Younger Canadians wanting to live in Canada’s urban centres are going to have to get used to settling for smaller living spaces.

In other words, we’re witnessing the “Manhattanization” of our cities, according to Peter Routledge, head of the Office of the Superintendent of Financial Institutions (OSFI), which regulates the country’s federally regulated financial institutions.

“I think if Canadians want to live in big metropolitan areas, they’ll have to get used to the notion that they’re going to have to live in a smaller space,” he said during an interview on The Herle Burly podcast.

“Longer term, if the federal government can work with local and provincial governments in infrastructure investments to create zoning laws that will allow for densification, longer term we’ll be able to offer the Canadian dream of homeownership to more Canadians earlier in their lives,” he said.

“But you might live in 700 square feet instead of 2,100 square feet. But you’ll be able to walk out your street and your groceries are a block away, and your favourite two or three restaurants are four or five blocks away,” he added. “Culturally, I think we need to begin to accept…that’s the future of urban living in Canada.”

Routledge made the comments after being asked about the prospects of homeownership for younger Canadians who haven’t yet got their foot on the real estate ladder.

The hurdle for homeownership is becoming more challenging by the month. In January, the average selling price for a home in the Greater Toronto Area rose 28.6% year-over-year to $1,242,793, according to new data from the Toronto Regional Real Estate Board.

It’s an issue that Routledge sympathizes with, but admits there are no short-term solutions.

“Having prices correct down to the point where younger Canadians can jump into the housing market, that would be quite a shock for the system to absorb,” he said, adding that underlying factors, such as demand, aren’t going away anytime soon.

“I do think as rates go up, you’ll see some kind of normalization of prices and that may make it a little more accessible, but that’s not going to solve the problem,” he admitted. “The longer-term solution is to…bring up the construction of housing to a level that meets household formation.”

What’s behind rising prices?

There are a couple of key factors that have helped drive up prices, Routledge noted, one being the “thousands and thousands of really well-educated folks with financial resources” wanting to immigrate to Canada.

“Household formation in Canada is very, very high…probably the highest in the G7 on a population-adjusted basis. We’re not building dwellings, or housing units, fast enough for household formation,” he said.

The other component is an increase in purchases from the investor class. While investors typically make up between 15 and 17% of home sales in any given year, Routledge said that figure now stands at 22-23%, which he said is adding “significant” incremental demand into the system.

“There is a speculative fever that takes over private markets, and that’s what is playing out,” he said. Routledge added, however, that it appears we’re now at the latter stages of that phase. “My expectation is that, as rates go up, assuming they do, some of that fever is going to abate a little and you’ll see a slowdown in prices.”

House prices could fall in some markets by 10-20%

For some regions that have seen a “really rapid” rise in prices, Routledge said a decline of 10% to 20% is possible.

“But that will just be a return back to a little bit more sanity after a sudden build-up in prices,” he added.

Realistically, that would only take prices back six to 12 months in most markets.

After all, what’s a 10% pull-back in a market that’s seen a 20-30% increase in prices in the past year?