The Bank of Canada has just announced that it’s holding its key interest rate (or policy rate) at its current level until its next meeting. However, many people are puzzled as to why house prices aren’t following.
At first glance, this certainly seems like a contradiction.
In fact, the key interest rate and property prices are actually quite distinct! They’re related, of course, but one doesn’t determine the other.
The Key Interest Rate Mainly Affects Mortgages
The first thing to understand is that the key interest rate mainly impacts the cost of borrowing.
When the policy rate falls, financial institutions generally lower their mortgage rates, and more people can afford to buy a home.
And this is where the key interest rate plays a small role. In a market where many buyers compete for a limited number of properties (in a highly desirable neighbourhood, for example), multiple bids may push the selling price of these properties up.
Conversely, when the policy rate goes up—and mortgage rates along with it—many households’ purchasing power shrinks. Some homeowners who want to sell their property quickly then decide to reduce their asking price to attract buyers. But even in this situation, real estate prices tend to remain steady.
In any case, a low key interest rate doesn’t mean that sellers have to drop their prices.
The Factors That Determine Prices
A few factors significantly influence house values, namely:
- Supply and demand: As explained earlier, when a large number of buyers are competing for a limited number of homes, prices remain high, regardless of whether the key interest rate stays stable or falls. Conversely, prices may fall when there are plenty of properties on the market and a smaller pool of buyers.
- Sustained population growth, which boosts demand for housing.
- Soaring construction costs, both for materials and labour, due to, for example, the inflation we have experienced in recent years.
- Land prices, which have been steadily increasing in several sought-after areas.
- Homeowners that choose to delay selling, thereby limiting the quantity of available properties.
Even if mortgage rates decrease sightly, these factors will continue to push prices up.
Are Stable Rates Good News?
A stable policy rate is often considered good news for the property market.
After several months of uncertainty, many prospective buyers who had put their plans on hold are finally taking the plunge. They’re tired of waiting indefinitely for a drop in interest rates that could prove smaller or take longer than expected.
The result: more buyers visiting properties for sale.
In a housing market with limited supply, this surge in demand may help to keep prices high… or even drive them up. But in a market with an ample supply of attractive homes, stable interest rates benefit both buyers and sellers.
Key Interest Rates Don’t Fully Explain Real Estate Prices
No single thing explains price shifts in the property market. The combined effects of all the above-mentioned factors shape the market’s evolution.
This means the best approach for buyers consists in evaluating their financial situation, their needs, and market conditions. To help them make this important decision, they can rely on the guidance of a real estate broker.