Canada’s largest bank is turning more bearish, according to its latest forecast. In the bank’s Q3 2022 earnings filed this week, RBC made downward revisions to its base case forecast for home prices. Combined with recent statements explaining the bank sees a “historic” correction, they’re sending a clear message to consumers — the outlook for housing continues to erode faster than positives have appeared.
Macroeconomic Forecasts
Every quarter banks are required to prepare macroeconomic forecasts for risk planning. These scenarios help the bank prepare for economic shock or a boom. It’s an IFRS-9 reporting requirement, and helps regulators and analysts understand market risks. At least 3 scenarios are required — a base case, and two alternatives (one upside, one downside).
The base case forecast is what we call a “Goldilocks scenario.” It’s not too hot, and not too cold. Things just keep humming along with no significant change in outlook. It might not make sense logically, but it does from a quantitive perspective. After all, it makes no sense that Goldilocks can tread into bear territory without getting her head ripped off. However, statistically, there can be a 50-50 chance of it happening.
The alternative scenarios include one downside and one upside. It’s exactly what it sounds like — the worst and best case forecasts that could happen. This helps an organization stash some cash for a rainy day, but not too much so they can still make investments during a boom. The downside is a market bear’s wet dream, unlikely ever to be fully realized. The upside is an unlikely bull stampede, where unicorns and Canadians without mortgages exist. Things have to go extremely wrong in either case for either scenario to happen.
It’s important to note that management has qualitative data that isn’t easily modeled. Things like quantifying social anxiety or political fallout. Behavioral factors, such as fear of missing out (FOMO) or the joy of missing out (JOMO). In our experience, banks often state if they see a scenario playing out to an alternative. It can happen in the days leading up to the report, or management outright explains it at earnings.
Remember the last point. We’ll come back to it soon.
Canadian Real Estate Got A Downward Revision In RBC’s Base Case Scenario
RBC’s base case forecast got a downward revision in its near-term outlook. The bank sees the CREA House Price Index (HPI) falling 5.6% over the next 12 months. It’s a downward revision of 2 points compared to the previous quarterly filings. The following 4 years are expected to see an average compounded growth of 5.1%, up 0.8 points from last quarter. A sharper decline but a faster recovery.
RBC has strongly indicated they’re weighing risk to the downside. Not just outright saying it last quarter, but they’re also called a “historic” correction just a few days ago. The bank explained it sees the RPS HPI (an alternative price index) falling 12.4 points over the next year. The RPS is roughly a third of the movement observed in the CREA HPI. RBC outright explained this will likely be the largest correction seen in at least 40 years. Clearly their opinion is weighted more towards the downside.
Canadian Real Estate Still Expected To Fall 30% In A Downside Scenario
The downside, or worst-case, scenario is unchanged from the previous forecast. RBC sees prices falling 30% over the next 12 months in this forecast. Housing would then see compound annual growth averaging 4.2% over the following 4 years. More forecasts are looking like this than they are the base case scenario. BMO and Oxford Economics are two notable examples.
Canadian Real Estate Still Expected To Rise 11% In An Upside Scenario
The alternative “upside,” or best case, scenario sees double-digit growth. RBC has forecast 10.9% growth over the next 12 months in this case, unchanged from last quarter. Compound annual growth averaging 9.6% for the following 4 years is also expected. It’s extremely high growth, but it may not seem that way to some after the frothy market just seen.
RBC’s forecast doesn’t show much of a revision for the best or worst-case scenarios. The only meaningful change is in the base case, which got a downward near-term revision. When considered with recent statements, it’s clear their expectations are to the downside.
However, it will be hard for the average person to see any risk these days. The last recession resulted in soaring home prices, an unusual dynamic not often seen. It’s resulted in many people, including some professionals, explaining home prices rise in the event of a downturn. The moral hazard is real, and it might just be the bubbliest sign for Canadian real estate. It always goes up, and if things get worse, it goes up even higher. The central bank is expected to always make people whole, even if it causes wide-scale economic disparity.
The worst case scenario: Because society would collapse if banks told you what they’re actually telling their wealthiest clients. Good on Better Dwelling for publishing their institutional commentary. It’s always two different pictures, and I noticed you put a fire under other media orgs to start sharing those comments too.
It is delightful to see random companies like NarCity trying to capitalize on this area like they have a clue. Here’s the best place to buy fried butter, but also insolvencies are down. Like a NarCity journalist could even explain the insolvency process. haha.
IFRS-9 standards are intentionally vague so they can tell investors one thing while on the institutional side they tell them the downside is more likely.
In theory it sounds great. In reality, how do they model the RWA for a 50-50 probability? Is getting punched in the face a 50-50 issue (you get punched or don’t), or is the fact almost no one is likely to punch you make it a 0.0009% chance of happening? No real standards, which is why you need to contrast it with their outside statements from management.
Rents are trying to rush and capture the payments, as they try to keep up with inflation. Most people don’t understand they’re rushing into renting an expensive place that will see their peers leave to more attractive spaces soon.
More than a few GTA real estate owners trying to sell right now are in some denial about what’s happening to real estate prices. Some are expecting bidding wars to begin anew any day now.
imho: The real estate prices are still high in Victoria and Sydney, on Vancouver Island. A lot of highend luxury homes are for sale in Victoria, Oak Bay, and other areas. Very few condos are under $500K, and of them, most were built in 1978 or 1980’s. Sellers are still trying to capitalize on the unusual price run-up during the pandemic. I don’t see any “distress” sellers out there. Not yet, anyway.
There’s a nice floating home in the shape of a boat, for sale, in Victoria West or Esquimalt. I think they reduced it to under $250K. It’s an alternative living type of home, and the least expensive on the MLS for that type of living-on-the-water-home.
Another doward revision by another bank. They are just guessing, no one really knows where the bottom will be , or they would not be constantly revising forecasts. Its a case of wait and see. Bottom might be spring 2023 if propertys starts to sell, but its unlikely to be in 2022. The market might fall a long way before then and if it does not move in spring 2023 expect another drop.
They’re expecting a lot of capital to flow into North America from Europe and Asia – but the entire world is inflating. Interest rates aren’t coming down for a good few years (3-5 years) unless the BoC wants to devalue the CAD for more exports.
If they do achieve the mythical soft landing of a space shuttle on a carrier deck, the bottom would be 3-4 years. How far down will prices go? best guess is 43% +/- 3 (pulling numbers out of my ass here).