Don't expect the same reaction now that the BoC is cutting rates.

Note: This article was originally published in 2024

While market conditions may have changed since then, the insights shared here reflect the mortgage trends, economic context, and buyer behavior of that period.

For current guidance or updated analysis, contact Cam directly at cam@clre.ca or check out our latest market insights.

The pandemic era for real estate was a perfect storm which over stimulated demand.

There is a large recency bias within the real estate community that the housing market is going to react the same way that it did in 2020 now that the Bank of Canada has begun to cut the policy rate.  While it is undeniable that lower interest payments are supportive of higher housing prices, there are massive differences in the current environment as compared to 2020 which will certainly change the market reaction now.

Bank of Canada in 2020.

In March of 2020 the Bank of Canada was in crisis mode. In a single month as a response to the onset of the pandemic the Bank of Canada initiated 3 emergency cuts to the Policy rate of 50 bps each lowering from 1.75% to .25%. This was the lowest rate in history only seen once before in 2009 in the aftermath of the Great Financial Crisis. While the press release put out by the Boc stated the cuts were "a proactive measure taken in light of the negative shocks to Canada’s economy arising from the COVID-19 pandemic ..." behind the scenes a crisis was unfolding in the plumbing of the Canadian & global financial system. 

Corporations and large financial institutions, fearing major disruptions in their businesses, began to sell large portions of their savings held in Government Treasury Bonds to raise cash to ensure they had enough money to cover ongoing expenses. In normal times the market for high quality liquid assets like guaranteed Government bonds is deep and free flowing, but all of sudden everyone was selling and buyers became scarce. In the worst days in March the bond market went completely illiquid and there were no buyers to be found anywhere . While this does not seem of grave importance, bonds form the base layer of collateral for lending between the institutions of our financial system. Without a functioning bond market, there's no lending at all, which means no flow of money, which means everything everywhere in the financial system stops completely. 

The Bank of Canada and other Central banks did what was required by their mandates and stepped in, created bank reserves in order to purchase Government bonds (QE or quantitative easing) restored liquidity and kept the financial system from imploding. Had they not acted, it's not an overstatement to say that global financial markets were teetering on the verge of total collapse.  

Covid Lockdown & the unique effect on Real Estate.

Meanwhile in the real world, lockdowns severely disrupted society. By May of 2020 unemployment in Canada had spiked to 13.7% which was the highest reading on record. It took until February of 2022 for unemployment to reach pre-pandemic levels again.  

The effect on real estate that followed is remembered as a period of intense activity and massive price gains. After an initial period of fear where prices dropped roughly 10%, the buyers appeared. Armed with record low borrowing costs, they began to scoop up deals at a steep discount to 2019 comparables and also at incredibly low carrying costs. 

However low interest rates were not the only factor that  drove activity and fueled higher prices. The lockdown itself had a number of unforeseen and unique effects on the housing market. On a psychological level, the effect of being trapped in our homes made everyone feel the strong urge to have more living space. Apartments and houses which were perfectly suitable for lifestyle pre-pandemic were suddenly small and confining. People were desperately seeking a sense of normalcy and looking at houses was an activity which allowed people to get out of the house and try to move forward with their lives. 

There were also significant changes to the labour market in the lockdown which contributed as well. The unemployment spike was heavily concentrated within retail, travel & hospitality sectors which are typically not home buyers demographics to begin with. Many people who shifted to working from home suddenly had a more disposable income than they ever had before. Almost overnight the entire spectrum of discretionary spending changed as there were no longer vacations to rake, restaurants & bars for going out, shopping in stores, clothes for work, driving our cars etc.

In addition, wage growth increased dramatically as labour markets experienced a shortage of workers in many sectors. This was driven both by early retirement by older Canadians, decreased immigration during the pandemic,  absenteeism from Covid illnesses and the growth of many businesses due to the adoption of online work. If that wasn't enough, asset prices across the board exploded higher. Central bank's QE programs supported markets and incentivized risk taking at cheap rates. By August of 2020 the US stock market index had reclaimed its pre-pandemic high and went on another 40% by the end of 2022. There were spectacular gains made in many types of highly risky assets like cryptocurrency, SPACs and stock options. I can tell you anecdotally that those gains often found their way into real estate purchases. 

And finally the real estate market itself had been on a multi decade uptrend. Aside from a few short term moments of weakness, the  constant price gains across many years had been entrenched into the mindset of the market and many involved in real estate had completely become out of touch with risk. Speculative activity was already very high and only accelerated in the face of all the other contributing factors of the pandemic era. It is estimated that as much as 25% of all the purchasing in 2021 to early 2022 was from investors and speculators.  Condo preconstruction contracts allowed unregulated and unregistered leverage, and acted as a financial derivative allowing exposure to real estate without owning it. Home flippers had been making huge profits and their activity set a price floor on the market by adding a bid to all of the homes needing too much renovation to live in. 

Source TREB

All of these factors combined and soon the rally in home prices that had been active for multiple decades accelerated at its fastest pace ever, culminating in early 2022 with the onset of a new interest hiking cycle. 

2024 is different.

Fast forward to August of 2024 where the environment now is substantially different. The BoC has now made two 25 bps cuts in response to a weakening economy,  but is not trying to manage a crisis of the financial system imploding and the economy shuttered. They are not supporting asset markets with QE in fact are still reversing their support via Quantitative Tightening (QT) . The overnight rate remains elevated at 4.5% and even though interest rate markets are pricing in more cuts are coming, fixed rates are still nearly 300bps higher than 2020. That also means that rate markets have already moved and only further economic weakness will bring fixed mortgages lower. The overnight (variable) rate needs to drop a lot more before mortgages get cheaper. 

In addition the economy and labour market has changed for the worse. Unemployment is rising again to 6.4% as measured last in July. The job losses are not highly segregated now into specific sectors but are broad across the economy affecting demographic groups which are typically the home buyers. The work from home dynamic is reversing and along with that comes the expenses of commuting and being in the office. While inflation has cooled enough for the BoC to make cuts, life is far more expensive now than just a few years ago. Falling inflation doesn't make goods and services cheaper, it's only that the advance of price increases has slowed from the rapid pace which prompted interest rate hikes in the first place. Real estate in fact is more expensive than it ever has been despite the fact that home values are somewhat lower than at the peak in 2022.As it stands now affordability just really has not improved very much. 

Finally and perhaps most importantly, participants in the real estate market have become reacquainted with risk. The multi decade trend of constant price gains has been halted. Everyday we read stories in the media about distressed sales and large losses. While these stories are certainly cherry picked to drive internet traffic and do not tell the whole story about current market conditions, it's undeniable that the market psychology has shifted from rampant risk taking to a more cautious tone. People looking to get active in the market are far more hesitant now. Taking big financial risk in the face of economic weakness seems counterintuitive to the reality of many people looking at their lives and job outlook, especially at the lower end of the income spectrum who are the potential buyers who have been priced out. 

There is still a big imbalance between the amount of homes that have been built and the demand from the level of population in the GTA, but the pandemic era was far more about the massive overstimulation of demand than the supply of homes. With the changes we've seen since rates have risen so dramatically, don't expect real estate to act the same way it did a few years ago now that the BoC has finally started its easing cycle.