Get to the Point – May 2022
Thank you for taking a listen to Get to the Point audio. Could rising interest rates actually bolster the condo and townhome markets? In about 6 to 18 months from now, yes. Yes it could You see, conventional wisdom tells us the rising interest rates affect the condo and townhome segments the most.
At first glance, this makes a lot of sense since the purchasing power of these buyers is reduced when rates climb. However, one of our development partners whose background is finance, recently offered a very unique perspective. For reasons that I broadly understand, but I won’t attempt to explain in great detail, markets with escalating interest rates similar to our current one virtually put a stop to the development of multifamily rental projects. This a result of rapidly rising interest rates and our local low CAP rates converging to create a scenario whereby these rental developments are neither financially feasible, nor attractive to pursue.
If this condition exists for an extended period of time this could reduce our housing inventory stock substantially. We often forget that our dismal vacancy rates contribute to our inventory crunch and escalating prices. But what does this all have to do with potential strengthening of the condo market? In short, there is real potential to see inventory stabilizing while a reduction in demand reinforced by an increase of investor buyers. You see, a very typical pattern in the Vancouver market has been the stabilizing of inventory numbers when absorption slows. In previous market downturns we’ve witnessed homeowners decide to wait out a “soft market” if their price expectations are not met.
So, if our rental stock is reduced further, we’ll see upward pressure on rental rates. In volatile economic climates, investors tend to flock to real estate investments as they are viewed as more stable.
So, if our rental stock is reduced we’ll see upward pressure on rental rates. These attractive rental figures and a low vacancy rates could lead to investors viewing condos in a city like Vancouver as a safe long term investment. In previous volatile economic climates investors have flocked to real estate investments as they are viewed to be more stable, especially in a city like Vancouver.
This trend would stabilize inventory and prices of condos in specific markets, typically those close to the urban core. Switching gears to townhomes, it’s a simpler explanation. Townhomes have always filled the gap between condos and single family detached homes. In an increasing interest rate climate, they begin to play a more significant role. As rates climb, it becomes increasingly difficult to qualify for larger purchases such as single family homes. This could push purchasers from the detached segment down into the townhome segment since qualifying for mortgages in the townhome price bracket would be easier. This means that if we don’t see a sharp increase to the townhome inventory soon and for an extended period of time, the purchasers moving down from the detached segment absorbing the townhome inventory, thus stabilizing the townhome market.
Lastly, a factor caused by increasing interest rates that would result in upward pressure in both condo and townhome segments is the substantial reduction in home starts. It’s widely agreed upon by analysts that we are currently inventory deprived. It would take doubling of the current inventory levels at a rapid rate to balance out our entire market. Meaning across all areas and all product categories.
So what happens if real estate developers decide to take a step back. Well guess what, that is exactly what is happening right now.
Aside from hesitation due to uncertainty about the short-term future of the market, the major lenders that finance real estate developers are looking to drastically minimize their exposure to risk. This simply means less money available for developers to purchase development sites
The domino effect could be a substantial reduction in housing starts, specifically in the multifamily realm.
Decrease in already low rental stock. Shrinking residential inventory due to homeowner reluctance to compromise on their expectations. A reduction in home starts by real estate developers.
In the past, these ingredients have been proven to be a bad recipe for inventory levels.
So what’s the point? I understand that increasing interest rates causes both psychological and economic hurdles in the home purchasing process. This is clearly having real effects on the market. At the same time, we have a shortage of housing which doesn’t appear to be getting better anytime soon. We may actually be looking back in a couple of years and point to this moment in time as the conditions that shaped yet another growth cycle in our real estate market. I believe it to be probable, but only time will tell.