Anyone who reads REW.ca and the mainstream media knows that there is a lot of talk about what is pushing up local real estate prices, and a lot of opinions from various camps about whether it’s overseas buyers, limited supply, land costs, densification, Vancouver’s desirability or whatever. And the truth is that there are many, many factors affecting our prices that have all been spiralling upwards around each other, with each factor causing the next to go up. But there’s one factor that is really supporting that upward spiral from below, and that is our record-low interest rates.
Here’s a really simplified example for the sake of easy math. Let’s say that the price of a home, the home that you want to buy, has tripled in the past 20 years. In 1995 you’d have taken out a mortgage of $200,000 to buy that home, now you have to take out $600,000. That’s a 200 per cent rise. With salaries increasing by an average of only, let’s say, 50-70 per cent in that time (a conservative estimate), the home seems impossible for the same person to afford now. Right?
Well, wrong, actually.
Why? Because in that same time frame, interest rates have also decreased from around a typical 12 per cent five-year fixed rate in 1995 to today’s rate of 2.6 per cent.
This means that in 1995, if you had a mortgage of $200,000 you’d pay $2000 a month to service it. Today, if you have a mortgage of $600,000 on a 2.6 per cent rate, you’d pay about $2700 a month to service it – around 35 per cent more than 20 years ago. With salaries having risen easily more than 50 per cent in that, it’s actually cheaper, relatively speaking, for you to service the mortgage today, even though prices have tripled.
Now, this is a very simplistic scenario just to make a point. But the point is, people will buy what they really want, if they can afford it. And people really want Vancouver real estate. And with super-low interest rates, a lot people can afford to buy local property at their current prices. Certainly at least as many can afford to buy now as could afford to buy homes 20 years ago, when interest rates were 12 per cent or more.
That’s one of the fundamental reasons why, despite the perceived unaffordability of house prices in Vancouver, and with salaries increasing at a much slower pace than house prices, people still keep buying more and more homes, and prices keep going up and up. And when you read the latest affordability report with an index that compares house prices with local incomes, low interest rates are one crucial reason why that comparison is useless.
There is, of course, the danger that rates will rise, and the high house prices are only being perceived as manageable because of the low rates, and people are taking out too much money to buy a home and could get into trouble if interest rates rise. And yes, home buyers need to be really wary of this. But it’s certainly unlikely that we’ll see a return to those 12 per cent rates any time soon. Mortgage experts that I have spoken to agree that people should build in a buffer so that they could still afford their mortgages if their rate rose by two per cent. On my condo in the West End, for example, I locked in a five-year rate of 2.79 per cent in February 2015, but ensured I bought a property where, if my rate went up to 4.79 per cent in five years’ time, I’m still able to pay it.
I was talking about this with mortgage broker Peter Kinch on my radio show last weekend, the Real Estate Therapist Show on Roundhouse Radio 98.3FM, and we agreed that interest rates were a key factor in local prices. I asked him if an increase in rates would, therefore, bring local real estate prices down again.
“If interest rates do go up, that would be one factor that could slow down this market,” agreed Kinch. “I don’t see any fundamentals that would suggest the burst of a bubble, but an interest rate increase would contribute to a soft landing. That doesn’t mean prices would go down, they might just stop rising.”
(In fact, Kinch says that interest rates have already risen, as banks are offering reduced discounts off prime compared with a month or so ago – full story on that here.)
It’s important to raise the argument that the whole of Canada has had low interest rates, so why haven’t real estate prices risen similarly across the whole country? Well, that’s where all those other factors – land restraints, densification, population, generational wealth transfer, desirability and, yes, overseas buyers – all come in. Those factors are specific to Vancouver and are pushing the upward spiral of prices, which are being effectively underwritten by the low interest rates.
By the way, all those myriad factors are the key reason why it is so tricky to collect data on overseas buyers to measure their impact on local house prices, as many people are clamouring for. As we are unable to islolate the effect of each factor on the market, it would be impossible to tell how much impact came from overseas buyers, and how much from low interest rates and all the other factors in play.
But that is a discussion for another day.