Written by 11:56 PM Mortgage Industry News Views: 3

Housing’s Waterloo

If you’ve got a fascination with home prices, like most Canadians, you’ve likely pondered when the real estate bull will die. It’s the trillion-dollar question these days, literally.

News on Monday provided another reason to ask that question. It came from CMHC, whose stress tests reportedly foresee a 26% home price correction if oil remains below $35 for five years. More on that.

There’s no telling how accurate CMHC’s model is, or the probability of sub-$35 oil long term. But one thing we do know is that our economy doesn’t just hinge on oil prices; it’s also heavily leveraged to interest rates.

Interest rates dictate the size of mortgage payments, a fundamental component of housing affordability. For decades rates have trended lower, making it easier for borrowers to pay more for homes and inflating valuations. Look at this trend below, from just the last decade alone.

5yr swap

This is a graph of the 5-year swap rate, which correlates tightly with the cost of funding fixed-rate mortgages. Note the persistently lower major highs. This downtrend cannot continue.

Of course, we can go negative on rates, especially given the devastation occurring in the oil sector and its effect on unemployment. A half-dozen industrialized countries already have sub-zero 5-year government yields, and a host of others are just 10 basis points away. But deeply negative yields are a whole different story. Investors may accept paying a “fee” to governments to safely hold their money, but no one is going to lose 25 to 50+ basis points every year on 5-year maturities indefinitely.

So let’s agree for conversation that the zero bound, or thereabouts, is the floor for Canadian rates. If that’s the case then Canadian yields have just one point +/- to fall before long-term mortgage rates hit a bottom.

Think about that because at that point, there would be no further interest rate reductions to improve affordability. A big thick pillar of home price appreciation would be knocked out, leaving the housing market to rely primarily on household formation, employment/income gains and supply constraints to keep prices on an uptrend. 

This might leave some asking, “Could the zero bound in rates be housing’s Waterloo?” To that question the answer’s not certain, but this we know: a table can still stand with three corner legs, but it gets pretty wobbly.

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Last modified: April 26, 2017

Robert McLister is one of Canada’s best-known mortgage experts. A mortgage columnist for The Globe and Mail, interest rate analyst and editor of MortgageLogic.news, Rob has been covering Canada's mortgage market since 2007.