As of October 2024, the Bank of Canada has reduced its policy interest rate four times this year, bringing the rate down to 3.75%. This ongoing monetary easing signals a strategy to stimulate economic activity, especially in sectors like housing and construction. For developers, this presents both opportunities and challenges, particularly when considering the broader impact on construction costs and the real estate market in 2025.

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Impact of Reduced Interest Rates on Financing Costs

The most immediate effect of the Bank of Canada's monetary easing is the reduction in borrowing costs. Typically, construction projects depend on substantial financing, and lower interest rates allow developers to secure cheaper loans, lowering the cost of capital.

• Borrowing Costs: Based on the current rate of 3.75%, developers can expect mortgage and loan rates to drop by an average of 0.5 to 0.75 percentage points compared to the beginning of 2024, potentially saving hundreds of thousands of dollars in interest over the lifecycle of a major project.
• Construction Loan Rates: As construction loans often carry higher interest rates due to risk factors, the 2025 rates are expected to hover around 5%–6%, down from 6%–7% in 2023.

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For a $10 million project, this translates into annual interest savings of $100,000–$150,000 on a typical five-year construction loan, freeing up capital that can be reinvested into materials, labor, or other development costs.

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Projected Construction Costs in 2025

While financing will be more accessible due to lower interest rates, the costs of construction materials and labor are forecasted to continue rising. Despite the rate cuts, inflationary pressures, particularly in commodities like lumber and steel, along with labor shortages, are projected to increase construction costs by 4%–6% year-over-year.

• Material Costs: After a volatile period of price swings for construction materials, lumber prices are expected to stabilize at $500 per thousand board feet in 2025, after peaking at over $1,000 in 2021. Other materials like steel and concrete are expected to rise by 3%–5% due to continued supply chain disruptions.
• Labor Shortages: The construction sector is anticipated to see labor cost increases of 6%–8% in 2025, particularly due to skilled labor shortages in key urban centers like Toronto and Vancouver. This labor shortage is driven by both an aging workforce and increasing demand for housing projects, which will exacerbate wage inflation in the sector.

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Forecast: Total Construction Cost Growth in 2025

Taking into account both lower borrowing costs and rising material and labor prices, developers in 2025 can expect an overall increase in total project costs of around 3%–5%. This is slightly higher than 2024 but mitigated by cheaper financing:

• Overall Project Cost Growth: While developers will benefit from a reduction in borrowing costs of around 0.5%–1% due to monetary easing, rising material and labor expenses will still push total construction costs upward. For a typical residential project valued at $10 million, the net result is expected to be an additional $300,000–$500,000 in costs compared to 2024, depending on regional factors and availability of labor.

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Regional Outlook: Winners and Losers in 2025

The impact of monetary easing will vary depending on the region:

• Toronto and Vancouver: As the two largest and most expensive housing markets in Canada, developers in these regions will benefit from lower financing costs but face severe labor shortages and rising land prices. The net increase in project costs in these regions could be 4%–6%, reflecting both labor competition and the ongoing scarcity of land for development.
• Calgary and Edmonton: These cities are likely to see more favorable conditions for developers, as labor shortages are less severe compared to Toronto or Vancouver. Construction cost increases are expected to be 2%–4%, with slightly lower materials inflation due to proximity to key supply routes.
• Secondary Markets: In cities like Kelowna or Winnipeg, the increase in construction costs will be more moderate. Developers here will benefit from lower interest rates and fewer supply constraints. Total cost increases in these regions could be as low as 2%–3%.

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Supply Constraints and Real Estate Prices

Despite lower borrowing costs, developers will continue to face challenges related to housing supply. The Bank of Canada's 2024 Monetary Policy Report notes that housing demand, driven by immigration and population growth, will remain robust, with a projected population increase of 1.1 million by 2025. However, supply-side constraints, including land availability and zoning regulations, will prevent housing supply from keeping pace with demand.

• Housing Starts Forecast: The Bank of Canada expects around 215,000 new housing starts in 2025, which, while an improvement over 2024, still falls short of meeting demand. This supply-demand imbalance will likely result in 5%–7% increases in home prices, particularly in high-demand regions like Toronto and Vancouver.

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Long-Term Implications for Developers

For developers, the easing of monetary policy presents an opportunity to lock in cheaper financing for long-term projects. However, the cost savings from lower interest rates will be partially offset by rising material and labor expenses, as well as ongoing supply constraints.

• Strategic Focus: Developers should prioritize projects in secondary markets or regions with fewer labor and material bottlenecks, where cost increases are expected to be more moderate.
• Timing Considerations: Given the forecast for further rate cuts in 2025, developers who secure financing earlier in the year may benefit more from lower interest rates. However, they should also be prepared for higher construction costs as labor shortages and material price inflation continue.

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Conclusion

Monetary easing by the Bank of Canada, which has brought the policy rate down to 3.75%, will provide some relief to developers in 2025 by lowering borrowing costs. However, rising construction costs due to material and labor shortages will likely offset much of these savings, with total project costs expected to increase by 3%–5%. Developers must navigate these challenges carefully, focusing on strategic investments in regions with fewer supply constraints while leveraging favorable financing conditions to mitigate cost pressures.

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By understanding the dynamic between interest rates, labor markets, and material costs, developers can better position themselves for success in the evolving Canadian housing landscape.

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Sources: Bank Of Canada