How much will home prices drop as interest rates rise? Depends where you live

Slowing home sales and declining prices in cities across Canada have homeowners and prospective buyers alike wondering how low valuations could get as interest rates rise and the post-pandemic market starts to materialize.

But just how low prices will go depends on what part of the country you’re living in, with a recent report from Desjardins Economic Studies suggesting cities that saw the most growth in the pandemic now have the furthest to fall.

Major Canadian housing markets including Toronto and Vancouver saw less sales activity and even price drops in April and May as the Bank of Canada began raising interest rates over the past three months.

This “chillier wind,” as RBC economist Robert Hogue dubbed it in a report last week, is expected to continue driving home values down from their pandemic-era highs as demand softens and housing inventories are given time to rebuild.

Randall Bartlett, senior director of Canadian Economics at Desjardins, tells Global News that rising interest rates are the “pin that’s bursting the housing bubble that developed during the pandemic.”

The Desjardins report released this past week predicts that from the peak of national home prices in February of this year to the end of 2023, the average sale price in Canada will drop 15 per cent.

Virtually all markets are expected to see some drops, but some could see value erode more rapidly.

In the Maritimes, for example, prices in Nova Scotia and New Brunswick are expected to fall 20 per cent over that timeframe. Ontario and Prince Edward Island could see drops of 18 per cent, with British Columbia giving back as much as 15 per cent.

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Markets that saw the highest price growth over the past two years, when interest rates were low and urbanites were fleeing the big cities, are now set to see the biggest retreat in home value, Desjardins predicts.

“Some markets are going to come down more quickly toward that balance than others are. And the corrections are going to be larger in some places,” Bartlett says.

Royal LePage COO Karen Yolevski tells Global News that while national trends can be helpful, Canada’s housing market is really made up of individual “micro-markets” and each follows its own path.

“We’ve been describing it as a bit of a patchwork. Some areas are still seeing multiple offers on homes. Some are seeing a bit of that price moderation,” she explains.

Desjardins expects provinces that saw prices grow at a more moderate pace during the pandemic — Alberta, Saskatchewan, Newfoundland and Labrador among them — will see less decline by the end of next year.

Major cities including Montreal, Toronto and Vancouver will also likely see less of a drop in part thanks to consistent demand tied to their statuses as immigration hubs.

But in markets such as Nova Scotia and New Brunswick, which saw prices rise nearly 70 per cent from the end of 2019 to the peak recorded in February, there’s a lot more value to give back, Bartlett says.

The onset of the pandemic saw many workers ditch the big city and move farther afield, either searching for a more affordable housing market with more space or closer to friends and families.

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Now that many workplaces across Canada are beginning to call employees back to the office, on a permanent or hybrid basis, a reverse phenomenon could be taking hold.

“Our expectation is that not only will it be higher interest rates that are pulling those markets down, but also the fact that people are going to be returning to work in some fashion,” Bartlett says.

Ontario itself became a microcosm of this national trend, Bartlett says, as residents working in the Greater Toronto Area moved to work remotely in more affordable communities for the same salary.

As a result, Desjardins predicts that cities within a couple hours’ drive of Toronto — Bancroft, Windsor-Essex and Tilsonburg among them — are the most at-risk of a pull-back in the next 18 months.

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But as the pandemic hopefully wanes, not every worker will necessarily return to the status quo.

Yolevski tells Global News that buyers are in a “bit of a stalemate” right now as they wait to see not just how high interest rates will go, but what kind of lifestyle is feasible for them post-pandemic.

“There are some buyers on the sidelines right now just waiting to plan their next step. Some of them also are wondering where they can live long term,” she says.

Bartlett agrees, and says he expects the staying power of remote or hybrid working arrangements to help insulate price drops in smaller communities.

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While Desjardins expects each province to see at least modest price drops, Bartlett says the forecast calls for a correction, not a collapse.

It’s not likely that any housing market sees prices fall below their pre-pandemic levels, he says, calling the upcoming drop a welcome return to “balance” for younger Canadians and lower-income households who have been kept on the sidelines of homeownership for years.

“There are some positives coming out of this,” he says.

The big unknown is how high interest rates will go, Bartlett notes. He concedes Desjardins is more “dove-ish” than most in its forecast, expecting the Bank of Canada will raise rates as high as 2.0 per cent to 2.25 per cent before it’s “constrained” by the housing market correction.

But the central bank has warned in the past that rates might have to go as high as three per cent to tamp down rampant inflation.

Bank of Canada governor Tiff Macklem said this past week that he believes the economy can continue to handle rising rates and said the housing market is just one factor the bank considers when evaluating the impact of high rates.

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“Where we could see a greater correction is if the Bank of Canada decides it needs to do more to push back on inflation,” Bartlett says.

Even if the correction is steeper than Desjardins forecasts, Yolevski says that homeowners stressing about eroding equity can find some solace that housing prices tend to trend higher over time.

For the majority of buyers who purchase a home as a place to live first and a store of value second, she predicts that price drops in the near term likely won’t sink their investment.

“If you’re buying for shelter, you’re buying for the longer term, it’s likely that these dips won’t have as much of an impact,” Yolevski says. “It’s likely that we will continue to see a strong market over time.”