High Interest Rates Resulted In 30,000 Fewer Housing Starts In 2023: CMHC

Those in the housing and development industry will all tell you that the elevated interest rates over the past few years have been a significant challenge for them and that they've had to slow things down. That is no longer anecdotal evidence, as the Canada Mortgage and Housing Corporation (CMHC) can now put a number on this.

"Our modelling suggests that in 2023, higher interest rates decreased housing starts by about 30,000 units in Canada," said CMHC Deputy Chief Economist Aled ab Iorwerth in a commentary article on October 3.

This 30,000-unit decline amounts to about a 12% decline in housing starts, out of a total annual average of around 250,000.

The Bank of Canada's policy interest rate finished 2022 at 4.25%, was then raised to 4.50% in January, and stayed there until it was raised to 4.75% in June, then to 5.00% in July, where it stayed for the rest of 2023 until this June when the rate cuts began.

How Interest Rates Affect Housing Starts

Housing supply is sensitive to interest rates, says ab Iorwerth, but in varying ways.

For condominium projects, they are affected by the buyer side being tempered as a result of higher financing costs. Developers are usually required by their lenders to hit pre-sale targets — often between 60% and 70% — so if buyers aren't buying, builders can't begin building.

"Small investors provide much of the funding to build condo apartments," said ab Iorwerth, in a recognition of the importance of investor-purchasers. "Developers raise funds from prospective buyers who may occupy those units or rent them out. [...] So, the willingness of individual buyers and investors to borrow will dictate the construction of condo buildings."

For rental projects, the effect is felt by the developers / corporate borrowers who have to face the elevated costs themselves.

"Large investors are also critical to supplying financing for building large multi-storey purpose-built rental buildings," said ab Iorwerth. "While their multi-million-dollar construction costs will ultimately be covered by renters over time, those upfront expenditures need to be paid before revenues begin to flow in. To manage this timing mismatch, financial institutions step in with debt to match current costs with future revenues. But this financing mechanism makes the decision of whether to proceed with construction more sensitive to interest rates and reliant on whether financial institutions are willing to provide credit."

Concluding his thought in a statement that will likely play as music to the ears of investors and blasphemy to opponents of the "financialization of housing," ab Iorwerth said that "The sensitivity of private investors in housing — whether large or small — to macroeconomic fluctuations suggests that ensuring long-term continuous flow of investment funds is essential to increasing housing supply."

The Bank of Canada's policy interest rate from April 2022 to September 2024. / nesto

Is The Worst Over?

Although the Bank of Canada has now begun cutting interest rates, after finally hitting their 2% inflation target, the relief is not immediate.

"We remain concerned that starts in Toronto have yet to reflect the full impact of higher interest rates," said ab Iorwerth. "While delayed effects of higher rates will likely continue, the move to lower interest rates should stimulate housing supply over the coming year. Given this opportunity, efforts conducive to supporting more housing supply must continue."

He also recognized that most of the housing supply in Canada comes from the private sector and said that because this is the reality, governments have to support the private sector.

"Over the past two decades, Canada has built a structural deficit in housing supply that can only be remedied through extensive investment by the private sector," he said. "With the private sector providing roughly 95% of housing in Canada, this is especially true to address the affordability challenges of the middle-class, whether for rental or for ownership. Unfortunately, this also means relying on a sector that is affected by changes in the economy, notably changes in interest rates. So, all levels of government need to ensure that the private sector can build as much housing as possible when the going is good, and interest rates are low."

Some of the ways governments can support the private sector include reducing approval times, reducing uncertainty, and designing frameworks that can ensure construction is able to continue even when interest rates are high.

"Ultimately, building a future where all Canadians have access to housing that is affordable requires a collective effort," ab Iorwerth concluded. "While higher interest rates still present a short-term hurdle, they offer important learnings for us all. We must consider ways to empower the private sector throughout the economic cycle if we are to address the housing crisis."