How Inflation and High Interest Rates Led to Rising Rental Prices

By Viler Lika

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[vc_row][vc_column][vc_column_text]Many believe that rental prices have increased as a result of higher mortgage costs for homeowners being passed down to tenants. We believe that it’s more of a supply and demand phenomenon indirectly correlated to rising interest rates.

Summary of the correlation between rising inflation and higher rental prices:

  • The government needed to increase interest rates to fight rising inflation.
  • Higher interest rates caused mortgage payments to climb significantly.
  • Now mortgage payments are higher (less affordability) and it’s harder for buyers to qualify, which causes the demand for house purchases to drop and therefore home prices to decline.
  • Declining home prices are causing more potential buyers to wait for the market to bottom out before they buy, which further slows down home sales.
  • This means that thousands of people who would have left the rental market to buy a home, instead are choosing to wait and rent for longer.
  • This puts more pressure on the rental market since thousands of new tenants enter the rental market, but those thousands of tenants that would have upgraded to ownership, are staying put.
  • The added pressure and demand on the rental market and an already low vacancy rate in rental units is what’s causing the fast-rising rental prices.

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The Canadian housing market has been on a rollercoaster ride over the last couple years.  According to SingleKey rental data, the average rent across the country is $2,043 per month, nearly a 22 percent increase from the low of 2021.  From a renter’s perspective, the market seems particularly unfavourable, and it may be tempting to think that the cause is simply greedy landlords.  In reality, today’s sky-high rent prices result from a complex domino effect driven by inflation.

Inflation has led to rising interest rates and falling demand for mortgages.  After hitting a summer peak of 8.1 percent annually, the rate of inflation is down but still elevated at 6.9 percent (as of September), while wages have risen only a little over 5 percent.  The government has responded by increasing the prime interest rate from 0.25 percent at the beginning of the year to 3.25 percent, as it currently stands. The trickle-down effects have caused mortgage payments to climb significantly.  Just the last 50-point increase will cost homeowners with fairly standard $400,000 mortgages to pay $1300 more per year—more than a hundred dollars extra per month.  Five-year conventional mortgage rates have risen this year from 4.79 percent to 6.49 percent, while the one-year rates have skyrocketed from 2.79 percent to 6.04 percent.

Since mortgages are now more expensive, fewer buyers can qualify for them, leading to a cooling in the housing market. In fact, National Bank notes that the drop in home prices is worse now than it was in 2008, with a 7 percent decline since May.  The seasonally adjusted average MLS price dropped 15.6 percent from February to August.

Many potential buyers have seen the rising interest rates and falling house prices and decided to exit the market, driving more competition in the rental market. Some people may simply be unable to purchase a home because of the higher mortgage costs, but even those who can afford the payments are often choosing to wait to see how low the prices will go. Having fewer people move from renting to buying puts more pressure on the supply of rental units. As thousands of new people enter the market, thousands of people who would normally have upgraded to buying have chosen to stay put. This added pressure on the rental market is the immediate reason for rapidly increasing rental prices. Landlords are not charging more simply because their costs have increased (though inflation is undoubtedly having its effect here too). Landlords are charging more because more renters are looking for homes.

The rise in rental prices is classic supply and demand. While this is bad news for renters, these market conditions cannot last forever, and when housing prices begin stabilizing, some renters will choose to buy in more favourable conditions and free up supply in the rental market.  When that will happen is anyone’s guess, but the beauty of a free market is that imbalances, like we are seeing now, will eventually self-correct.

Viler is the CEO of SingleKey, the leading tenant screening platform in Canada that helps homeowners make more informed decisions when selecting tenants, as well as guaranteeing rental income in order to effectively manage risk.

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