For the 5^th time in 2022, the Bank of Canada raised target overnight interest rates in a move to combat inflation. The rate jumped up by 0.75% on September 7^th, bringing it to 3.25%. This is a 3% increase in the interest rate from the beginning of 2022, when it was just 0.25%.

The next overnight interest rate increase is set to be announced October 26^th, 2022.

With the Bank of Canada looking to counter inflation through quantitative tightening, what impact will the continued rising interest rates have on real estate values?

Commercial Real Estate Impacts

Interest rate increases could have a large impact on commercial real estate (CRE), although the market is still looking strong overall.

When interest rates increase, it leads to higher mortgage rates. Investors then need to look for lower CRE prices to compensate for the higher cost of capital.

Increased risks

Large development projects incur extra risk as market conditions change continuously. This is especially true with industrial real estate. Land prices for industrial plots have soared, and project approval times can take years. By the time project approvals have been granted, the cost of construction could increase, as well as the cost of financing.

Delayed lease price increases

Another challenge for commercial real estate is the delay in commercial lease prices. Even though financing is more expensive for investors, existing commercial leases may not provide the amount of cashflow to support the investment. Since commercial leases have a long lead time, it’s not possible to adjust them to reflect current economic conditions.

With multifamily and single-family investments, leases aren’t usually an issue since leases are typically 1 year at a time. Commercial property leases tend to last for 3+ years, depending on the property type.

Long-term outlook

Despite mismatches between some commercial leases and development costs, developers still have a good outlook for the future. The Canadian economy is holding strong, with good prospects for the future as unemployment remains low, domestic demand rises, and exports strengthen.

Slowing Residential Real Estate May Drive Multi-family

Prospective homebuyers in Canada may be hesitant to begin looking for a new home since interest rates will make lending more expensive. With rising home prices, buyers could be priced out of the market. Buyers may approach the market with more hesitancy, especially buyers who don’t have a strong urgency to buy immediately.

There is an expectation that home prices may fall, especially in traditionally hot metro markets like Toronto. As demand reduces, prices will fall to meet new market demands.

Home values already saw a sharp reduction in August, continuing a developing trend that represents a complete reverse from early 2022 when home prices jumped to record levels.

As interest rates continue to rise, pushing mortgage rates higher, home values may also continue to reduce. However, the high cost of capital may still cause people to shy away from buying and opt for less permanent options as renters in multi-family housing units or other solutions.

However, if the quantitative tightening measures help to stem inflation, it could also work to erase some of the impact of interest rate increases. Inflation is another factor driving up land and home prices as well as increasing construction costs for new homes.

Both home and commercial real estate values will be temporarily impacted by changes to the interest rate. Permanent market impacts will largely depend on other market forces, namely inflation trends and economic strength.