The Bank of Canada recently reduced its key policy interest rate by 50 basis points, bringing the rate down to 3.75% from 4.25%. This fourth consecutive rate cut since June comes in response to changing economic conditions and aims to stimulate economic activity, including the real estate market. However, the impact on Canada’s real estate market may be more gradual than immediate, given the complexity of the current economic environment.

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Immediate Effects

The interest rate cut to 3.75% directly lowers borrowing costs for many Canadians, particularly those with variable-rate mortgages and those approaching mortgage renewal. These homeowners will see lower monthly payments, offering immediate relief to those struggling with rising living costs. Lower interest rates mean cheaper financing, allowing buyers to qualify for larger loans, which can help boost demand for homes.

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While borrowing costs are reduced, the real estate market has not yet seen a dramatic shift. In the third quarter of 2024, the national aggregate home price increased by only 1.6% year-over-year, reaching $815,500. However, on a quarter-over-quarter basis, home prices dropped by 1.1%, reflecting a mixed market response to earlier rate cuts.

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The Psychological Factor

The psychological factor remains one of the most critical aspects shaping market behavior. Despite four consecutive rate cuts, buyer demand remains cautious, particularly among first-time homebuyers and smaller investors. Many potential buyers are holding off on making purchases, waiting for greater stability and for the market to bottom out.

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Economists suggest that this "wait-and-see" mentality may create a delayed but rapid market shift once confidence is restored. Buyers and investors may begin to act quickly, potentially resulting in a surge in demand that could cause prices to rise. Historically, the real estate market often reacts to interest rate cuts with a lag of several months, as was seen in previous housing cycles.

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Risks of Rising Demand and Home Prices

While the interest rate cuts aim to stimulate the housing market by lowering borrowing costs, they also risk triggering another surge in home prices. As more buyers enter the market, demand could quickly outstrip supply, driving prices up. This effect could negate the benefits of reduced borrowing costs and make homes less affordable for those on the sidelines.

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Major urban centers like Toronto and Vancouver, where housing affordability is already stretched, could see renewed price growth as more buyers rush in. According to recent data, Toronto saw over 650,000 square feet of positive absorption in commercial real estate during the third quarter of 2024, indicating renewed confidence in property investments.

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Long-Term Implications

Experts predict that the full impact of the rate cuts will not be felt until mid-2025, as real estate investors and potential buyers wait for clearer economic signals and the market to stabilize. Further rate cuts are anticipated in 2024 and 2025, potentially providing additional incentives for buyers to re-enter the market.

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This gradual re-entry could create an unseasonably busy winter season, followed by an even more active spring market in 2025. However, the extent of this rebound will depend on several factors, including future rate announcements and broader economic conditions.

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Conclusion

The Bank of Canada's interest rate cut to 3.75% is expected to have a significant impact on the Canadian real estate market, although the effects may not be immediate. Lower borrowing costs are providing relief for homeowners and could stimulate housing demand in the coming months. However, the market's response will likely hinge on future rate decisions and the broader economic recovery. For buyers and investors, now may be the time to prepare for the next phase of market activity, which could see rising demand and home prices as the effects of the interest rate cuts take hold.

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The psychological shift among potential buyers, waiting for the right moment to act, may also play a crucial role in shaping the real estate landscape in 2025. As more confidence builds, the market could heat up rapidly, leading to higher home prices despite the current affordability gains.

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Source: Bank of Canada