A drop in rents could impact home prices across Canada, according to Capital Economics, as a sharp drop in immigration and tourism are causing higher vacancy rates in some of the country’s biggest cities.

“With property investors basing their price expectations on the assumption that rents would instead keep rising strongly, this represents a big risk to house prices,” Steven Brown, senior Canada economist at Capital Economics, wrote in a note to clients Thursday.

Recent reports from rental websites such as Padmapper and Rentals.ca show a rapid decline in rents in major Canadian cities such as Toronto, Ottawa, and Vancouver and Montreal.  Brown said the surge in unemployment among low-income earners, a drop in immigration, and a decreased demand for short-term rentals were among the factors contributing to high vacancy rates, which is driving rental prices lower.

He added the halt in immigration and rise in supply could be “very significant” for the country's real estate sector. He noted immigration into Canada has plunged to almost zero since mid-March when international travel restrictions were put in place due to the COVID-19 pandemic. Brown estimates Canada saw approximately 30,000 new arrivals per month prior to that.

“Even if travel restrictions are soon loosened and vacancy rates rise by far less than these extreme scenarios, rents seem likely to decline by at least five per cent to 10 per cent in Toronto and Vancouver,” Brown said. “That represents a big risk for house prices.” 

While Brown acknowledged there’s uncertainty around future vacancy rates, he said the situation “looks very concerning in Toronto and Vancouver” as those cities have the highest amount of short-term rentals and new immigrants.

Using Toronto as an example, Brown said an increase of the vacancy rate to 4.5 per cent from 1.5 per cent could cause a 15-per-cent decline in rent prices.  

“Many recent investors reportedly already faced negative cashflows as rents were too low to cover all their expenses,” he said. “With rents now falling, some may sell properties, which could cause a drop in house prices in excess of the five per cent we have pencilled in.”

Earlier in the week, the head of Canada Mortgage and Housing Corporation (CMHC) warned home prices could fall as much as 18 per cent over the next year if the economy doesn’t recover sufficiently.