Making Sense of Interest Rate Uncertainty

Financing real estate is becoming more expensive quickly — do you have a plan?

The Bank of Canada’s recent decision to raise interest rates should come as no surprise, especially since it can be used as one tool for mitigating the economic impacts of rapidly rising inflation. But few expected such a steep 0.5% rate hike so quickly.

Further rate hikes are inevitable and will place taxpayers in a tight squeeze, with six in ten Canadians worried they will not be able to stay on top of mounting debt. It also effectively puts the brakes on a red hot housing market with variable-rate mortgage payments set to increase dramatically.

Joe Rullier, Senior Vice-President with Colliers International — Private Capital Markets Division, has been warning of a sharp increase and breaks down what this means for buyers and developers alike.

A Record-Setting Hike

As reported by the Canadian Press, The Bank of Canada “raised its key interest rate by the highest amount in more than 20 years and warns more rate hikes are coming.” The hike is twice what was predicted in the short-term by most analysts. For Rullier, it’s just one more challenge to overcome among those advocating for accelerated residential and commercial development for Montreal (#BuildUpMTL).

“Look at all the obstacles that are slowing down and even stopping development in its tracks: things like the 4% welcome tax, zoning permits that are indefinitely delayed or never materialize, and now the biggest interest rate hike in two decades. Meanwhile construction costs are through the roof; it’s this confluence of debilitating factors that are halting, even killing, development. It just doesn’t make sense.”

Unfortunately, indications are that the worst is yet to come. All signs point to another 0.5% increase this spring or summer with some economists predicting that the base rate could go as high at 2.5% by Q1 2023. Rullier is concerned about the bearish policy but says it’s not time to push the panic button just yet.

“It’s definitely slowing down in the market but not to the point where it necessitates such a significant intervention. The year started strong but it looks like the beginning of the end for this streak. By 2023, we could see a switch where buyers with more liquidity are looking for deals because owners are over-leveraged and have to unload assets.”

Financing Challenges for Real Estate

While some argue the hike is a necessary evil, it’s a lose-lose for real estate because it raises the cost of everything, from land to taxes and, of course, mortgages.

“We’re seeing a lot more asset classes on the market, but they’re not moving. That’s a sign of how buyers are feeling cautious, less confident. Another sign is how banks are getting a lot tougher in their mortgage stress test. Effectively it’s becoming a lot harder to finance your property. And that in and of itself is a sign of how banks are also facing great uncertainty.”

Why the urgency? Bank of Canada Governor Tiff Macklem blames high inflation and the invasion of Ukraine, the latter of which is responsible for driving up energy prices while disrupting global supply chains. Even climate change is playing a role in the destabilization of economies. The question is, when will the markets see some relief.

“Here at home, construction costs are rising and private developers are starting to feel the pinch. Yes we’re seeing more supply coming back to the market but it’s not moving as quickly. I don’t like crystal ball-gazing but I foresee a
stronger summer followed by a cooler fall. Next year may see a cooling of the real estate boom for a time but it’s important to realize that demand in cities like Montreal isn’t going anywhere. Regardless of the rates, it’s still necessary to ramp construction to increase our supply.”

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© Joe Rullier 2024
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Joé Rullier.