The latest rate hike by the Bank of Canada is expected to have widespread ripple effects for renters and real estate investors, beyond its implications for homeowners with mortgages.
The increase of a quarter of a percentage point and another hike of the same size that could come in September will boost demand for rentals, force some landlords to sell and put a further damper on the construction of new rental and condo units, experts say.
The central bank raised its trend-setting interest rate to 5 per cent on Wednesday, which was widely expected by financial markets. But it also warned it may take until the middle of 2025 for inflation to return to the bank’s target of 2 per cent. That wording raises the chance of another hike at the bank’s next rate announcement in September, according to analysts.
Already high interest rates and the potential for more increases will force more would-be homebuyers to postpone a real estate purchase and continue to rent instead, said Benjamin Tal, deputy chief economist at CIBC.
Rates inching higher will also likely force some landlords who can no longer cover their mortgage payment, property taxes and other costs with rent to sell their properties, Shaun Hildebrand, president of Urbanation, a real estate research firm, said in reference to the Greater Toronto Area.
Some landlords will struggle to handle added financial pressure because they face mortgage renewals at higher rates, he said.
“Most of those units will be off-loaded to end users,” Mr. Hildebrand said, meaning buyers who intend to live in the home instead of renting it out.
“Investors are just not interested in buying at where prices are right now and where interest rates are right now,” he said, because “the cash flow situation for those units would be so much worse than units that were bought several years ago at lower prices.”
While he doesn’t see a stampede of investors ditching their condos, even a small uptick in such sales means fewer units available in a rental market where demand already far outstrips supply.
Average rents advertised by landlords on available units in Canada reached a high of $2,042 in June, up 7.5 per cent from the same month last year, according to a report by rental listings site Rentals.ca and Urbanation.
In the short term, CIBC’s Mr. Tal sees rent inflation continuing to climb. He also expects tenant turnover to continue to trend lower, with an increasing number of existing renters staying put, especially in units subject to rent control.
But a more significant ripple effect of the Bank of Canada’s renewed rate-hiking campaign may not be felt in the rental market until 2027 or 2028.
That’s because a further rise in interest rates reduces incentives for developers to build new rental apartments and condos. The impact on construction companies is twofold, said Mr. Tal. On one hand, rising rates increase the financing cost of new projects. On the other hand, they depress demand for preconstruction condos from investors. (Most buyers of preconstruction condos are investors who plan to rent their units and resell them at a higher price).
High mortgage rates are making it increasingly challenging for investors to cover their costs on recently built condos. In a May report, Mr. Hildebrand and Mr. Tal found that among GTA condo units completed in 2022, fewer than half of those that were financed with a mortgage and rented out were yielding a positive cash flow. By comparison, that share was 60 per cent for units completed in 2020.
The report estimates landlords were losing an average of $223 per month on condos completed in 2022. Based on a smaller sample, it found that the math was even more challenging for investors holding units completed in the first three months of 2023, who were facing an average monthly shortfall of more than $400.
Higher borrowing costs make it harder for investors to secure a mortgage for units that are currently coming to completion, which will likely diminish their appetite to take on further investments, Mr. Hildebrand said. Rising rates also create uncertainty about the market outlook at a time when the price of preconstruction condos is “still pretty much at record highs,” he said.
The impact of a drop in preconstruction condo sales won’t be immediately apparent: in the GTA alone, there are currently 100,000 condos under construction.
But the concern is a delayed supply crunch in a few years as Canada’s population continues to grow, he said.