Photo: Dillon Kydd / Unsplash

Coming off a year that produced record-breaking sales activity, Canada’s housing market is scorching hot, coupling exorbitantly high demand with historically low inventory.

According to a recent report by RBC, approximately 667,000 home transactions were completed last year, up 21 per cent (or 114,000 units) from the previous record set in 2020.

And those record-setting figures were posted despite new listings declining 3.2 per cent month-over-month in December, resulting in a record low 1.6 months of national housing inventory. By comparison, the long-term average is slightly higher than five months.

The tug-of-war between buyer demand and limited supply has caused bidding wars and surging prices. The MLS Home Price Index rose to $812,000 by the end of 2021, an annual increase of 26.6 per cent, or nearly $170,000.

However, several factors could pour cold water on the Canadian housing market in the year ahead, including rising interest rates and policy initiatives aimed at increasing affordability and curbing investor speculation.

“Intense buyer competition should keep prices on a steep upward trajectory in the near term,” said RBC senior economist Robert Hogue in the report. “However, we believe interest rate increases will alter the market’s course later this year.”

Rate hikes set to arrive in the spring

RBC anticipates the Bank of Canada will begin raising interest rates in the spring, boosting its overnight rate up 150 basis points in less than a year and a half.

While some buyers have been motivated to lock in lower rates, elevating transaction levels, demand is expected to cool once rates rise, helping to create more balanced market conditions. The question is exactly how much heat will be taken out of Canada’s housing market.

“With interest rates set to climb, we look for some froth to come out of sales activity this year,” TD Bank said in a recent report. “However, solid macro conditions, coupled with a highly-elevated price backdrop (which is likely causing buyers to act now rather than later), should sustain sales above pre-pandemic levels.”

TD expects prices to continue rising this year, although interest rate hikes will slow the pace. Investor activity is one of main reasons. While investors have made up an increasing percentage of homebuyers in recent years, they are more sensitive to higher rates.

“Less government spending and tighter monetary policy will be a key theme in 2022,” said Vancouver realtor Steve Saretsky. “The Bank of Canada is poised to sneak in a few rate hikes this year, just how many remains the big question mark.

“The key figure is mortgage rates, if they creep back up above three per cent and hold, it will no doubt slow the housing market, particularly in highly levered cities such as Vancouver and Toronto.”

New housing measures on the way

Policy changes could also shift Canada’s housing market in the year ahead. In his recent mandate letter to Ahmed Hussen, minister of housing and diversity and inclusion, Prime Minister Justin Trudeau outlined measures to address affordability, increase supply, and discourage speculation through the creation of a Fairness in Real Estate Action Plan.

The plan would aim to temporarily ban foreign homebuyers from purchasing non-recreational property, end the blind bidding process, and introduce an anti-flipping tax that would require residential properties to be held for at least 12 months before reselling.

The federal government’s Canada Mortgage and Housing Corporation has already begun reviewing down payment requirements for investment properties. Meanwhile, last month the Ontario government established a housing affordability task force to recommend additional measures.

It remains to be seen exactly which policy measures are implemented and how much impact they might have on increasing housing supply and affordability, although RBC notes that increased inventory should be prioritized to meet demand.

“Our view is expediting new supply should be a priority though it’s unclear what policymakers will ultimately do and when,” said Hogue.