For some time now, the Canadian housing market has been a situation where new existing home listings have been subdued, while prices have been static to lower. With interest rates remaining high, many homeowners have tended to sit tight and not move into a new home that might result in a higher mortgage rate. In its April report, the Canadian Real Estate Association (CREA) reported that existing home sales rose by only 0.5% in the month of March and were still 10% below the 10-year average. The National Composite MLS price index was down 0.3% on the month. Still, realtors are indicating that activity has begun to pick up, though it is unclear what the main catalyst is.

 

 

Mortgage rates have largely been flat this year and indeed higher than where borrowers thought they would be when rate cut expectations were at their pinnacle in December. The average 1-year discounted fixed rate (not the posted rate) is sitting around 6.4% - only about 0.2% below the peak we saw last September. In terms of the Canada Mortgage and Housing Corporation (CMHC) conventional 5-year rate, it was down from close to 6.5% in November to around 6.3%, though discounted rates have seen a larger decline. That is consistent with the rally that we have seen in the 5-year Government of Canada yield from close to 4.4% last October to 3.6% this week. Note, however, that 5-year benchmark has actually risen from a low near 3.2% at the start of the year, whereas the discounted 5-year mortgage rate has stayed flat.

 

If interest rates aren’t behind the lift in sales activity, could it be that recent weakness in prices is having an effect. As the above chart shows, all property types have experienced a pullback from the peak in 2022.  The largest declines have been in single family homes (one and two-storey units), while apartment units have undergone a shallower retreat. The population explosion from increased immigration explains some of the divergence between single and multi-unit segments. Prior to the 2022 peak, homeowners resisted listing for fear of missing out on an even higher price months later. The sharp rise in interest rates cancelled this effect and now that prices are moderating, homeowners may be thinking that if they don’t list now that prices could move even lower down the road.

 

 

There are two main drivers when it comes to the housing sector in Canada – interest rates and the labour market. The first is intuitive and, while there hasn’t been much movement in borrowing costs so far, most economists (including ourselves) believe that there is a higher probability that we will get relief versus further increases. That is simply a recognition of the fact that Canada’s economy is slipping and shifting into a state of excess supply. I discussed this last week, with respect to a number of comparisons with the U.S. – especially the rate of unemployment.

 

True, this morning’s April employment figures showed a surprising 90K increase in net new jobs, however, this was pretty much all in part-time workers. Furthermore, there has been significant volatility in some of the underlying sectors, such as professional, scientific and technical services and accommodation and food. While immigration flows have been massive, there are not enough jobs to go round. Therefore, the unemployment rate will likely be poised to rise further this year. In my opinion, that will erode job certainty and, with it, financial security. Given the higher cost for most line items in the household budget, including energy and interest rates, we might even see a pattern of downsizing.  It also argues in favour of a tilt towards a “buyer’s market” in housing.

 

Another possible element at play, at least in recent weeks, could be the reaction to the federal government’s proposed increase in the capital gains inclusion rate. We are not talking about primary dwellings here, but secondary properties. Included in this category would be investment homes, whether buy fix and flip, or rentals. Now, measures put in place over the past few years have already gone after the speculative side of the market for both foreign and domestic investors, but there are still going to be situations where residential investment properties were acquired prior to the new rules and now the changes to capital gains might create an incentive to take profits now instead of after June 25th.  The other snag is that Ottawa, municipalities and condo corporations have tightened up the rules around short-term rentals, making it potentially less profitable.

 

The secondary market also includes recreational property, like cottages, and this could have an impact on the number of listings in the coming weeks. To be clear, if someone purchased a vacation property in the last few years for lifestyle purposes, they are probably not going to put it up for sale because of a possible increase in capital gains treatment. Yet, there are situations where parents or grandparents that own recreational properties, purchased decades ago, may have been thinking of gifting these properties to their heirs, or perhaps selling them to supplement retirement lifestyle expenses down the road. Remember that whether you sell your property or gift it, CRA treats this as a deemed disposition and capital gains are assessed based on the market value of the property versus the adjusted cost base.  Even if the original estate plan didn’t have the ownership transition or selling of a property until next year or later, the change in capital gains treatment might cause an individual or family to advance that decision.

 

At the time of writing, the legislation behind the changes to capital gains treatment has not been tabled. Considering that we are just over six weeks away from the proposed implementation date, the confusion among individuals and accountants is understandable. Another reason why we don’t anticipate a major reaction in the housing market to this budget item, but there could definitely be an increased motivation to gift or list if it hits the House in the coming weeks.

 

 

The question is whether anecdotal observations of increased listing activity runs head-on into weaker economic fundamentals, thus causing an imbalance between supply and demand. For now, it doesn’t look like there is any trend increase in home inventory on the market. Inventory is stated in terms of the number of months it would take to extinguish the number of homes on the market, based on current pace of sales. We have been holding at slightly below 4 months worth of sales so far this year and that is below the peak seen late in 2023. This is a far cry from the excessively tight markets of 2021-2022, when inventory was less 2 months, however, it is below near-6 months back in 2019. That was a period where economic growth was weak and it is entirely possible that we could be returning to similar economic conditions and, hence, home inventory levels.

 

What does all this mean in terms of the investment strategy this summer? First, any backsliding in the housing market has a greater impact on the so-called “wealth effect” than investment portfolios. If we do get interest rate relief from the Bank of Canada at the next meeting(s), then this will provide support to housing and mitigate the possible negative wealth effect. If not, then we are looking at a less than positive consumer sector and this is the largest piece of the economic pie. Echoing my comments last week, that means we have to have a greater lean towards Canadian sectors that can show growth (energy, materials, healthcare and tech) and shift away from those more sensitive to the domestic economy.

 

On behalf of the Pyle Wealth Advisory team, have a wonderful weekend.   

Andrew Pyle

 

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Andrew Pyle is an Investment Advisor with CIBC Wood Gundy in Peterborough. The views of Andrew Pyle do not necessarily reflect those of CIBC World Markets Inc.

 

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