The Interest Rate Argument

Google Toronto housing market price charts, or any variation of that search, and one of the images you will see will be the chart below.

trend line

(https://www.livabl.com/2017/01/history-of-toronto-real-estate-peaks-and-crashes.html

The chart ends before the 30% price jump in March and April of 2017 that took the average housing price to over $900,000, but even ending in 2016 we see a drastic increase over the long-term trend line.

A comment that is made repeatedly is that despite the record high housing prices, thanks to the record low interest rates it is not actually the most expensive time to afford a house in the GTA.  The argument being that the record low interest rates have controlled the overall cost of affording a mortgage, thus making housing prices sustainable.

To confirm whether this is true or not we need to reflect on historic mortgages rates in the GTA/Canada.  The short answer (see the chart below for real figures) is that the historically most common mortgage rate usually runs between 6-8% in Canada, with just under 9% being the long term average.  Things got crazy through the 70s and 80s, but generally 6-8% is your typical mortgage.  This is to say that things have absolutely been less expensive lately.  In fact, the rock bottom rates available through 2017, enabling people to land mortgages around 2.5% were an incredible deal.  This undoubtedly strengthened peoples buying power and drove housing prices up.

Mortgage rate

However, by the end of 2017 interest rates were going back up and the Bank of Canada has essentially promised they will continue to raise their benchmark rate.  What does this all mean in comparison to the original review of the average housing price to the historical trend line?  The math is imperfect, but an interest rate of 2.5% enabled the average buyer to afford a mortgage 50% higher than if their interest rate was between 6-8%.  Meaning, housing prices may have been justified through 2015 and into 2016, if we examine this strictly from a mortgage payment affordability review.  If you factor in down payments, we once again get a lot of “where is the money coming from” questions (rich parents that literally everyone has, right?).

Year Trend Price Trend + 50% Trend + 40% Trend + 30% Trend + 20% Actual
2016 $500,000 $750,000 $700,000 $650,000 $600,000 $729,922

The table above shows the average price impact that the low mortgage payments had on the market.  Buyers in the GTA could afford well above the historic trend line because the low interest rates allowed for it.  However, those record low rates are disappearing and mortgage rates are on the rise.  As this happens, buyers will be unable to support such high mortgages and necessary drops will need to occur.  As mortgage rates rise the purchasing benefit (estimated at roughly 50%) will decrease, and could substantially drop the average price, or at least the average buyer’s purchasing power.  From the increases that we have already seen from the Bank of Canada’s benchmark rate, I would estimate we are already below the ‘Trend + 40%’ number and we will likely continue to fall.

At some point towards the end of 2016 and certainly during the drastic rise of early 2017, record low interest rates could no longer support housing prices.  Now, interest rates are on the rise so despite the housing price drop from the 2017 peak, interest rates can no longer explain the current cost of Toronto housing prices.

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