Rising Interest Rates Make the Situation Worse

RBC’s affordability measure hasn’t been this bad since 1990. The ownership costs to carry a home bought in the second quarter of 2018 would have taken up 53.9% of a typical household’s income. This is up sharply from 43.2% three years ago.

Blame interest rates for the rise in ownership costs in the past year. Mortgage rates increased in each of the past four quarters and accounted for the entire rise in RBC’s aggregate measure for Canada over that period.

Unaffordability is off the charts in Vancouver, Toronto and now Victoria. Interest rates have a big impact in these high-priced markets. The situation is much less strained in other markets, although affordability deteriorated in all markets in Canada in the past year.

It’ll probably get worse. We expect further interest rate hikes in the period ahead. This is poised to drive ownership costs even higher across Canada. Household income increases will soften the blow for buyers


All about interest rates – From overheating to correction to the onset of recovery, we’ve seen pretty much everything in the past three years in Canada’s housing market. Yet an eye-watering loss of affordability has been a constant. Over that period, RBC’s aggregate measure jumped by 10 percentage points to 53.9%, its highest level since 1990s (a rise in the measure represents a loss of affordability). Surging prices in Vancouver and Toronto jacked up ownership costs substantially between 2015 and early 2017. Since the middle of 2017, it’s been rising interest rates that have been the main factor squeezing affordability. We’ve seen a material rise in mortgage rates since the Bank of Canada launched its hiking campaign in July 2017 and this kept ownership costs on a steep upward trajectory despite home prices stabilizing. The higher borrowing costs in fact accounted for virtually the entire 2.6 percentage-point increase in RBC’s measure in the past year and most of the 1.1 percentage point advance in the second quarter of 2018. Add the stress test on top of this and the picture gets even more daunting for many Canadian buyers. Clearly, affordability—or rather, the lack thereof—remains a big issue in some of Canada’s major markets.


High-priced markets now face the worst affordability conditions ever…  Unsurprisingly, ownership costs rose the most in high-priced markets last quarter. That’s because mortgage payments are very sensitive to interest rates in these markets. RBC’s aggregate measure increased by 1.6 percentage points 88.4% in the Vancouver area, 1.8 percentage points to 75.9% in the Toronto area and 2.4 percentage points to 65.0% in Victoria. These represented the worst ever levels on record since the mid-1980s in all three markets. No wonder the current generation of local buyers feels overwhelmed—no other generation has faced as much affordability pressure in this country.


…though higher interest rates affected nearly all markets – Of course, the impact of rising interest rates extended far beyond the boundaries of Vancouver, Toronto and Victoria. All markets that we track experienced a loss of affordability over the past year arising primarily (albeit not exclusively) from higher interest rates. Only St. John’s saw a marginal improvement in the second quarter due to weak market conditions and a drop in prices. For the most part, the rise in RBC’s aggregate measure was modest and levels remain close to historical norms. So ownership costs continue to be manageable in the majority of local markets in Canada. Montreal could become an exception, though, if prices accelerate further in the area. RBC’s measure for Montreal is above its long-run average by a fairly wide margin, which could be a sign that affordability pressures are building.


Condo affordability is slipping fast – One interesting development over the past year is that affordability eroded more for condos than for single-detached homes in Canada. This reflected a sharp turn of events in the Toronto area where detached home prices fell (following a significant run-up the previous year) while condo prices continued to rise rapidly. Demand for condos has been fueled by affordability issues plaguing the single-detached segment that diverted buyers toward lower-priced housing categories. This phenomenon subsided somewhat in the second quarter of 2018, as single-detached home prices began to rise again and condo price gains slowed.


No real relief in sight – The outlook for affordability isn’t very promising. We expect the Bank of Canada to proceed with further rate hikes that will raise its overnight rate from 1.50% currently to 2.25% in the first half of 2019. This will keep mortgage rates under upward pressure and boost ownership costs even more across Canada in the period ahead. We estimate that, everything else remaining constant, a 75 basis-point increase in mortgage rates would lift RBC’s aggregate affordability measure for Canada by roughly 2.8 percentage points. Growing household income will provide some partial offset. So potential buyers hoping to get a meaningful break will likely be disappointed. We expect intensifying affordability pressures to restrain homebuyer demand over the coming year.


Due to space limitation, we are unable to reproduce the entire 10-page report, which includes a brief summary and chart of affordability measures by each major Canadian city.

Feel free to request an e-copy at susan.gottlieb@rbc.com


Susan Gottlieb is Vice President and Wealth Advisor with RBC Dominion Securities Inc. This article is for information purposes only. Please consult with a professional advisor before taking any action based on information in this article.



Initially reported by RBC Economics in September 2018.  Sources: Canadian Real Estate Association, RBC Economics Research, RPS, Royal LePage, Statistics Canada, Bank of Canada, RBC Economics Research. The material contained in this report is the property of Royal Bank of Canada and may not be reproduced in any way, in whole or in part, without ex-press authorization of the copyright holder in writing. The statements and statistics contained herein have been prepared by RBC Economics Research based on information from sources considered to be reliable. We make no representation or warranty, express or implied, as to its accuracy or completeness. This publication is for the information of investors and business persons and does not constitute an offer to sell or a solicitation to buy securities.



Categories: Financial Wellness & Advice