Canada’s real estate market peaked in February 2022, with prices hitting an all-time high. The inventory of homes for sale was low and buyers with a bad case of FOMO (fear of missing out) snapped up anything that was available. Bidding wars were common and conditional offers were immediately rejected by sellers.

But sharply rising interest rates have changed everything. From March to the end of June, sales declined by 27 per cent and average selling prices were down 14 per cent from the February peak.

“Home sales have been impacted by both the affordability challenge presented by mortgage rate hikes and the psychological effect wherein home buyers who can afford higher borrowing costs have put their decision on hold to see where home prices end up,” says Kevin Crigger, president of the Toronto Regional Real Estate Board.

Robert Kavcic, senior economist and director, economics at BMO, says, “Canadians widely expected home prices to keep rising, which pulled in investors and multi-property buyers, while also causing many households to stretch in fear of missing out.” But, citing a survey by Nanos, Kavcic says less than 44 per cent of Canadians now expect higher prices in the coming year, compared to more than 64 per cent who thought that earlier this year. The pre-pandemic norms were around 40 per cent.

“We’ve long argued that breaking the market psychology was the key to settling conditions back down, and that deed now looks to be about done,” says Kavcic.

Scotiabank economist Farah Omran says, “Also back on the table are conditional offers, a sensical market lever in normal time that the abnormal pandemic times made irrelevant, as such offers were considered uncompetitive. With certain conditions, like inspections, being normalized again, home appraisals may be pulling prices down closer to market values.”

While the sense of urgency for buyers may have eased, Omran says it “is likely creeping up on sellers who bought new homes before selling their existing ones…some of these households could now be finding themselves in need of capital and are therefore rushing to list their homes and sell. This may be bringing more temporary supply to the market and causing larger discounts as they accept bids that are below asking.”

There has been “an unprecedented surge in the number of terminated condo listings across the Greater Toronto Area” so far this year, says a report by Strata.ca. “Many sellers are still operating under the impression that this is a sellers’ market, so they are listing too high and not seeing any action,” says Alex Hood, a Realtor at the brokerage. “At the same time, rising inflation and interest rates are making buyers feel uncertain about the trajectory of the market, which is causing them to be more conservative with their bids.”

Omran says these sellers are in the “denial/rejection phase – seeing what similar homes sold for just a couple of months ago, they are having a hard time readjusting their expectations and asking price, creating a mismatch between inventory and market clearing price.”

But even as prices keep dropping, most experts say the dip will be temporary.

“While at times it can feel that way, the housing market is not in a free fall,” says Benjamin Tal, an economist at CIBC Capital Markets. “We estimate that close to three-quarters of the 14 per cent decline in the average national home price since the February peak was due to the composition factor, with sales activity shifting from more expensive units (low-rise) to less expensive units (high-rise). This is a similar but much more painful version of the trajectory that we saw in the 2017-18 price adjustment.”

Tal adds, “The reset is not over. Sales activity will continue to fall alongside the average home price. That price will have to fall by an additional 25 per cent to reach pre-COVID levels. And back then, nobody suggested that Toronto or Vancouver were affordable. The point is that the ongoing correction will not solve the housing affordability crisis.”

In fact, it’s making the shortage of affordable housing options worse, says Tal. In Toronto’s new condo market, rising interest rates and construction costs, alongside a shortage of labour, is leading to cancelled projects. “We are in the midst of a project delay/cancellation wave, with developers choosing to sit on their hands, rather than engaging in a money-losing proposition,” says Tal.

Bob Dugan, chief economist at Canada Mortgage and Housing Corp., says the “high rates of house price increases during the last two years have been unsustainable. The cost of housing reached levels that are unaffordable for a large share of new home buyers, translating into a slowdown in 2022 and 2023.”

He says average national home prices will drop by three to five per cent by mid-2023, compared to their level in early 2022. Mortgage rates will stabilize by 2024 and lead to “positive but moderate growth,” Dugan says.

RBC Economics recently downgraded its forecast for the housing market, predicting average house prices could drop by 17 per cent or more on a quarterly basis, as buyers look for less expensive homes.

“We’d argue the unfolding downturn should be seen as a welcome cool down following a two-year-long frenzy that put a huge financial burden on many new homeowners and made ownership dreams harder to achieve,” says RBC assistant chief economist Robert Hogue. “While a more severe or prolonged slump cannot be ruled out, we expect the correction to be over sometime in the first half of 2023 – lasting approximately a year – with some markets likely stabilizing faster than others. Solid demographic fundamentals (including soaring immigration) and a low likelihood of overbuilding should keep the market from entering a death spiral.”