2017 and Beyond: The Toronto Real Estate Space Odyssey

1)  What are the underlying factors that are influencing the market to behave in this prolonged manner?

2) What are the possible long-term consequences to the City of Toronto and its inhabitants?

The What all comes down to one thing. Supply.

To put it bluntly, we are increasingly running out of space. Space to build, space to grow, and spaces to live are becoming increasingly scarce, and in turn, it’s in this time of scarcity concerning Toronto’s housing inventory, that is driving prices up. We are experiencing a significant lack of supply of housing stock, with everyone wondering what is to blame. Fundamentally, the big What is a Supply issue that has run rampant and been left unchallenged for over a decade. Note: If you severely undersupply a housing market graced with a robust economy and rapidly growing population for over a decade, the net result will be a severe housing shortage. No one seems to want to call it as such, but that is exactly what Toronto is experiencing – a severe housing shortage with no signs of abating.

Toronto’s Housing Inventory (or Lack Thereof)

Let’s take a deep dive into better understanding the Toronto housing inventory.
Right now, we are sitting in a very heated Seller’s Market, which is measured by using the Months of Inventory (MOI) ratio. Applying this ratio is the most accurate way of determining whether a Market is in favour of Buyers or Sellers.

As a basic rule of thumb, an MOI that is below four months indisputably indicates a Sellers Market, and an MOI exceeding six months always points to Buyer territory; an MOI between five and six months always signals balanced conditions. With this in mind, the GTA had a paltry 36 days of inventory at the end of 2016, meaning it would take a little over a month for all currently listed homes to sell across the Greater Toronto Area, which is on the extreme end of a Seller’s Market range.

Low Months of Inventory = low Supply, high Demand, and rising Prices

Below are the inventory charts of the three major resale residential asset classes in the GTA (data taken from TREB Market Stats).

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As the above charts clearly indicate, there is a steeply declining inventory trend in all of the major residential resale sectors. Is there any relief coming by way of new Development? Let’s take a look…

2016 New Construction Supply and Demand Curves

In 2016, the demand for new construction homes, relative to the supply fell completely out of balance.
According to a recent study completed by Urbanation, a consulting and market research firm that focuses on the Greater Toronto Area’s Housing Market, we have never seen the demand for new condominiums exceed the supply by as much as it has in the third quarter of 2016. Total sales for the year (19,917) outnumbered the volume of new launches (12,678) by as early as September 2016, by a margin of 7,239 units. That’s nearly three times higher than the margin averaged during 2015 and 2014! For context, the gap between sales and new launches has averaged less than 1,000 units over the past decade, with six of the previous ten years showing a higher volume of new openings than sales. In addition, the total supply of new homes available to purchase in Builders’ Inventory declined by more than 10,000 homes in the past year. There were 15,421 new homes and condominiums available for purchase in September across the GTA compared to 25,848 at this time last year (BILD Toronto).

As BILD President and CEO Bryan Tuckey explains, “We have a serious housing supply challenge in the GTA due to a significant shortage of shovel-ready land and long and uncertain project approval timelines.” It is these factors that have severely restricted the number of new homes being brought to Market and have caused home prices to surge month after month.

Condo Apartments

The average resale condo price index in the GTA surpassed $500psf for the first time in 2016 as strong demand with a prominent lack of supply pushed the Market into record territory. Within the 416, the former City of Toronto’s Condo Market was ‘set on fire’ in 2016 with an average price per square foot approaching a record $700. The Toronto condo market has had thestrongest annual rate of sales growth in 2016, followed by detached homes.

Low-Rise Segment (includes detached, semi-detached and townhomes)

In November 2016, the average price of a single-family, detached home in the 416 sold for a staggering $1.3M, up 25.3% year-over-year; and, semi-detached homes were selling for an average of $902,012, up 19.2% from the same time in 2015. This accelerated price growth was primarily attributed to constrained supply of inventory while demand remained prevalent. At the end of December of 2016, Active Listings were at their lowest point in a decade-and-a-half while on the inverse, the population has increased by well over a million people in that time.

