It may be too early yet to say what the longer-term effects will be, but each buyer is expected to be affected differently
The cost of borrowing money continues to rise in Canada, making purchases of real estate and farmland less attractive to potential buyers.
On Oct. 26, the Bank of Canada hiked its overnight lending rate by another 0.5 percent, pushing its benchmark rate to 3.75 percent.
Rates set by the Bank of Canada have a direct impact on commercial lending rates offered by Canadian banks and credit unions.
The latest rate increase, the sixth in eight months, is intended to cool an overheated Canadian economy and keep inflation rates in check.
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Less than 10 months ago, the Bank of Canada’s overnight rate was sitting at a record low 0.25 percent.
Prime rates offered by commercial lenders were below three percent.
Today, prime rates offered by most commercial lenders have more than doubled and are sitting at nearly six percent.
Last month, the Canadian Real Estate Association said debt servicing obligations are now having a significant impact on purchasing decisions.
“It makes for an interesting dynamic, one that doesn’t really have many historical precedents,” said CREA chair Jill Oudil, commenting on the new real estate market dynamics.
“The market has changed so much in the last year, and the adjustment to higher borrowing costs is still underway.”
The Toronto housing market is an interesting example.
In Toronto, the volume of residential real estate sales in October 2022 was down 49 percent compared with October 2021.
Average sale prices were down six percent.
So how are western Canadian farmland markets responding?
Is demand for prairie farmland softening in an environment of rapidly rising interest rates?
Perhaps, in some cases, says Ted Cawkwell, an agriculture realty specialist and owner of Cawkwell Group, a Saskatchewan farmland realtor.
“The effects are just starting to maybe show up now,” Cawkwell said.
“I think we’re still a little too early to say what the longer-term effects will be. That being said, I think (higher rates) will affect each buyer differently.”
Cawkwell said there are two main types of farmland buyers in Saskatchewan: farmers and non-farmer investors, who buy land as an investment and rent it back to producers.
“That group (the non-farmer investor) has been impacted hugely already,” he said.
“If they’re looking to get like a three percent return on their investment and their interest rate just went up from three to six percent… suddenly it’s a really tough manoeuvre for them….
“Those guys will be the first ones out of the market.”
Among the second group, farmer buyers, the impact of higher rates will be harder to gauge and more variable, depending on the individual circumstances.
“If you’re in an area where you’ve had really good crops and profitability in the past few years, I don’t think you’ll see as much of an impact in those areas.
“I think those guys are sitting pretty good with cash flow and if they have to pay a few extra points of interest to get the deal done, (they will)….”
But in other areas, where growers have had consecutive years of drought and low yields, softening demand for farmland will likely result in lower prices.
Poor yields, declining farm revenues and rising costs for other farm inputs such as fuel, fertilizers, chemicals and machinery have left growers in some areas struggling for cash flow.
That, combined with higher borrowing costs, will dampen demand for farmland in some areas.
“If you’re short on cash flow and all of a sudden borrowing cost have essentially doubled, that’s going to have an immediate impact.”
To illustrate the impact of rising interest rates, consider a hypothetical scenario in which a potential land buyer borrowed $500,000 on Dec. 31, 2021, at a fixed 2.5 percent interest rate, amortized over 25 years.
Under that scenario, the total debt servicing cost over a five-year term would be in the range of $134,390, assuming regular payments of $2,240 per month.
Of that amount, an estimated $57,580 would be paid as interest and $76,810 would be applied against the principal amount borrowed.
By comparison, under today’s higher interest rate environment, five-year carrying costs for the same borrower on a loan negotiated Oct. 31, 2022, would be 42 percent higher at $191,051, based on regular payments of $3,184 per month.
Of the $191,051 five-year carrying cost of the latter loan, $139,917 would be paid as interest and $51,134 would be applied against the principal amount borrowed.
Ultimately, higher borrowing costs will impact markets, said Cawkwell.
“Any time you have a rising interest rate, it’s going to have a negative impact on farmland values,” he said.
“I’m not going to say farmland values are going to stop increasing and I’m not going to say they’re going to drop, but there’s going to be a negative impact.
“Whatever trajectory we’re on for the increase in farmland values, that trajectory is going to slow down.”
J.P. Gervais, chief economist at Farm Credit Canada, agreed.
“Farmland values continue to increase on average, but at a slower pace than the beginning of 2022,” Gervais said.
“In some regions of Western Canada, values have plateaued. (The) impact of higher rates on land prices seems to be mitigated by limited supply of available farmland and farm income trending in the right direction.”
Gervais said FCC is anticipating another Bank of Canada interest rate hike before the end of the year.
“We believe there will be another rate hike of 25 basis points (0.25 percent) in December,” he said.
“Financial markets estimate there’s a high probability to see an additional (0.25 percent) hike in January, (but) we think the Bank of Canada will be done raising rates in December.”
Either way, borrowing costs are expected to plateau in early 2023 with the Bank of Canada overnight rate sitting at four to 4.25 percent, Gervais said.
That would push prime commercial lending rates to 6.5 or seven percent, the highest rates seen in the past 20 years.
