5-to-3.5 ppts above 10-year GoC yields, a spread that closed dramatically during this tightening cycle (Chart 6). But, a combination of factors are now working to re-establish fundamental valuations. Market rent continues to rise at a strong clip; prices for investment property have corrected across many markets (e.g., multifamily); and interest rates should back off this year. While we’re getting closer, most investors probably still need to see some further valuation adjustment driven by some combination of these variables.

Policymakers discover the demand curve

It’s fascinating that policymakers and the popular narrative have shifted from ‘supply is the solution’ to addressing the demand curve too, a stance we have firmly maintained for a number of years. Market froth during the era of ultra-low interest rates was the first pillar of excess demand, which was doused overnight by interest rate hikes. Extreme population growth is the second pillar, namely nonpermanent resident flows that continue to run well in excess of official permanent resident targets. We’ll reiterate that there is precisely zero chance that the supply side of the market can meet this level of demand, leaving rents to surge (Chart 7). A more hawkish stance on these population flows would take some momentum out of rent growth, especially alongside a wave of investor-owned completions.

Key Takeaways

Prices will find a more sustained floor by mid-year, but subsequent growth will remain subdued. Rate cuts will improve market psychology.
Regional performance will vary. Alberta is best positioned and could push new highs, while exurbs (e.g. Southwestern Ontario) and cottage country lag.
A rich pipeline of condo supply will lead the segment to underperform scarcer single detached homes.

Fundamental cash-flow driven investment has replaced speculation, and some further valuation adjustment will take place—but we’re getting closer.
New construction will remain robust, but well shy of government targets—no surprise.
Rent growth could ebb with more completions and a more hawkish stance on nonpermanent resident flows, but it will take time to bend that curve down.