A global real estate correction has begun and Canada is expected to lead the way. That was the message from Goldman Sachs (GS) Research’s latest client note on rising interest rates. Excessively low interest rates fueled record home sales and a multi-decade high for inflation. Now that interest rates are rising to cool that inflation, it’s removing incentives for homebuyers. This is expected to lead to a decline in housing prices in most advanced economies. However, Canada is seen making the sharpest declines due to its extreme price boom.
From Toronto to Oakland, real estate markets are slowing
Advanced economies have left interest rates too low for too long and are now scrambling to make up for lost time. The rapid rise in interest rates slows down the inflation they create, but also the global economy. This will have a major impact on interest-sensitive areas such as real estate, which will be the first to see the impact. “The pandemic-induced housing boom appears to be cooling,” notes GS.
“From Toronto to Oakland, the housing market is slowing as interest rates in advanced economies are expected to rise quickly.”
Rising mortgage rates in the US, Canada, UK and New Zealand have already started to cool home sales. According to the financial firm’s research team, the US saw a whopping 40% drop. Higher rates are looming and are expected to further slow housing construction.
The global real estate slump is a “real risk” that Canada could lead to a downturn
Declining home sales typically lead to lower home prices, but not all places got the memo. House prices continue to rise in the US, Germany and the UK. Researchers expect prices to start falling in the not-so-distant future. A study conducted by the bank found a decline of 10% or more for US home sales, which caused prices to fall 6 months later. If home sales fall much faster than inventory, this problem could be even worse.
They also mention that house prices have already started to fall in Canada, Australia, New Zealand and Sweden. “In Canada, housing prices fell the most in areas that had the greatest growth at the start of the pandemic,” the bank notes to investors.
They expect a modest decline in home prices over the next few years. Canada is forecast to see the biggest drop, with real home prices falling 12%. France followed with a 9% drop, and the US with only 3%. These are national prices, so inflated markets are seen making bigger declines. “The slowdown will be sharpest in Canada due to weak recent momentum, low affordability and rapid changes in Bank of Canada policies,” the bank said.
Global economic growth is forecast to slow over the next few quarters, with home sales bolstering the outlook. “And while a tight housing market may be enough to avoid a downturn, the rapidly deteriorating affordability and large decline in home sales suggest a housing downturn is a real risk.”
Canada has the worst housing affordability among developed economies
Lack of affordability is what will keep buyers from stepping in until home prices fall. The GS Housing Affordability Index (HAI) looks at households’ capacity to service mortgage loans. We may see a brief spike in affordability early in the pandemic as rates were initially reduced. Affordability then declines rapidly as the market adjusts to accommodate the increased credit capacity. It’s an issue cited by the Bank of Canada, warning that low rates don’t improve affordability.
Shortly after interest rates went up, affordability fell even more, a typical but temporary phenomenon. Just as low interest rates work to stimulate demand and raise prices, higher interest rates do the opposite. By slowing demand, prices can cool to more reasonable levels, but it takes several months to correct. Once again, the US has yet to see this, but it is expected in the coming months. GS is not alone in seeing inflated home prices correcting after rate normalization. The Bank for International Settlements (BIS) recently warned that low interest rates are creating housing bubbles in advanced economies. While they say it’s a global phenomenon, they say it’s due to monetary policy mistakes repeated in many advanced economies. They suggest that higher rates can be painful, but not addressing the problem can make it worse. If the trend is not correct, the BIS warns that the consequences will be beyond the housing market.
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