Several Adverse Factors Facing Toronto's Housing Market in 2022

Peter Lee

In 2022, the U.S. Federal Reserve embarked on a series of interest rate hikes. In a free-market economy, interest rates function as a key macroeconomic regulator, typically controlled by a country’s central bank. In the U.S., this is managed by the Federal Reserve Board. In fact, every market economy regards interest rate policy as a vital tool of macroeconomic adjustment.

When the economy overheats or inflation rises, interest rates are increased to tighten credit; when inflation and overheating ease, rates are lowered to stimulate investment and growth. Thus, central bank interest rates play an essential role in maintaining economic balance.

Real estate is a major pillar of national economies. Its boom or bust directly impacts overall economic health. The U.S. financial crisis is a clear example—triggered by a real estate bubble. Hence, Federal Reserve rate hikes also serve as a macro tool for regulating the real estate market. Fed Chairman Jerome Powell explicitly stated that the Fed would raise interest rates multiple times in 2022. In theory, changes in U.S. interest rates directly influence global housing prices. The correlation is inverse—when rates go up, housing prices tend to decline.

When central banks lower rates, mortgage rates fall, reducing borrowing and holding costs for homebuyers. Demand for homes rises, supply tightens, and prices increase. Conversely, when interest rates rise, mortgages become more expensive, reducing demand and increasing supply, thus pushing home prices down. With the Fed now in a rate-hike cycle, property investors should proceed with caution.

But if higher interest rates hurt the housing market, couldn’t central banks just keep rates low? The answer is no. Interest rates must be adjustable in both directions. In a sluggish economy or low inflation scenario, central banks lower rates to stimulate growth. But if rates are already near zero, they lose that policy tool. A persistently ultra-low rate leaves no room for further cuts when needed, diminishing the central bank’s effectiveness. Therefore, rates must remain within a band that allows downward flexibility.

In addition, persistent high inflation requires the Fed to raise rates. Neither businesses nor households can withstand prolonged inflationary pressure. Project managers, for example, typically factor in a 2% inflation rate when budgeting for long-term infrastructure projects. If inflation is below this threshold, profits rise. If it exceeds it—as is currently the case—materials become more expensive, profits shrink, and losses may result. Large-scale construction projects like condos, bridges, or subways risk financial losses due to surging input costs, potentially stalling economic activity. Thus, rate hikes become an economic necessity.

Also noteworthy is that 2022 is a U.S. midterm election year. To gain voter support, the Democratic Party must reduce inflation, and raising interest rates is the most effective tool. High inflation hits lower- and middle-income families the hardest. When I first arrived in North America, I was surprised to learn that many companies pay employees weekly. If a paycheck was delayed, even for a day, some workers grew anxious or even protested—they depended on Friday’s wages to buy necessities like bread and milk.

Later, when I ran a small convenience store, I observed something even more revealing: customers in suits would attempt to buy cigarettes, only to find their debit cards had insufficient funds. One even muttered to himself, “I should still have $10—where did it go?” I was shocked that someone would monitor their balance down to the last $10. But in North America, this is common. Soaring inflation quickly erodes purchasing power, making aggressive rate hikes politically and economically unavoidable.

Moreover, deglobalization and the return of U.S. manufacturing also pose risks to the North American real estate market. Reviving domestic manufacturing and initiating massive infrastructure projects will require vast funding. The U.S. government will likely issue large amounts of Treasury bonds. If bond supply exceeds demand, yields must rise to attract buyers. Since Treasury yields are a key factor in banks’ lending rates, mortgage rates will rise in tandem.

As bond yields rise, bank borrowing becomes costlier, pushing up mortgage rates. Homeowners face higher carrying costs, buyers hesitate, and sellers increase, leading to a build-up of housing inventory. This weakens demand and puts downward pressure on prices. Furthermore, deglobalization reduces cross-border migration, further diminishing foreign investment in North American real estate.

Another headwind in 2022 is the Fed’s quantitative tightening (QT)—its balance sheet reduction policy. If quantitative easing (QE) is akin to “flooding the system with liquidity,” QT is “draining it.” As the Fed sells off assets and pulls liquidity out of the system, capital becomes scarcer. Assets like real estate become more abundant relative to capital, leading to price depreciation. This dynamic is especially impactful in property markets.

Additionally, rising bond yields during QT drive up bank financing costs, which in turn increase mortgage rates and burdens on homeowners. The combined effect of higher rates and less liquidity is undoubtedly negative for housing markets.

This round of rate hikes and QT may serve as a global wealth reshuffling. Over the past few decades, a significant portion of Chinese diaspora wealth—domestic and overseas—has been stored in real estate. Wealthier families own more and better homes; middle-class families, fewer and more modest ones. Few have diversified beyond property. For many, real estate is not just a hedge against inflation and currency devaluation, but a symbol of social status.

Now, as the era of global QE ends, the Fed’s tightening is slowly draining the “water” from real estate markets. As the liquidity recedes, so will the bubbles—housing prices may trend downward globally. Some families may witness substantial asset depreciation.

(This article is intended for academic discussion only and does not constitute investment advice.)