August 21, 2014 11:23 am

RBC warns home prices could start falling in 2016

RBC, the country's largest lender, says home prices could see "outright declines" when higher borrowing rates "start to bite."

The Canadian Press

Home prices in Toronto and the surrounding suburbs have been on fire this summer as interest rates have drifted to extreme lows, tempting buyers to take out bigger home loans.

Calgary’s housing market has witnessed similarly outsized gains, while pricey Vancouver is eking out relatively strong price growth, as well.

But what goes down often comes back up (and vice versa).

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In this case, extraordinarily low mortgage rates appear poised to at last begin rising “later this year,” according to a new forecast from the Royal Bank of Canada.

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For big markets like Toronto, where affordability is already stretched to near-maximum levels, the upward rate drift through 2015 is going to “decelerate substantially” the growth of home prices.

But RBC cautions, “the bigger test could well await after 2015 should interest rates normalize fully over the medium term.”

Economists use the term “normalize” when describing interest rates moving back into line with historical norms.

“We could see outright price declines in the 2016 or later timeframe,” said RBC senior economist Robert Hogue, adding that wages and incomes aren’t likely to suddenly catch fire to allow many households to comfortably handle the added financial pressure higher rates will bring.

“[Home] prices will be the principle adjustment mechanism,” Hogue said.

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In fact, the strong gains now in many big centres may well come back to haunt the housing market, the RBC economist suggests.

“The higher home prices get relative to income by the time rising interest rates really start to bite, the more prices will have to adjust (downwardly),” he said.

Average home prices in Toronto, the country’s biggest housing market, are up nearly 10 per cent this month compared to August 2013 (to $538,530), an unsustainable clip in the view of most housing experts.

Household income gains this year are hovering at just over two per cent, according to economists.

“Any price increases exceeding the rate of household income gains in the near term likely would result in steeper price declines down the road,” Hogue said.

RBC doesn’t foresee a protracted housing slump, though.

“We believe the intensifying downward pressures will lead to a cooling of the market, not a crash,” Hogue’s report said.

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