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Who Wants To Talk About Interest Rates?

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Let’s start with a bang, shall we?

The recent drop in Toronto home prices is solely due to the increase in interest rates.

Yay or nay?

Well, I suppose before we confirm or deny, we must first address this “drop in Toronto home prices,” since many home-sellers are in denial.

“Denial ain’t just a river in Egypt,” a smart woman once said.

I literally just got off the phone with a client, to whom I said, “I’m having very honest, direct conversations with people these days, and I’m simply giving them the lay of the land, and letting them decide what they want to do.  I would say that 7/10 of them are hearing me and in agreement…”

She laughed.

She understood.

In March, I told her that she might achieve $825-$850K for her condo, but in June, that’s likely going to be closer to $800,000.

She’s fine with that.  I mean, “fine” with the state of the market and what she can expect to sell her condo for, but nobody is really “fine” with selling for less than they would have, could have, should have.

Now, I’m sure you want to hear about on of the 3/10, just for fun, right?

A gentleman called me last week and said that he had been “contemplating” selling his Mississauga home for some time now, and when I pressed him on that timing, he said, “Two years.”  It’s very rare to hear this, of course.  Most people have an impetus for selling, either they bought another property, or they’re relocating for work.  But I would guess this gentleman owns multiple properties and has the luxury of choice.

He cited the same of an almost identical property down the street, which happened to be on the roundabout that I would argue is much more sought-after.  This property sold for $2,150,000 in the third week of February.

I knew what I felt the property would fetch in June, which was likely when we would list, given the time it takes to prepare, so I asked him, “What would you reasonably expect to get for your home?”

Any guesses among you, the readers?

Well, since I referred to him as one of the 3/10, you know he’s going to be out to lunch.

But how out to lunch?

He said, “I’d like to get at least what the chap at the end of the block got earlier this year.”

At least.

Huh?  How does that make any sense?

“His property wasn’t as upgraded as mine,” he told me, which I couldn’t really confirm without seeing it in person, but given that the other property was on the circle at the end of the dead-end street, and was superior, this guy would need to have solid-gold kitchen counters to offset that premium and account for the market.

I told him that, on paper, the average home price in Peel Region had declined by 5.7% from February to April, and that the May numbers will show a further decline.

“Not from where I’m standing,” was his response.

I told him that he should expect to get $2,000,000 for his house, but I added that in September, his house would have been worth $1,750,000, so he was doing pretty well!

Of course, I looked up the history of the home and saw that he purchased it in 2009 for $752,000, and offered, “You know, you’re doing pretty well here, all things considered.”

Then he laid down a challenge.

“You know, I found you online.  Looks like you’ve got a pretty good following and a good foothold in this industry.  You clearly know your stuff.  But if you can’t get me the price I need, then maybe I’m calling the wrong person.”

Desperate times call for desperate measures, right?  Don’t blame the game, blame the player?

Except, this gent wasn’t desperate.  He was simply overvaluing his house.  That “comp” at the end of the street made his house worth the same, on a good day, if he really had “upgrades,” and if the market has trailed off, then he’s looking around $2 Million for his house.  What’s wrong with that?

Imagine a scenario where the neighbour to your left sold for $1,000,000 in January and the neighbour to your right sold for $1,250,000 in March.  Now, you’re told that you can sell for $1,150,000.  That’s more than your neighbour to the left but less than your neighbour to the right.  Is there anything wrong with this?

I think we’ve become so desensitized to the idea of real estate as a “market” that we forget that markets can ebb and flow.

That is what’s happening in the market right now, at least to some folks.

And ALL of these folks, no matter what, seem to be blaming interest rate hikes.

One person told me this week, “It’s like Justin Trudeau wants me to get less money for my home!”

Hey, listen, I’m hardly Trudeau’s biggest fan, and I’d love to pile on here, but Justin Trudeau couldn’t personally care less about what you sell your home for, nor were monetary policy decisions made based on the real estate market.

That’s where opinions will differ, of course.

You want my two cents?

Inflation is rampant across the country.  It’s actually rampant worldwide.

The International Monetary Fund expects inflation in developed nations to be at 5.7% in 2022, and 8.7% in developing countries.

Canada’s rate of inflation for 2021 was 3.4%.

But lately, those numbers have skyrocketed.

5.1% in January.

5.7% in February.

6.7% in March.

6.8% in April.

This simply cannot continue.

We have a provincial election coming up, and amazingly, inflation has become a talking point!

Liberal leader, Stephen Del Duca, said the following:

As the guy who goes grocery shopping for my family every single Saturday I think about the price of food, and how it’s gone up. It’s skyrocketed under Doug Ford.”

This is amazing to me, since inflation worldwide is rampant.

We’ve got a war in Russia/Ukraine, the price of gas has become a political football, supply-chain issues are the worst they’ve ever been, and food prices in Canada are up 7.7% in the past year.  So to blame Doug Ford for this is just silly.

But all politics is silly.

