Toronto Real Estate Prices Have Dropped. For How Long?

Real Estate

The Bank of Canada is getting ready to start lowering its interest rate. When will this happen, and how will it affect Torontos real estate market? This question is on a lot of peoples minds right now. Inflation eased slightly again in April, coming in at 2.7% compared to 2.9% in March. In principle, this is exactly what the Bank of Canada expected, given its goal of bringing inflation down to around 2% by the start of next year. What matters today is not so much that inflation is already close to normal, but that it is fully under control. Even rising gas prices weren't able to knock inflation off course, even though that risk was real.

Will the Bank of Canada cut its lending rate on June 5, or will it decide it can afford to wait a bit longer? Economists are making all sorts of predictions, but at this point nobody really knows whether a rate cut is coming on June 5. On one hand, inflation is under control, which clearly suggests the Bank of Canada has achieved its goal and can start easing rates to stimulate the economy. On the other hand, the data on the economy, unemployment, consumer spending, and loan defaults are all coming in better than expected, meaning there's room to wait a little longer. It's even hard to lean on the opinions of Canada's leading economists right now, since they're split almost right down the middle - 53% believe the rate will be cut in June, and 47% believe it won't.

I'll share my own view. I think the lending rate won't be cut on June 5, but rather on July 24, at the Bank of Canada's next meeting, where it will be lowered by 0.25%. In the grand scheme of things, this doesn't really change anything. The bulk of mortgage renewals will land in 2025, and by then the rate should already have come down substantially overall. Most economists project it will fall by 0.75% by the end of this year, and that it will keep coming down throughout 2025. There's a strong chance that by mid-2025, the Bank of Canada's key rate will sit at around 3.5%, meaning the prime rate - which mortgage rates are tied to, and which currently sits at 7.2% - will come down to around 5%. In other words, by the middle of next year, mortgages could be available at around 3.5%, and this matters enormously not just for the huge number of homeowners whose contracts with their banks are coming up for renewal next year, but also for those who are only just planning to buy property. Today, the main obstacle standing in their way isn't even the high monthly payments - it's qualifying for the loan in the first place, which will become considerably easier once the rate comes down.

Are other scenarios possible? In my view, no, not really. The current state of the economy needs stimulus, and the authorities certainly don't want to see mass loan defaults either. So it's already possible to breathe a little easier today - though, of course, not for everyone. Those whose closings on pre-construction condos and homes fall in the second half of this year will still find it very difficult to secure financing and close the deal.

Now let's look at what will happen to the Toronto real estate market as interest rates come down.

In my view, rates starting to fall by this fall will already produce results, and the fall market this year will be noticeably more active than what we're seeing today. Buyers who can now qualify for financing will return to the market - but given that rates won't have come down all that much by fall, the market won't turn red-hot just yet. I don't think the return of a relatively small share of buyers will meaningfully move prices, since there's plenty of inventory on the market, and the buyers coming back won't be enough to absorb everything currently available.

By spring of next year, lending rates will fall further, easing loan qualification even more, and buyers who previously couldn't qualify for a mortgage will start coming back to the market. As rates continue to drop, more and more people will be able to afford to buy. Right now there's an enormous amount of pent-up demand built up - people who, because of high borrowing costs, haven't been able to buy for nearly three years - and as soon as rates fall, this huge pool of potential buyers will come flooding back into the market.

I expect this pent-up demand to return in full force in the second half of 2025. This could happen even sooner if the 2% stress test gets scrapped, which would instantly make qualifying for a mortgage far easier. But for now, even though the stress test looks completely absurd at this point, there's no indication it's about to be eliminated. I think the main reason for that is the government's reluctance to see a sharp run-up in real estate prices before next year's election. Once buyers return to the market in full force, it will take at least 5 to 6 months to absorb the inventory currently sitting on the market. And that's when things will really start heating up in terms of price growth.

It's worth remembering that a chain reaction always emerges at the tail end of a downturn. Buyers start showing up in the market, and sellers pull their listings en masse once they see prices starting to climb, realizing it's worth waiting to sell for considerably more down the road. Today's situation differs from previous downturns in one more important way: as rates come down, those who are currently trying to sell because their loan payments have become unaffordable will also start seeing their own monthly payments shrink at the same time. That means it will become easier for them to simply pull out of the market and wait for a much more favorable time to sell.

And there's one more crucial factor that shouldn't be underestimated when forecasting future real estate prices in Ontario. Since 2020, the number of new construction starts has been falling sharply. Today, developers who can't manage to pre-sell the 75% of units required to finance construction simply aren't breaking ground. The average multi-unit building takes about five years to build, which means that between 2026 and 2029, the market will see almost no fresh supply of newly built units feeding into it. In my view, these will be the years of truly substantial price growth.

In some ways, the situation closely resembles what happened after the 2012-2013 real estate downturn, when developers couldn't sell off what they'd already built, and new construction simply stopped starting. Back then, a three-year gap opened up in construction starts, which in turn produced a serious supply shortage - and, as a result, the price growth we saw in 2016-2019.

Back in 2016, when the price per square foot for condos in downtown Toronto was around $600, I predicted with confidence that it would hit $1,000 per square foot by 2019-2020. As it turned out, prices actually crossed $1,000 per square foot as early as the beginning of 2019. Today, I'm absolutely confident that the price per square foot for good downtown Toronto projects will reach at least $1,800 per square foot by 2027-2028. Right now, the future of Toronto's real estate market is highly predictable, because there are a number of pricing factors at play that simply can't be changed - and every single one of them points to real estate prices in Toronto beginning to rise starting next year.