Housing supply

Scarcity of housing supply could dampen impact of rising rates on property market, economists warn

A record mismatch between housing demand and supply is forcing economists to reconsider the role interest rates will play in cooling house prices.

Typically, rising rates cool a boiling housing market by making mortgages more expensive. During the current rate hike cycle, however, housing supply is so low relative to pent-up demand – both in Canada and the United States – that traditional economic models may not apply.

This dynamic caught the attention of some U.S. economists this week, who began warning that rate hikes are unlikely to have the power they normally have in the housing market.

In the United States, mortgage rates have already climbed to 5%, an 11-year high. “Standard economic models suggest that an increase of this magnitude should weigh heavily on housing, the segment of the economy most sensitive to interest rates and the classic transmission channel for monetary policy, Ronnie Walker wrote. , US economist at Goldman Sachs, in a note to clients.

“However, the extreme imbalance between supply and demand in today’s housing market will likely soften the blow to activity from higher rates,” he wrote. “Using state-level data, we show that existing home sales are only one-third as sensitive to rate changes in a limited-supply environment.”

Walker and his team also found that housing starts have historically been insensitive to changes in mortgage rates when supply can’t keep up with demand. The likely reason: “Homebuilders can continue building without worrying that homes will remain vacant after completion.”

This momentum is supported by new data on US housing starts released on Tuesday. Despite a significant year-to-date increase in mortgage costs, housing starts in March beat expectations, rising 0.3% month-over-month instead of the estimated decline. “The market may still have room to maneuver before the Fed tightening cycle becomes a binding constraint,” Shernette McLeod of TD Economics wrote in a note to clients.

It is still too early in the rate hike cycle to make any definitive statements. However, if housing demand remains robust, it “could suggest the Fed will need to raise rates more than expected,” wrote Bill McBride, who writes the housing newsletter CalculatedRisk, this week.

In other words, if the effectiveness of each increase is diminished by the strong mismatch of supply and demand, an abnormally large number of increases may be needed to restore some order to the housing market.

The economists writing on the dynamics this week have focused on housing in the United States, but there are many parallels with Canada. On the one hand, the housing stock in the United States is at an all-time high, and Canada is close to its own. Nationally, at the end of March, there was 1.8 months of inventory in Canada, which is only slightly higher than the record low of just 1.6 months in the previous three months. , according to the Canadian Real Estate Association, or CREA. The average of long-term stocks is more than five months.

House prices have also soared in both countries. In the United States, they have climbed 19% over the past year, while in Canada, they have risen 27% nationally over the same period, according to the ACI, although they barely budged in the last month.

It is possible that the two housing markets will diverge, in part because of structural differences between them. The United States, for example, relies on 30-year mortgages, while Canadian fixed mortgage rates reset every five years.

But even then, the Fed’s response to the US housing market has an outsized influence on the Canadian economy as a whole. The vast majority of Canadian exports are sold in the United States, and any difference between the interest rates of the two countries can have a significant influence on the value of the Canadian dollar against the greenback.

Canadians should therefore pay attention to the uniqueness of the US housing market at this time. Goldman analyst Walker found that when home vacancy rates are above 2%, a one percentage point increase in mortgage rates typically slows existing home sales by 6.5%. . When the vacancy rate is below 1%, sales only slow down by 2.5%.

Currently, the nationwide housing vacancy rate in the United States is 0.9%, the lowest level since 1978 and equal to the lowest level in the 66-year history of measure, according to Goldman Sachs.

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