Inflation is real in this country, and that 3.4% recorded in 2021 was downright scary!  That was the highest annual rate of inflation in Canada since 1991 when inflation sat at 5.63%.

So when we saw figures of 5.1%, 5.7%, 6.7%, and 6.8% to start 2022, it was likely determined, at the federal level, that this simply cannot continue.

How do you get inflation under control – in theory, at least?

Raise interest rates!

March 2nd, 2022: increase of 25 basis points.

April 13th, 2022: increase of 50 basis points.

Widely expected, June 1st, 2022: increase of 50 basis points.

And possibly on the table for July 13th, 2022: another increase of 50 basis points.

For those playing along at home, that would take us from an overnight lending rate of 0.25% to start 2022 up to 2.00% by the summer or fall.

There are two ways of looking at this:

1) Isn’t 2.00% really, really close to zero?  Why is this a problem?  Why are people scared of this?  This is cheap money!

2) An increase from 0.25% to 2.00% represents an eight-fold increase in the rate.  It could take five-year rates from sub-2% to upwards of 6%.

Now, consider that the overnight lending rate only has a direct impact on the variable rate mortgage, whereas the fixed-rates are affected by the bond market.  But an increasing interest-rate environment is going to lead to higher fixed-rate mortgages over time.  There’s simply no avoiding it.

Every home-seller out there right now is cursing the government for increasing interest rates.  They all seem to think this is why they’re getting less money for their house or condo than they could have sold for in February or March.

While there might be some truth to that, I also think we could spend a significant amount time talking about buyer fatigue, front-loaded real estate calendars, and how unsustainable month-over-month price appreciation always leads to a drop in activity and pricing.

In any event, the interest rate debate is not going away.

This article appeared in the Financial Post on Tuesday:

“Stop Hiking Interest Rates! Canadians Want Bank Of Canada To Press Pause Amid Deep Financial Worries”

From the article:

A large number of Canadians want the Bank of Canada to press pause on additional interest rate increases as they fret about their finances, a new poll suggests.

Close to half of Canadians want the central bank to keep interest rates at one per cent and monitor how it’s affecting inflation before making any more moves, according to a survey conducted by the Angus Reid Institute. Only 27 per cent said the bank should hike more aggressively to dampen inflation, and another 13 per cent said rates should go lower to protect the housing and stock markets from spiralling.

It’s not unusual to see Canadians disagreeing with the government, right?

But in this case, do they actually know what’s best for them?

Inflation is the invisible devil.  It slowly, quietly eats away at us, our savings, our lifestyles, and our livlihood, but it’s not like a new tax where the government says, “Give us $5,000 please.”  Nobody notices inflation.  Unless, say, you went out to The Keg for the first time in two years and suddenly your New York peppercorn is $50, and you’re pretty sure that it used to be $38…

Also from the article:

As interest rates rise, Canadians are also starting to worry about the impact on their mortgage and debt payments. Almost one in five said they are extremely worried about the debt they’re carrying. In turn, people are trying to stop spending so much, and said they’re eating out less, cancelling streaming services, driving less and even changing their diets to save on grocery bills. That could point to headwinds ahead for the economy.

Ah hello, my old friend: financial responsibility!

Imagine people feeling the financial pinch and deciding to cut back on expenses?  Bravo!

But as the article notes: this isn’t good for the economy.

People looking to save money and eat out at restaurants less will hurt those restaurants, which hurts the owners, employees, and associated vendors.

It’s a vicious circle, isn’t it?

To stop inflation, we have to increase interest rates.  But increasing interest rates creates financial pressure, and that will lead people to spend less.  People spending less will hurt the economy, and then we’re all worse off.

Here’s an interesting point:

But, opinions over what the Bank of Canada should do with rates appears to be divided along political lines. Past Conservative voters are more likely to want interest rates to come down, the survey said. Seventeen per cent of Conservative party voters think interest rates should drop, compared to eight per cent of Liberal voters and nine per cent of NDP voters, a “significant” divide, Kurl said.

Debate that, if you so choose.

Meanwhile, here in the cozy cofines of the Toronto housing market, buyers and sellers alike are pointing to higher interest rates as the cause of pain.

We’ve already established why sellers don’t like the higher rates.  They blame rates for the drop in market activity and associated drop in prices.

But buyers?  Shouldn’t they be championing the rise in rates, which helps calm the market?

Sure, in theory.  But in practice, it hurts their affordability.

Let’s say, for argument’s sake that John & Jane had a pre-approval for a 5-year, fixed rate mortgage of 3.79% in February.

Purchasing a $1,500,000 house with a 20% down payment would result in a monthly mortgage payment, on a 30-year amortization, of $5,564.48

But John and Jane didn’t buy inFebruary, or March, or even April.  It wasn’t for lack of trying, however!  They made offers and simply kept losing!  So here they are, looking forward to June, and their mortgage rate-hold has expired!  They’re now staring at a five-year rate of 4.49%.

