Housing Crisis Persists as Interest Rates Drop

Text transcript

Welcome to advisor To Go, brought to you by CIBC Asset Management, a podcast bringing advisors the latest financial insights and developments from our subject matter experts themselves. 

Benjamin Tal, deputy chief economist, CIBC. 

The question is, to what extent is inflation still sticky? And the answer is, no. It was stickier than expected for a while. The Bank of Canada was a bit nervous about it. They basically postponed the rate cuts. At this point, inflation is really not an issue anymore. No question about it.  

If you look at the inflation minus mortgage interest payments, which is one-third of inflation, it’s basically 1% now. So clearly, the war has been won against inflation. The Bank of Canada is not extremely concerned about it at this point. In fact, there is the issue that maybe inflation might be too low over the next few months. Therefore, they are in the midst of cutting interest rates, and they will continue to cut interest rates into late 2025.  

So, if interest rates today are at 425, we see them going down to two and a half, 225 by the end of 2025. That’s a significant decline that clearly will help the economy.  

I think that in the short term, clearly, lower interest rates will help to an extent, but will not solve the major issue. The condo market, we have to realize, is in many cities frozen, because we have a situation in which there is a lot of inventories. Investors are out of the market because of higher interest rates, and builders are not building.  

So, in many centres in the country, including Vancouver and Toronto, this is actually not a bad time to buy a condo, because the market is soft. But two or three years from now, the situation will change dramatically, because of the fact that now they are not really building anything. The new supply is basically zero, which means that two or three years from now the market will be back to semi-normal, investors will be back in the market, interest rates will be lower, and supply that’s supposed to come now will not be around. So, you don’t have to be an economist to predict what will happen.  

But you’re absolutely right to suggest that this is not the number one issue. The number one issue is affordability. Affordability is a major crisis, and I’m not using this world lightly, and the only way to solve that issue is to cut prices. How do you cut prices? By raising supply, by improving supply, by making sure that we are building much, much faster and more in all municipalities and all the regions of the country. This is the number one issue.  

For many years, we have been using demand tools to fight supply issues. For the first time, it seems that governments at all levels are realizing that we have to accelerate the rate at which we build new houses. That’s the only solution, including a rental solution, not just home ownership, but also rental.  

I think that when it comes to the housing market, it’s really a tale of two markets. The low-rise segment of the market, the detached segment of the market is doing fine. I think that there is no question about the fact that it’s struggling, but it’s not really on its knees. There is still a shortage of inventories, and there is some pressure in that market, so it’s behaving normally. That’s the low-rise, detached segment of the market.  

As I mentioned, the condo space is basically frozen. It’s in a recession, and that will last until maybe 2026. So, we have a year and a half or two of relatively soft conditions in the in the condo space, before we see some improvement.  

The purpose-built rentals, namely apartment buildings, we are seeing some improvement there because we have seen the government taking some steps, including removing the HST and GST on new projects. That really helped. I think that we are in a process of looking for other ways to cut costs for purpose-built rentals, and that’s something that governments are now very busy doing, trying to reduce the cost and increase affordability in the market. So, I would pay very close attention to developments of the purpose-built rental apartment buildings. 

The question is, to what extent an increase in savings that we have seen in Canada will protect mortgage holders from paying more when interest rates renew? And the answer is, not much. Why? Because the people with the money are not the people with the debt. That’s the simple answer. The distribution is very different. We have seen a significant increase in savings among people without mortgages, people that take advantage of high GIC rates, and we have seen a significant increase in accumulation of GICs over the past two years, because there is a very high correlation between interest rates and GIC volumes.  

Now, with interest rates starting to go down, we’re starting to see the opposite, and this one is actually going to dividend paying stocks. So we are in a situation in which dividend paying stocks will benefit from this trajectory, because a lot of money that now is sitting in five-year rate, four-year rate GICs will exit the GIC market and will actually go to the dividend paying stock space, which I think is going to benefit over the next year. 

The question is, to what extent what Ottawa did recently is going to change things significantly. It’s a step in the right direction, but it’s really going to boost demand, while the main issue is supply. While increasing amortization to 30 years will make it more affordable, at the same time it means that the borrowers will be using debt for longer. Also, increasing the insured cap to 1.5 makes sense, because many, many units in Toronto, Vancouver and other places are more than $1 million and therefore not eligible for insurance. So, this basically corrects it. So, I have no issue with that. That’s something that is the right thing.  

But remember, this is not the solution. This is just a temporary fix. The solution is increased supply. And when it comes to increased supply, we have to think of a few things. One is incentives for developers to build purpose-built rentals. The other is to start thinking about factory-made houses. We are still building houses, you know the way we built 50 years ago. If you take a pilot from 50 years ago and you put them in an airplane today, they will not know what to do. If you take a construction worker from 50 years ago and put them on a site, they will know exactly what to do. They will know exactly what to do. And that’s exactly what we are seeing. No innovation in the construction market, and that’s something that is going to change very quickly, because we have the technology to basically build houses in factories. 3D printing.  

Sweden is a country that 80% of the houses are made in factories. I think that this is something that we have to invest in, in addition to get more construction workers, because we have a major shortage — 300,000 construction workers will be retiring over the next 10 years. We need to replace them. Because it’s nice to have a target, but if you don’t have the capacity to build, you will not reach that target, and that’s something that we have to focus on.  

So, many things to do in the supply side. The demand side is relatively muted. It’s not important to basically stimulate demand. Demand is strong enough, especially with interest rates going down. We need much more supply. That’s the story.  

We are in a situation in which all governments at all levels are basically panicking about housing. They all realize that the next elections will be about housing, and for the first time, we see a situation in which all levels of government are eager to solve the issue and how to supply. So we see a lot of policy changes very, very quickly in order to take tackle the crisis that many young Canadians are facing. And I think that’s a step in the right direction. We have to take advantage of the fact that politicians at all levels are willing to do things and push and push and push in order to get much more supply. Because again, we have a generation of Canadians that can only dream about owning a house. This is time to try to help them, and this is a golden opportunity to convince governments to increase supply in a very significant way.