Rental Market

Low Inventory levels have also mired the rental market with bidding wars now becoming commonplace and expected. Rental market conditions in the Greater Toronto Area became even more constrained in 2016 (Q3) as available supply fell to a five-year low, plunging by 35% from last year, and had the lowest level of recorded units available since Urbanation began tracking the market in 2011.
With the total number of condo rental listings down and rental demand as strong as ever, the average rent for condos hit nearly $1,990 a month for a typical 719-square-foot condo in the fourth quarter of 2016, up 11.7% compared to the same period a year earlier. Rents rose the most in the Toronto city core, where condos rented for an average of $2,134 a month by the end of 2016; this is the highest historical rate of appreciation for Toronto Condos tracked by Urbanation.

Is there any relief in sight and what are the three levels of government doing to ameliorate the situation? The short answer is that they are making matters worse.

Municipal

Recently, a relatively modest rebate was enacted by the province in its portion of the Land Transfer Tax (LTT) to give a break to first-time home buyers; however, it now looks like City Council is moving toward implementing an increase in Toronto’s portion of the LTT by 7% later this year. The City’s approach only tackles the issue of Demand on the notion that if the demand-side is taxed, fewer people will buy while subsequently raising revenues. The problem is – given the high costs associated with the tax, it has and will deter homeowners from selling their primary residences, causing a drop in homes going on the Market, for sale. To demonstrate, the LLT costs of acquiring a $1.3M home, for example, would be $44,000 – this number would make anyone think twice before putting their house up for sale.

Because the cost to acquire is so expensive, a lot of would-be sellers in Toronto have opted to stay put and invest their money into renovating their home instead, increasing the value of the property that they already own, as opposed to watching their money being vaporized into Land Transfer Taxes.

The high costs associated with the LTT have and will continue to result in a limiting amount of homes going up for sale; and ultimately, contribute to Toronto’s scarce supply of available homes going onto the Market.

Provincial

The Provincial Government also has a substantial influence on the Housing Market, contributing to land supply restrictions resulting from the plan called, Places to Grow Legislation. According to Chief Economist for CIBC, Benjamin Tal, “The Legislation is the number one reason GTA house prices are rising” and I couldn’t agree more.

Places to Grow is the Ontario Government’s program to plan for growth and development in a way that supports economic prosperity, protects the environment and helps communities achieve a high quality of life across the Province. The centrepiece of the Liberal Government’s 2005 Legislation is the Greenbelt, which essentially has had the effect of making the GTA an “island” surrounded by green land and restricting expansion. Although the primary objectives of the initiative may sound favourable, the routes that are being taken to achieve such are ineffective and, ultimately creating adverse effects on the City’s Housing Market

      Source: Greenbelt.ca

Tal links the inflation of home prices back to Government Policy explaining, “The number one reason for house price inflation in the GTA is supply — which is all about government policy,” And there is “zero chance” of that policy changing.

The Ontario Government recently proposed even higher density targets to the provincial growth plan which will increase intensification targets for GTA municipalities from 40 per cent to 60 per cent; this is at a time when the government should be loosening densification targets to allow for more supply.

Federal

On the Federal level, the last two years of successive Governments have stated their concern over the lack of affordability in Toronto and Vancouver and have subsequently taken action aimed solely to curb demand. In that time, the Federal Government has also brought in no less than five changes to the CMHC lending rules, affecting mortgage lending and bank capitalization.

The most recent changes to the CMHC lending rules made it effective that anyone with less than 20% deposit applying for an insured loan would have to qualify at an additional 2% stress test, which in turn reduced affordability for home buyers by an estimated 17%. The net result was that it pushed many first time home buyers looking to buy on the fringes of the low-rise market into the condo market, driving the existing inventory to its very limits.

These types of policies can have significant, unintended consequences as they tend to favour those who are already in the Market, as the young and those on the fringes of the Housing Market will be forced into the Rental Market, perhaps forever.

