Immigration cuts will help narrow Canada’s housing gap but won’t solve crisis

The drastic reduction in immigration targets announced by the federal government is one of the more consequential policy reversals in recent memory. It will sharply reduce growth in housing demand over the coming years, making it possible for Canada to narrow the housing supply gap.

Ottawa estimates that slashing targets for permanent residents and reducing the number of non-permanent residents by more than 900,000 over two years will result in the population falling by 0.4% by 2026. It will start to grow slowly from 2027 onwards.

We doubt non-permanent residents can be cut by so much so quickly, but the policy shift will slam the brakes on population growth after reaching a six-decade high recently.

It will also significantly curtail household formation in the country. This is important, because it drives the number of new housing units needed.

Housing markets are currently significantly undersupplied. Canada will now get a golden opportunity to reduce the housing shortage so long as the recent pace of homebuilding is sustained-or better yet-further expanded.

We project that nearly 400,000 fewer households (or -46%) will be formed over the next three years than we had expected in The Great Rebuild. It reduces pressure on construction as fewer new homes are required in that timeframe.

We now expect an average 150,000 new households will be formed annually under this stricter policy-well within the number of new units the construction industry can deliver. Housing completions averaged 225,000 units in Canada in the past three years.

The new forecast is a sharp contrast to our prior outlook that expected continued underbuilding through to 2027-leading to a wider supply gap.

What the new policy shift won't do is instantly rebalance the market. We estimate growth in housing stock fell short of new households by 545,000 between 2015 and 2023. This gap will take years to undo.

It also won't guarantee a reduction in the shortages of every type of housing and price point. High construction costs will continue constrain homebuilders' ability to deliver homes at the more affordable end of the range.

Lower immigration will impact rental market

First, it will cool the rental market. We expect any net outflow of non-permanent residents will shrink rental demand in the near term-especially in areas close to post-secondary education institutions where ballooning international student enrolment crushed vacancy rates. Evidence of this has already emerged in some markets.

In Toronto, this comes at a time when rental supply is growing following a wave of new condo completions in the past year, many of which are owned by investors.

Rising vacancy rates from lower demand and, in some cases, mounting supply will curb rent price hikes. They could even drive rent lower if vacancies jump materially (above 3% as a general rule). Slight declines in asking rent have been seen in Toronto and Vancouver lately, which could be a sign of broader easing on the way.

Second, lower immigration could temper investor demand for condos and purpose-built apartment buildings. Some investors may have to rethink a residential investment's future returns, given the softer outlook for rent.

Interest rate drop a bigger factor for buying demand

Any cooling on the broader ownership market, however, is unlikely to be felt immediately. In fact, we see more reasons for homebuyer demand to grow in the next year or two than decline.

We expect a powerful boost from interest rate cuts. While those interest rate cuts are coming in response to a weaker economy and higher unemployment rate, a portion of the large pent-up demand that has built since the Bank of Canada started hiking rates to combat inflation from March 2022 is set to be unleashed, revitalizing sales activity for existing and new homes. A rebound in pre-construction sales is also critical to sustain healthy homebuilding levels in the years ahead.

In addition, we could see the wave of immigrants in the past decade bring more buyers to market. Newcomers to Canada typically spend their first five to 10 years as renters as they get established. We think a growing number of recent immigrants will be ready to step on the housing ladder in the next few years. The drastic immigration cuts announced on Oct. 24 are more likely to directly impact homebuyer demand further down the road.

We expect homebuyer demand will recover gradually in the near term, and pick up momentum once the BoC is deeper into its rate-cutting cycle next year. Softer demographics will temper the recovery's pace, keeping sales only modestly above the 10-year average through 2026 nationally-still far below the pandemic peak.

Will a stricter immigration policy solve the affordability crisis?

Narrowing the supply gap over time will give Canadians more housing options to choose from, but it will not solve the affordability crisis.

We see some material relief in the rental market if the stock of purpose-built apartments can be further increased. Vacancy rates must go up considerably from current levels for rent to stabilize or fall.

But, it will take a long time to restore ownership affordability in Canada's largest and priciest markets. We don't expect lower immigration targets will bring home prices down under our base case economic scenario. But they will keep them flatter than otherwise would be the case. Our view is interest rates closer to neutral levels and stabilizing labour market conditions will generally sustain small price gains over the medium term-with local trends varying.

Much of the affordability improvement we foresee in the period ahead will come from lower interest rates and growth in household income. But, both point to only a partial reversal of the massive loss in affordability during the pandemic.

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