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episode # 341

Is the Vancouver Real Estate Market a Bursting Bubble? With Moody’s Economist Brendan LaCerda

What are the global elite thinking about Vancouver real estate at this moment? Well, to get that answer, we connected with Moody’s Analytics, an international forecasting company helping the global financial decision-makers make sound economic choices. Past guest Brendan LaCerda, Director and Economist, joins Adam & Matt and discusses inflation, interest rates, and just how far the market will drop. Got a pillow to hug? Maybe grab one of those full-sized maternity pillows and hunker down!

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Episode Summary


Who is Brendan LaCerda?

I am a Director of Economics at Moody’s Analytics. We build economic models to create economic forecasts. I spend my days working with banks and other institutions to work through the hypotheticals and see if they’ll be able to survive the next crisis. 

There’s never been a busier time to be in this business! We’re constantly looking to the forecast because things are changing so quickly. 

When we last spoke to you in March 2020, you made a few predictions. Where did you get it right and where did you get it wrong?

In the early days of the pandemic, fears were high and I had a pessimistic outlook on the housing market. It turned out to be quite the opposite. I always say don’t trust a forecaster who isn’t honest about their mistakes! 

But it’s useful to look back on past errors and figure out why I screwed up. We were a bit pessimistic on how fast things would improve. It wasn’t clear that we’d have very effective vaccines within a year. Imagine if we had to wait 2+ years for those? 

We really missed on the policy response; our assumptions were more jaded. Governments in 2008/2009 didn’t provide enough stimulus but now it looks like we may have overcorrected in 2020/2021. The Bank of Canada expanded their balance sheet by about $500 billion, created out of thin air to keep markets functioning. We didn’t expect that level of support.

We also didn’t expect the mortgage deferral program to defer 14% of accounts nationally at its peak. But all that support did turn the economy around quickly and poured fuel on the housing market. 

Is it easier or harder to forecast now in 2022? 

It’s not as challenging to forecast now. Two years ago, we didn’t know how the virus or policy would evolve. Now, there’s more certainty about the virus, so it’s just policy uncertainty. I extend that out to global crises, like Russia and Ukraine, that make forecasting really challenging. 

Did Canadian policy makers get it right? How different was Canada’s financial response to the pandemic from other G7 nations?

Canada is on the high end when it comes to providing stimulus; we’re in the top 5 with the United States being number one. So it was a very strong response from the Canadian government during covid. 

It was surprising to see that many global governments followed the same blueprint. There were programs for wage replacement, mortgage deferrals, expansion for unemployment benefits, etc. in both Canada and the US, and parts of Europe.

Europe wasn’t as robust with their stimulus, but they have tighter budgets. What helped Canada was that government finances were in a good shape at the start of things. China also did not deploy a lot of stimulus. 

Does 2022 mark a shift in the approach by the Bank of Canada? 

Any crisis invites us to ask: Are we doing this the right way? The Bank of Canada has decided to target interest rates but there are other ways to impact inflation. But is there a better way? Not obviously. A lot of the criticism directed at the central bank is around how slow they were to respond to rising inflation. 

Did the stimulus cause inflation? 

The stimulus provided the initial spark for inflation but what really amplified things was how covid impacted the global supply chain. That’s what sent inflation soaring. And then the third wave came after the crisis in Eastern Europe. 

But people want to know what will be on the other side of this. The long term equilibrium for the Bank of Canada’s interest rate is 2.5%. But clearly, it’s going higher than that. We’re going to overshoot on policy in order to bring inflation down faster. But rates will normalize eventually. 

How long will rates be high? What is the US doing with interest rates? 

In the US, they said they’d bring the federal policy rate to 4.25% by 2023 and expect it to stay around that through 2024. But I can’t believe that. If you push the rate to 4.25%, that means a mortgage rate of 7.25%. I don’t think the housing market can withstand a 7.25% rate. 