As a side note, condo appreciation in the GTA was at 9.3% in September 2016. By December, after the new mortgage rules came into effect, the appreciation rate year-over-year had almost doubled to 15.6% in one swoop, making bidding wars on condo apartments the new norm. A recent study from Ryerson University confirms that people’s expectations for housing aren’t necessarily changing, even as more and more of the housing stock is condos. Condo living used to be a lifestyle choice – now it’s an affordability choice. The fact that more and more people are buying condos is not indicative of their wants, but rather, what is within their financial bandwidth. With most Torontonians already priced out of the low-rise housing Market, if the dire inventory situation continues in Toronto, it will not be long before even a basic condo becomes out of reach.

The amount of government’s meddling on all levels into the Housing Market is unprecedented; and yet, despite all the new legislations, approval processes, lending rule changes, and taxation, they could not have been getting things more wrong. With governments treating the issue of rising housing prices as more of a political means for re-election rather than a long-term comprehensive strategy to address the issue. Trying to fix a Supply problem by focusing solely on Demand is like a doctor trying to cure a patient by only addressing the symptoms.

Ben Myers, Senior VP, Market Research & Analytics at Fortress Real Developments points out that “supply-side factors like urban containment, environmental protection, over regulation and high development charges are rarely discussed. For the sake of homeowners and potential home buyers, both demand and supply must be part of any debate going forward by governments looking to improve the short and long-term health of the Canadian housing market.” In order to allow for an affordable Market, the focus needs to be on opening up the supply coming online, period; end of story. Every other approach is a self-serving, ad hoc band-aid solution.

The truth is that no single body has the onus of governing Toronto’s Housing Market and as a result, uncoordinated, and unaligned policy & legislative changes from all different levels of government have reduced the GTA Housing Market into a metaphorical “Ping Pong Ball” – batted from all sides.

Veritas Investment Research held a very informative conference in early November to discuss “Great Canadian Housing and Real Estate”. Based on the numerous speakers that day, Veritas issued a summary of their findings. The first two, but intriguing points being:

1) Real Estate is not always local: Global capital, trade, and population flows create global “gateway” cities, with real estate markets that feature price appreciation uncoupled from their respective national home price indexes.

2) Houses are commodities too: Historically, value in use was the primary reason to own real estate; however, “gateway cities” transform real estate into an investable, exchangeable commodity sought by global capital.

Due in part to it’s large and highly concentrated, diverse population and accessibility, Toronto is recognized as a global “gateway city” and small-minded, demand focused solutions won’t work. The size, velocity and scale of our market are just too large. When cities reach a certain magnitude, more cohesive and strategic policies are required to create positive change efficiently.

The Immigration Time Bomb

The Advisory Council on Economic Growth released recommendations for annual immigration, denoting that numbers should be increased over a five-year period by 50% to 450,000 (up from 300,000). Should the Liberal Federal Government enact this recommendation, it would almost double the rate of immigration into Toronto from 100,000 to close to 200,000 annually.

Currently, the GTA’s population is projected to reach almost 9.5 million by 2041. With this number in mind, if the respective levels of Government can’t work with the private sector to stimulate supply, the ramifications could be striking.

    Source: Tony Saxton/Torstar News Service

Prominent New Zealand economist and author of “Wealth and New Zealand,” Max Rashbrooke, talks about the rising prices of residential homes in major cities of countries like Canada, Australia, New Zealand and Britain, and how they are beginning to emulate aristocratic societies with a risk of landed gentry forming like in feudal times.

As prices continue to rise, the opportunity to purchase may become exclusive to those who have generational wealth. Parents helping their children is not a new phenomenon, but as more and more are contributing to part or even all of the downpayment from housing purchases, it is only making the situation worse. Parents are using their savings or taking the money out of the equity they have built in their own homes. All this is doing is compounding the problem, and it will be extremely difficult for future generations to buy a house without their parents assistance.

“Parents will only be able to help if they themselves are wealthy homeowners, so you could have a landed wealth-owning class perpetuating through the generations. At that point being born into the right family matters a lot,” Rashbrooke says.

