I’ve stuck my neck out and predicted that once Canada’s credit bubble bursts, it will wreak havoc on the national real estate market. I believe that we are in a national housing bubble. Though not as extreme as the bubble in the US, it is nonetheless very problematic when one considers how the feedback mechanism of expanding credit and expanding real estate values artificially buoys the broader economy.
Like the US housing bubble, our national bubble is largely the result of extreme valuations in certain larger centres and certain housing sectors within those centres.
As I’ve explained before, the bursting of a credit bubble exerts strong deflationary forces which, while they may or may not exert pressure on international commodity markets, they absolutely will crush credit-dependent assets such as real estate. In this context, it may well be that even the ‘fairly priced’ smaller markets will see price pressure, though nothing like the two bubbliest markets: all of Vancouver and the Toronto condo market.
Once the national credit bubble bursts, the result on housing will likely be a drop in house values of 30% on a national basis, though the true carnage will be in markets like the two mentioned above, where a 50% peak-to-trough revaluation will be likely.
Today I want to look at some more data points that continue to suggest that the Toronto condo market continues to exhibit the classic symptoms of a major bubble.
Overbuilding Still Rampant
As I noted in an earlier post, Toronto has a love affair with condos. So much so that developers have projected such demand into the indefinite future. Toronto is North America’s new condo capital: Last year, developers completed about 16,000 units, twice as many as in New York (a city with 4 times the population) and three times as many as Vancouver. As of June, according to CMHC, there were over 34,000 units near completion in the GTA.
In addition, we found out yesterday that condo starts soared in Toronto in the past month, accounting for the bulk of the overall NATIONAL gains in housing starts.
“The volatile multi-unit sector was the big driver in November, jumping 20.9% to 101,800 annualized units. Ontario effectively drove the entire gain, with multi-units starts more than doubling in the province thanks to a number of Toronto condo projects breaking ground.”
Given that immigration to the city is projected to be 65,000 total individuals this year, this pace of condo development massively outpaces demand. So who’s doing the buying?
Investor Speculator demand for condos
CMHC released its rental market report today. It has estimated the percentage of investor-owned condos in Toronto at around 20%, not unusually high for a large city. But that number masks a rising trend in investor-owned condos in Toronto. A Globe and Mail piece published in August estimated the investor demand for new condos at 40% of total, though it didn’t indicate exactly where it got that estimate from.
This estimate seems fairly consistent with estimates from those in the industry.
“Many of the city’s condos aren’t purchased by end users. Rather, they’re often bought by investors who rent them out. If they can’t rent them, the alternative is to place them back on the market for resale, further adding to the city’s condo supply. Barry Lyon, president of N. Barry Lyon Consultants Ltd., sees this as a possible concern. “We’re all watching the rental market carefully. Thirty per cent of the condo market is defacto rental investor — some offshore but most are local.”
Why are they buying? It’s certainly not for the cash flow.
For the low average price of 307,000 you too could own an average Toronto condo. The average rent for such a condo is roughly $1400 per month.
Assuming the investor put down the required 20%, it would leave a total mortgage amount of approximately 245,000. At the extremely low rental financing rate of 3.5% financed over 30 years, the mortgage payments would be almost $1100. Add in condo fees and property taxes, and subtract the lost opportunity costs from the 20% down payment and you’d be looking at subsidizing someone to live in your own unit.
I found the anecdotes in this forum discussion about condo investing in Toronto to be quite telling.
“Areas of high appreciation rate (Downtown Toronto) generally yield negative cash flow. A condo that costs you $1600 to run per month (mortgage/tax/mt.fees) will generally fetch between $1500-$1650 per month. However, in Toronto where there are certain pockets of very high appreciation rate (think approx 10% per year) means that your Condo which was worth $300,000 last year is worth $330,000 today. So assuming you lose $100 per month on cash flow, you are still up approx $29,000 at the end of the year “on paper”.”
This is absolutely the definition of speculation. If these ‘investors’ are indicative of what is sustaining the demand for Toronto condos, God help you if you own one for ‘investment’ purposes. Is this rational use of capital? Can these same ‘investors’ be counted on to act equally ‘rationally’ if/when prices decline even moderately and the illusion of ever-increasing cap gains vanishes? What then?
One final insight into the demand for condo pre-constructions can be seen in the ‘wise’ musings of the Toronto condo king, who earlier this year guaranteed an easy $40,000 profit to anyone buying a pre-built condo for the purpose of flipping it after construction 2-3 years later.
“This is the single best way I have encountered or ever heard of to make money. It is that simple.”
“Really, if you could buy a $1 lottery ticket that guaranteed you would win $40K in 3 years, and all you had to do was stay where you were currently living, would you buy it? I guess so.”
A guarantee of higher condo prices three years out? Talk about having blinders on! The very notion that condo prices could fall *gasp* is completely ignored. Toronto prices always go up, right Brad?
“With rental rates as high as they are and the likelihood of low interest rates for a long duration, investment property is a great place to be.”
Apparently Mr. Lamb has not thought through the logical repercussions of having increasing numbers of speculators buying pre-built condos. The industry will naturally build to the demand, but to whom will the flippers sell to, as THEY ARE THE DEMAND?! With no discussion of the potential risks involved in this strategy, this is nothing but self-serving and misleading drivel. Good luck to anyone who follows this advice.
An early warning sign for the condo rental market can be seen in today’s rental market update from CMHC where they note that vacancy rates for Toronto condos, while still low, nearly doubled over the past year.
It’s blatantly obvious to me that demand for Toronto condos is being propelled by unsustainable speculative investing. It begs the question of what happens to that demand if the expected capital appreciation does not materialize. With all big banks now capitulating and predicting a minor correction in house prices in 2011 and 2012, will speculative demand remain in a sluggish market?
An even bigger question is whether or not these ‘investors’ would hold their cash-sucking investments at the same time that property values dropped, or would they rush to sell and lock in any gains (or losses) and overwhelm the true organic condo demand in a deluge of listings? And if they do rush to sell, they will be competing with all the condo king and his minions who are seeking to cash in on their guaranteed profits from pre-sales. To whom will they all sell?
I’m not against owning a condo as a long-term home, provided a buyer puts down a substantial down payment and is fully aware that they will likely lose that equity over the next few years. But if you are thinking of buying a condo as a speculative investment, think long and hard before you take that plunge.