The recent interest rate hike wasn’t a surprise to the real estate market. In fact, it was expected to happen. You may be seeing a lot of articles being published about how prices will drop as a result of this recent rate hike.
Considering February saw sales decline 16.8%, new listings drop 6.6%, and active listings fall 20% — how did the average price surge 27.7% — and why won’t prices drop anytime soon?
Here’s an exploration of why home prices won’t drop — along with an explanation of what could cause prices to drop… eventually.
For the past while, we’ve been in a real estate market where double digit price growth and historically low inventory has prevailed. As of February 2022, months of inventory amounted to less than one month, sales-to-new-listings was 72.2%, and homes sold in just a little over a week.
The prevailing market condition is creating a challenging market for buyers, and a spectacular market for sellers.
During a worldwide pandemic, real estate sales and prices grew to historical highs. Did everyone expect this would go on forever? Surely there must be an end in sight. Are we about to see that happen?
Several interest rate hikes are forecasted for this year resulting a real estate market where borrowing costs will start to increase. Naturally, prices should be affected because borrowing at higher rates would cost homeowners more, right?
Despite the increased costs of borrowing, both RE/MAX and the Toronto Regional Real Estate Board forecasted a conservative 10% average price growth this year — they made this forecast accounting for the possibility of several rate hikes.
How does that make sense? How is it logical that prices will still rise despite increasing borrowing costs?
The answer is simple: despite the increase in costs of borrowing, the supply of homes remains low, and the demand remains high. Yes, we are seeing a decline in sales compared to last year — but we’re still seeing a record high level of sales compared to historical figures.
This demand, coupled with the still low inventory of homes for sale in the real estate marketplace, is keeping prices elevated.
Small increases in the interest rates do not profoundly affect home buyers. Remember, buyers have been stress tested for a higher interest rate than what they are actually paying. This basically means that the lenders know homebuyers can pay for (and afford) a mortgage even if interest rates rose to loftier levels than what we see now.
A 0.25% interest rate increase doesn’t signify much — on a $500,000 mortgage, assuming someone has an interest rate of 1.45%, their monthly payment would be $1,987.96. At 1.70%, their monthly payment would become $2,047.01.
The difference? A whopping… $59.05.
Sure, sixty bucks does make a difference in a homeowner’s monthly living expenses. It’s enough to buy a few items from the grocery store. Pay for a portion of gas. Or cover some of the internet or phone bill.
But it’s not life changing enough to result in a decrease of price.
Several interest rate increases will have an even more profound effect — but again, homebuyers have been stress tested and pretty much pre-qualified to able to afford those interest rate increases. And the monthly payment increase isn’t enough to ween someone off homeownership.
However — something significant could cause prices to drop. Maybe not now, or not in the immediate future — but eventually.
What could cause prices to fall is… perception. Specifically, the home buyer’s perception.
If you drive, I’m sure you feel how expensive gasoline has become. If you’re dining out or ordering food for takeout, I’m sure you’re seeing how much more you’re spending versus a year or two ago.
If you’re shopping for groceries, I’m sure you’re wondering why it seems your budget isn’t affording you as much as you used to afford — and why $100 buys you a lot less today than before.
Have you stopped filling up for gas? Have you spent less dining out or eating take out? Have you cut your grocery spending by 5%… or more?
Likely not. Even though your hard earned income isn’t giving you as much stuff as you used to get before, you’re still spending.
And as real estate inventory remains low… and as home buyers continue to buy homes on the market… prices will continue to rise… not at a pace quite as aggressive as before… but they will rise…
…until buyers perceive they are paying too much… scratch their heads… and wonder why they’re offering so much to buy that particular property.
Perception will change the market. Buyers feeling they are spending too much on housing will rethink their offer, consider alternatives, and approach home purchasing with caution rather than with FOMO.
At present, if you’re in the market to buy, you’re seeing a lot more selection of homes, multiple offers not happening on offer night, and some properties cancelling and re-listing… at a price the sellers didn’t get on offer night. (How does that even make sense?)
Despite this, prices remain stable. Home sellers who are not motivated to sell and are just fishing for a high price for their home are taking their homes off the market and waiting for favourable market conditions to return. Exceptional homes are still selling with multiple offers resulting in high prices relative to homes that may not be as appealing, or haven’t been updated or renovated.
If you’re a buyer, waiting on the sidelines, to enter the market when prices ‘drop’ — you might be waiting for a while.
The most important thing a buyer should keep in mind in today’s market is making the right financial decision and buying a home they can afford. Real estate is a long term investment. Buy the right home that is a financial fit for you and start building equity.
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