Bank of Montreal’s survey of first-time home buyers, taken earlier this year, found 65% of millennials plan to rely on financial help from family to buy a home. But Shamubeel Eaqub, revered Economist and Author, sees that as a threat to the hopes of future generations who want to get on the property ladder.

Eaqub says there is a risk that home prices will continue to rise until it’s no longer possible for most people to save up for a down payment. If trends don’t change soon, that could be the case in Toronto and Vancouver. It now takes twice as much time to save up for a down payment in those cities, compared to their average since 2000.

• Inventory will continue to tighten. Buyers and Renters alike can expect to have a hard time facing bidding wars and bully offers at every turn.
• Expect double-digit resale price growth percentages in all residential resale sectors in 2017
• Anticipate soaring Pre-Construction pricing as very few sites in Toronto remain to be developed. Land prices are now more expensive and most vacant sites are already in the hands of Developers. With less competition, even pre-construction pricing – which has been relatively flat for the last few years – will begin to soar.
• Governments at all levels will continue to meddle and remain inept, with no cohesive long-term strategy to address dwindling supply levels.
• Bigger will be better: With average buyers now being pushed out of the Low-rise Market due to unaffordability, look for two and three bedroom condos to become hot commodities. Expect to see higher demand and appreciation for these units, with Developers having a greater percentage of larger units in their suite mixes when new projects come online.
• Bank of Mom and Dad: Look for more involvement from parents helping their kids enter the market with a downpayment or subsidization when it comes to purchases and leases.
• Jumping the Greenbelt: With the dream of purchasing a detached or semi-detached house now growing further and further out of reach for the average individual or family,  look for buyers that are “Jumping the Greenbelt”, and buying up homes outside of the Greater Golden Horseshoe such as Dufferin and Simcoe Counties, Peterborough and Kawartha Lakes
• The Trump Effect: Expect significant geopolitical instability in 2017 with an increase in the flow of people and capital looking to moving to Toronto.

Job Creation + Immigration + Low Interest Rates + Record Low Inventory = Price Appreciation

In 2016 the GTA saw a job growth rate of 55,000, an increase in immigration to Ontario to a nine-year high of 119,000 in the latest 12 months and a 15-year high for interprovincial in-migration to 77,000. All indications are that in 2017, the GTA economy and immigration will remain strong. On the Federal level, it is expected that interest rates and inflation will continue to remain low throughout this upcoming year.

The Forecast for the Toronto Real Estate market is to expect more of the same with the record level inventory levels  in 2016 as a harbinger of rising home prices to come in 2017.

I have been writing about the Manhattization of Toronto for well over a decade, and in that time I have witnessed our city and skyline transform and grow right before our eyes. I believe that Toronto has only just begun. Over the course of the last decade I have seen many clients and friends amass a small fortune in Toronto Real Estate while on the other side of the spectrum, I have witnessed others getting completely priced out of housing, ostensibly waiting for a Market Correction that never happened.

During the subprime crisis in 2008/2009 the Toronto Real Estate market was tested, and it showed tremendous resiliency at a time when most major markets around the world were decimated. There is no doubt that at some point in the future, our Market will be tested again by a recession or global event and over the short term, prices may be affected; however, when investing in Real Estate, successful real estate investors always think in terms of long-term potential. As expensive as prices appear in comparison to most other major cities, Toronto is a relative bargain, but undoubtedly, that will not remain for much longer.

The Toronto Real Estate Market has been on an incredible run, defying most expert’s predictions. When you take a deep dive into the past market fundamentals, it gives you an idea of not only what has transpired, but more importantly, it provides a clear picture of what is to come.

Pictured above: Toronto’s skyline in 2020 if all proposed projects are built. Image courtesy of Toronto Life.

While the media is mostly focused on the idea of a bubble and when will it burst… perhaps they are focusing on the wrong question. What if the Government and the private sector in Toronto will continue to be unable to meet supply with demand? What affects will that have on our society and the Canadian dream of home ownership? What would life be like if less than 10% of Torontonians owned their own home while everyone else rented? These are the questions that need to be considered by not only Toronto’s inhabitants, but it’s Governing bodies as well.