We’re already very close to a recession so there’s no way the banks can maintain overnight rates around 4%. Throughout history, we see rates go up and then quickly come back down because once the rate goes above 2.5%, it starts to destroy demand. The economy will get weaker the longer rates stay above that level. 

So if banks can’t maintain rates they say will be in place for a long time, is it a game of chicken?

A big part of what the bank is trying to do is bring down inflation expectations through the language they use at their press conferences. If people expect prices to be rising for a long time, it hurts business activity and planning. The Bank of Canada is aware of that, so they’re trying to dampen long run inflation expectations. 

What does 2023 look like?

The full effect of a change from the Bank of Canada can take nine months to two years to feel. So a lot of the tightening that we’ve seen this year will come to bear in 2023/2024. We won’t feel the full weight until next year. 

So going forward, the Bank of Canada needs to be more cautious about how fast and how high they go. They’re not getting the response they want so they keep going higher and faster, not realizing that it may take months or years for things to come crashing down.

I think the policy rate will peak at 4.25% but if it was up to me to make that decision, it wouldn’t be that high. A lot of the causes of inflation are not controlled by interest rates, like supply chain issues. So there is some amount of “riding it out” that we need to do. 

Policy makers would prefer a recession over a stag-flation scenario where unemployment is out of control. 

Are you afraid for the Canadian economy and for the Canadian housing market?

The Canadian economy’s ability to withstand these interest rate increases will hinge on the strength of the labour market. The danger comes if unemployment starts to climb. If the economy does slip into a recession, there’s no indication it will be particularly bad compared to previous recessions we’ve experienced. 

One thing we look at is the crisis of over-leveraged households in Canada. Canadian debt to income ratios are quite high compared to other countries and there’s no indication that our appetite for debt has slowed down. 

The Bank of Canada releases a quarterly report sharing the number of new mortgages given to buyers with a loan to income ratio of 450% or more. So for example, if the median Canadian home is $872,000 and you get a loan of $700,000 with 20% down, an LTI of 450% gives you a household income of $155,000. That’s the definition of over-leveraged. 20-25% of all of the newly issued mortgages fall into this category. 

The real issue is when these buyers who are already over-leveraged have to refinance or adjust to a new rate in five years, what does their new monthly payment become? That could keep you up at night! 

I’m happy that applicants have been stress-tested but there’s a lot of uncertainty. Not only do we need to wonder what interest rates will look like but we also have to consider the state of the labour market in five years. 

What is your house price projection for 2023/2024? 

Our current projection is house prices will be down by 10% by the end of 2023/early 2024 and that will be the bottom. That’s a 10% drop from the peak after two years where we saw a 50% increase. That’s our projection for median Canadian real estate. 

Vancouver typically fares slightly worse. Affordability is king so markets with the worst affordability, like Vancouver, are under threat in times of rising interest rates. 

I’ve seen some forecasters talk about 20-30% declines but we don’t go there because of limited supply supply. We don’t have enough supply but the number of units under construction in Canada is at a record high. The majority of those units are pre-sold, but it should still mean more supply into the market. But generally, inventory will still be weak so prices won’t decline too much. 

What is your general Canadian housing forecast? And what happens to Canadians who are over-leveraged on their homes? 

2023 is going to be a tough year for the housing market. We expect most of the declines to take place then. Once those interest rates start to reverse though, buyer sentiment will improve. There will be a sigh of relief and house prices will start to rise in 2024. 

Canada has a strong economy, high immigration and dynamic, growing cities. There’s no reason to have a grim long term outlook for Canada. 

If the issue of over-leveraged households does become problematic, I think we will see government intervention. I think we could see something like the 25-30 year fixed mortgages that we see in the United States. I wouldn’t be surprised if we go in that direction. 

Is there a sign of optimism from the last two years? 

The pandemic was awful but one of the great things to emerge from it was remote work and hybrid work, which has the ability to increase efficiency and help us tackle housing affordability. People can live where they prefer and where they can afford, instead of where work requires them to live. I think we’ll continue to see spillover benefits from the transition to hybrid/remote work. 

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