In the last quarter of 2021, the US central bank informed market about their intention to reduce stimulus (tapering) to tackle inflation. Starting 2022 new economic data reinforcing that policy. Here is a summary of thoughts in this matter.
Facts
- On Wednesday Jan 5th, the US central bank released its meeting summary, known as Fed Minute. The report showed that Fed’s members are more hawkish and favoring injecting less liquidity into the market. Stock market plunged in response to that.
- On Jan 7th, US job report for the month of December came out, supporting the idea of a strong labor market. North of the border here in our Lovely Canada: the job market number for Dec was even stronger. Canada posted 54.7K employment gain beating consensus forecast of 25k, bringing unemployment rate to 5.9% reaching to the 5.7% level we saw pre-pandemic.
Result
We are seeing less injection of liquidity from US and Canadian central banks. At the same time the market has its expectations updated upward to 3 rate hikes in 2022 (3 x 0.25%= 0.75%) which will bring us to the Nov 2018 level. There is now 80% chance the Fed starts raising rate in March.
Our recommendation for 2022:
- Higher rate is coming, meaning higher cost of capital, and more interest expenses for mortgages.
- Higher rates make less demand in the housing market, but at the same time we are going to have historical immigrants (new demand) to the Canadian market. Moreover, healthy global growth should enable already-elevated commodity prices to stay range-bound in 2022 which is positive for Canadian economy. Therefore, the net effect on the Canadian real estate is to be seen. However, these factors make off-the-market deals more valuable for investors. We recommend cash sustainable deals in rising rate environment.
- We do not see a jump in rates. Debt level is high and neither US nor Canadian government got meaningful majority public support. So, they can’t increase tax, and they can’t tolerate anger from people due to escalated interest rates. The only way out of debt is to devalue currency (good for real estate). Again: higher but not jump in rate.
- Higher rates are coming, and debt servicing is getting more expensive. If investors get into new loans, the term of the loan (Amortization period) should be as long as possible to reduce debt burden.
- What if we are wrong and central banks go too far too fast by tightening liquidity ? Then we can get into recession. In the recession or tight financial environment, you need cash, that’s where rental-oriented multifamily investment outweighs speculative richly priced houses. For now, buyers are active even though affordability has already sunk to an all-time low in several metropolitan areas in Canada, including Montreal, Ottawa, and Toronto. We expect continuation of rush to buy from investors in the short term as they try to lock their mortgages before new rates kicks in.
- If we are wrong and central banks go too far too fast by tightening liquidity, renting high end units can be challenging. We continue watching new build high end condominiums in Toronto, Montreal and Vancouver.
Conclusion
Elevated housing prices by themselves are not a catalyst for a change in real estate market, but they signal the potential for correction as interest rate rises. Therefore, we emphasize tilting towards less expensive cities with higher rental yields.
Uptimo Research
