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Home prices are falling, but what does that mean to people who haven’t been able to afford a house or condo? Thanks to rising mortgage rates, the cost of carrying a mortgage is no cheaper. In the meantime, rising rents are making it harder to put a down payment together.

To find out what all these trends mean to home buyers, I thought of John Pasalis. Mr. Pasalis is the owner of a Toronto residential real estate brokerage called Realosophy Realty. In addition to helping people buy and sell homes, he produces research and analysis used by the likes of the Bank of Canada, Statistics Canada and the International Monetary Fund.

Mr. Pasalis was one of the first guests on our Stress Test personal finance podcast for Gen Z and millennials, and he had some prescient things to say when I interviewed about housing just as the COVID-19 pandemic broke. Here’s a Q&A we did via e-mail recently:

Q: How much of the house price surge of the past couple of years was based on economic fundamentals and how much on speculative frenzy?

A: House prices were rising in the Greater Toronto Area before COVID, so part of this surge was driven by fundamentals. But the fact is that in many parts of the GTA, house prices nearly doubled in two years and this rapid rate of appreciation is not normal, it’s largely the result of a speculative frenzy.

A classic sign of a housing bubble is when more people start buying homes strictly as an investment versus as a place to live, and that’s exactly what happened. Recent research from the Bank of Canada found that the share of home sales to real estate investors grew faster than sales to end users over the past two years.

Q: I have heard from a lot of young adults over the past 12 months who desperately want into the housing market, but are having trouble affording the purchase. What encouragement can you offer them, now that house prices are falling while mortgage rates rise?

A: Homes are still very expensive, but things are improving. For example, buyers looking for a starter family home often want to spend under $1-million because the down payment requirement increases to 20 per cent above $1-million.

In the first three months of this year, only 7 per cent of all low-rise home sales in the GTA were three-bedroom homes that sold for under $1-million. Over the past three months, just over 25 per cent of sales were three-bedroom homes that sold for under $1-million. While home prices are still expensive, it’s encouraging to see far more homes selling for under $1-million again.

Q: Will there be a sweet spot for buyers where prices are down and mortgage rates retreat from their highs?

A: It’s very hard to say what that sweet spot is, and when we might hit it. Even though low-rise home prices are down around 25 per cent from their peak, homes are no more affordable today than they were at the peak of the market in February because interest rates are much higher. And this is largely why home sales remain at a 20-year low right now, because most buyers still can’t afford today’s prices at today’s interest rates. I don’t expect interest rates to decline by much in the near term, which means any improvement in affordability would have to come from a further decline in home prices.

Q: Rents are high and rising – how does that affect the housing market? On one hand, it makes ownership seem financially preferable. On the other, it’s hard to save a down payment while renting.

A: This is a problem with no easy solution, unfortunately. The best advice I can offer is for renters to do everything possible to reduce their monthly rent and to reduce the risk of it increasing in the future.

One way of doing this is by renting in a purpose-built rental apartment building versus a condominium. Not only are apartment buildings less expensive, they are also typically rent controlled and, unlike condo rentals, you cannot get kicked out because the owner wants to move into it. The longer you can stay in the same unit at an affordable rent, the more you can save.

Q: Investors were a big part of the surge in home prices in 2021. How much has investor demand for houses fallen and what’s your sense of whether they’re ready to jump into the market to take advantage of lower prices?

A: Demand from investors is virtually non-existent today, in part because of high interest rates. There definitely are cash-rich investors who are sitting on the sidelines ready to jump into the market at some point in the future to take advantage of lower prices.

But investor demand will likely be much lower than what we saw during COVID. The investors who are less likely to enter the market are the highly leveraged investors who were borrowing money from the home equity line of credit on their principal residence to buy an investment property. This is much harder to do in a high interest rate environment.

Q: Let’s say I just bought a house and I stretched so hard, it hurts. Now, prices are falling and I may at some point owe more than my home is worth. If I’m staying put for a while and have a solid job, how much should I care about being underwater?

A: We’ve been discussing this exact scenario with many of our clients who are looking at buying a home in the months ahead. The ones buying now understand that there is a chance that home prices may decline further after they buy.

So why are they buying? Some are buying because of a life and would rather own than rent. Others who were priced out of the market five months ago are feeling more hopeful that they can finally buy a family home of their own. And in all cases, these buyers plan to live in their homes for five to 10 years. They are more focused on where home prices might be in the long term versus the short term.

On the flip side, some of our clients who are very risk averse and in no rush to buy have decided to wait to see if home prices fall further. There is no universal right or wrong approach to the question of when to buy, each person should do what works best for them.

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