Inflation is on the rise throughout Canada in all major consumer price categories, including costs to homeowners and homebuyers.

Canadian Inflation in 2022

As of January 2022, inflation increased 5.1% year-over-year. This shows a major increase from the previous year, even in December 2021, inflation increased 4.8% year-over-year.

Each month since January of this year has had higher inflation than the last, with an accelerating pace. In February 2022, inflation reached 5.7% and in March 2022 it surged to 6.7%. These jumps have surpassed what was expected at this point in the year.

Inflation Trends

Since 2020, inflation in Canada has seen more extreme levels than usual. Between 1991 and 2020, inflation numbers saw only marginal changes from month to month, hovering around 1.5-2.5%. In early 2020, inflation fell to below 0% for the first time since the market crash in 2008-2009. While inflation began to rise by the end of 2020, the rate of increase picked up significantly in 2021 and has followed through into 2022.

How Inflation Affects Residential Real Estate

Inflation is complex. As the amount of money in circulation grows, it can affect the economy in different ways. With today’s high inflation rates, what could happen to real estate in Canada?

The residential housing market usually sees the effects of inflation through changes to the mortgage rates and cost of homes.

Mortgage Rates

Mortgage rates are correlated to inflation rates. As inflation goes up, mortgage rates will also go up. This is because the central bank uses interest rate increases as a way to control high inflation. As it becomes more expensive for banks to borrow from the central bank, the mortgage rate will also increase for home loans.

New fixed rate mortgages will have a higher mortgage rate, and adjustable rate mortgages will likely increase.

If mortgage rates go up enough, this can cause the price of residential real estate to go down. Over the next few years, some experts predict mortgage rate increases to slowly level off or reduce the cost of homes in some of the hottest markets, including Toronto and Vancouver.

Cost Increases

Inflation has a complicated impact on real estate costs. If supply and demand stay constant, inflation will usually cause residential real estate to increase in cost. If either supply or demand changes, the impact can vary.

In Canada, there are many factors that are already causing home prices to increase. High demand for homes and a tight market have put a lot of pressure on metropolitan housing markets. Demand has been high for a while, with no signs of slowing down.

Construction costs are also putting pressure on the market. As it gets more expensive to build new houses, the cost of each home goes up. The risk to developers also increases, so the rate of new construction may not be able to match demand.

These and other factors point to inflation causing already high home prices to increase in Canada, at least in the short term.

Inflation Hedging

Residential real estate is traditionally known as a great hedge against inflation, as long as you already own it. High inflation causes the cost of living to go up. Everything gets more expensive, including the cost of a mortgage and the property price itself.

When you own residential real estate, the true cost of your fixed rate mortgage goes down as inflation increases. Your home value will increase while your mortgage stays the same, meaning you’re effectively paying less than you would if you bought the house at the current price.

As home prices rise, you also get the benefit of equity growth. Your house is worth more, no matter how much you paid for it initially.

Here’s a simplified example of how that works:

• You buy a house for $200,000.
• After 10 years, you own $100,000 of equity with a $100,000 mortgage.
• As inflation rises, the value of the home grows to $250,000.
• You now own $150,000 of equity, still with a mortgage of $100,000. Your equity went up by 50% without any additional investment.

While this is a highly simplified example, it shows how homeowners can benefit from inflation that causes home values to increase.