That $1,500,000 purchase, with 20% down, on a 30-year amortization, is going to push the payment to $6,043.61 per month on the 4.49% rate.

Alright, well what if that $1,500,000 house could now be had for $1,450,000.

At the 4.49% rate, the payment is $5,842.15.

So while they’re paying a higher rate, if the house costs slightly less, then they’re not that far behind.

Interest rate “entitlement,” as I call it, runs the same as “peak sale entitlement.”  Just as the owner of the Mississauga house refuses to sell in June unless he gets a February price, many buyers out there feel jaded, and use words like “unfair” to describe an increase in interest rates.

But rates have been much higher in the past, just as they have been much lower!

Do you want feel really sick?

Imagine you’re that lucky-duck who got the 1.49%, five-year rate in 2021.  That $1.5M house with 20% down, at 1.49% brings your payment down to $4,133.04.

Interest rates fluctuate, just like the market.

Understanding markets, whether it’s for real estate, interest rates, equities, currencies, or goddam crypto, is paramount in this 2022 market.

I continue to be shocked at the number of people who feel that it’s “unfair” that interest rates have gone up.  If you can buy a house today and take a 2.69% variable rate, you need not look back at the 1.49% variable rates of yesteryear.  And if you do take that variable rate, then understand what happens when the Bank of Canada increases the overnight lending rate.

I would estimate that a majority of individuals do not know what happens to their variable rate mortgage when the BOC increases the interest rate.

Let’s say you bought a $1,000,000 condo with 20% down on a 2.79% variable rate.  Your monthly payment is $3,276.07.

When the variable rate increases to 3.29%, what happens?

Most people think that their payment rises, in this case, to $3,489.42.

That is incorrect.

What happens is that, inside that $3,276.07 payment that you signed up for, the proportion of principal and interest changes.

At 2.79%, that $3,276.07 payment is about $1,445/month in principal and $1,831/month in interest, averaged through Year-1.

At 3.29%, that $3,276.07 payment sees the principal amount drop to $1,331/month and the interest amount increase to $2,159/month.

I fear that most people don’t know this, although to be fair, maybe they shouldn’t?

But I also fear people’s fears.  I worry that their fears are irrational, unsubstantiated, or in some cases, illogical.

I don’t want to turn this into an advertisment for “Why to hire a mortgage broker,” but mortgage brokers explain all this, whereas the teller over-the-counter at CIBC will not.  At least, not in my experience, and not, in my opinion, anywhere remotely close to as intelligently and eloquently as a top mortage broker.

As we move forward into an increasing-rate environment, it’s crucial that buyers take an active role in learning everything they can about interest rates, and don’t simply make assumptions, which is what so many people have done in “easier” markets.

Another thing to be on the lookout for: a change to the mortgage stress test.

In an enviroment of ultra-low interest rates, it made sense for the Office of The Superintendent of Financial Institutions (OSFI) to ensure that buyers can afford to pay their mortgage if-and-when rates rise.  Ergo, qualifying borrowers at 4.79% when their mortgage rate would be 2.79%, to make sure they could make those payments, made sense!

But does the same thing hold today?

Here’s an article from last week’s Globe & Mail:

“Mortgage Stress Test Rules May Change As Interest Rates Climb And Housing Markets Cool”

From the article:

Since OSFI toughened the mortgage stress test last June, the country’s housing market and borrowing conditions have changed significantly. The regulator must grapple with whether its rules are still effective in the current environment.

OSFI rules apply to borrowers who do not require mortgage insurance, which occurs when borrowers make a down payment of at least 20 per cent of the property’s purchase price. The regulator requires borrowers to prove they can make their mortgage payments at an interest rate of 5.25 per cent, or 200 basis points above their mortgage contract, whichever is higher.

But now, fixed-mortgage rates are quickly rising as the Bank of Canada embarks on an aggressive round of interest-rate hikes, and could soon top OSFI’s minimum qualifying rate of 5.25 per cent.

Today, the average five-year fixed-rate mortgage has an interest rate of 4.19 per cent, according to mortgage brokers. That is up from January’s average of about 2.69 per cent. That means that a borrower must now prove they can make their mortgage payments with an interest rate of 6.19 per cent if they want a fixed-rate mortgage, which is already above the 5.25-per-cent stress-test floor. And the stress test will become even harder as mortgage rates continue to climb.

I believe the critics will be split on this one.

I mean, if it ain’t broke, don’t fix it, right?

On the other hand, why plan for a rainy day that’s never going to come?

Some of you might think that, based on a current 4.49%, five-year, fixed-rate mortgage, perhaps the days of 6.49% mortgages are on the horizon, but to that, I say slow your roll.

We’ve already seen the first 50 basis point hike in over two decades, and there’s not one, but two more rumoured for this year.

Revisiting the stress test makes perfect sense, and dare I say that we still have the safest banking system on the planet.

But that doesn’t mean we’ve heard the end of buyers and sellers both lamenting higher interest rates.

This should be an interesting summer!





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