Housing Market: 2 or More Rate Hikes Could Lead to a Severe Correction

Canada’s largest banks see property values easing in the near term as the housing market adjusts to higher interest rates.

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Canada’s largest bank confirms that a housing market correction is spreading far and wide. Robert Hogue, assistant chief economist at the Royal Bank of Canada, said the decline in activity in the Toronto and Vancouver areas is quickly becoming one of the deepest of the past 50 years.

There’s no doubt that rising interest rates are the catalyst for the correction. According to the bank, market exuberance has diminished because of the sudden realization that prices can’t rise forever. However, buyers are unlikely to rush their purchases despite falling prices.

The Bank of Canada’s key interest rate is now 2.5% following the 100 basis points increase last month. BOC Governor Tiff Macklem, said, “We are acutely aware that higher interest rates will affect Canadians who are already feeling the pain of high inflation, but by increasing the cost of borrowing, we will moderate spending and return inflation to its target.”

Target is soft landing

The Feds decided to front-load interest rate hikes because inflation is higher and more persistent. They believe the aggressive stance to curb soaring inflation will lead to a soft landing. Macklem said, “Front-loaded tightening cycles tend to be followed by softer landings.”

Meanwhile, RBC predicts another 75 basis points increase in the fall. While the dents caused by the rate hikes are still insignificant, the effects will be more strongly felt in the coming months. Nevertheless, the giant mortgage lender said it should be a welcome event after the run over the past two years.

Shifting consumer sentiment

Kevin Crigger, president of the Toronto Regional Real Estate Board (TRREB), said, “With significant increases to lending rates in a short period, there has been a shift in consumer sentiment, not market fundamentals.” Data shows that home sales in the Greater Toronto Area plunged 47.4% year-over-year in July, while sales activity declined 24.1% on a monthly basis.

But Bob Dugan, chief economist at Canada Mortgage and Housing Corporation (CMHC), said the decline in average home prices isn’t the measure of the housing market’s health. The average price change depends on the composition of properties sold from month to month.

Dugan said the mix of properties being sold each month can influence the national average price. Single-family homes could outsell condos this month and the trend reverse next month. Because single-family homes are generally pricier than condos, expect the national price to drop.

Resilient REIT

On the stock market, the real estate sector is underperforming year-to-date (-18.55%). Still, investing in real estate investment trusts (REITs) might be a better option than buying investment properties. A top pick today is Crombie (TSX:CRR.UN), notwithstanding the depressed share price of $16.60 (-8.09% year-to-date).

This $2.93 billion national retail property landlord is resilient because its real estate portfolio consists of grocery-anchored properties, providing it high exposure to an essential consumer staples industry. Also, the anchor tenant is Empire Company, one of the leading food retailers in Canada. Its ownership stake in Crombie is 41.5%. You can partake of the generous 5.36% dividend if you invest today.

Market will adjust

RBC expects the housing market to keep chilling. According to Hogue, property values should ease in the near term as the market adjusts to higher interest rates.  

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium service or advisor. We’re Motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer, so we sometimes publish articles that may not be in line with recommendations, rankings or other content.

Fool contributor Christopher Liew has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned.

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