An expert from the publication "Russian Toronto" explains what is causing the uncertainty in the Toronto real estate market.
Unlike all previous years, when trends in the real estate market were stable and determined by objective factors, the last year and a half have been an exception. The cause of destabilization was the actions of the government, which undertook to regulate the market through administrative measures.
The reason for the government's concern was the high rate of price growth in real estate, galloping rent increases, a housing shortage, and the fact that housing is becoming unaffordable for an increasing number of people.
There were two ways to resolve the situation – meeting demand by stimulating construction (the right path) and limiting demand through bans and tax increases (a very bad path that only worsens the situation). The government chose the second path.
Such government intervention in market regulation became a kind of "black swan." The term "black swan" appeared in economics not long ago and refers to unforeseen circumstances that appear suddenly and dramatically change the situation overnight.
So, the government's actions in 2017-2018 became such a "black swan" for the real estate market, completely disrupting the existing situation, creating chaos, and only exacerbating all the problems that the government deemed necessary to intervene to solve.
It must be said that after a year and a half, the market has gradually adapted to the new conditions and returned to self-regulation. However, overall, the situation on the market is not at all rosy, so the government will clearly try to change the rules of the game again to rectify the situation. What this will lead to is difficult to say now, as the situation will depend on the nature of the measures taken.
But even without considering government actions, over the past year, trends have emerged in the real estate market that themselves should lead to noticeable shifts. This primarily refers to a shift in activity from the condominium market to the townhouse market, and a noticeable revival of activity in the single-family home market.
RENTAL HOUSING
The situation in the real estate market of Toronto and Canada as a whole is characterized by a shortage of rental housing and its high cost. Naturally, the situation in different parts and especially cities of Canada differs in the severity of the problem, and in this regard, Toronto and Vancouver have significantly outpaced all others.
In particular, when describing the problems with rental housing in Toronto, the situation is no longer called anything other than a catastrophe. The need for housing, especially rental housing, is growing much faster than it is being built. This is what determines both the high growth in real estate prices, which has been going on for over twenty years, and the increase in rental costs.
Actually, government intervention in market affairs was precisely explained by the need to curb prices. For the most part, this was done purely out of populism and to some extent fear that the situation would get out of control, so a large package of administrative and prohibitive measures was adopted.
As usual, the command shout "prices stop, one-two" led to nothing good, and the situation with housing affordability has only worsened over the past year and a half, as demand continued to grow, while construction, on the contrary, decreased. Builders considered it too risky to start new projects under conditions of administrative arbitrariness.
As a result, the outcome of 2018 for rental housing is as follows: the vacancy rate in Toronto fell to 1.1%, while in the condominium sector this figure at the end of the year was 0.7% in Toronto. The vacancy rate is the percentage of available rental housing relative to the total volume of housing offered for rent. When this figure is around 3-4%, it is already a reason to sound the alarm – which is what they started doing about ten years ago, when the vacancy rate in Toronto dropped to 3%. What is currently observed in this market cannot be called anything other than an acute crisis.
Naturally, with such a market situation, rental prices are rising rapidly, even despite the law prohibiting rent increases of more than 1.8% per year. On average in Toronto, rental costs increased by 11% over 2018, while in some condominiums the increase was 25-35% per year.
The average cost of renting a two-bedroom apartment in Toronto is currently about $2,400 per month. And this is the average price, while in downtown, prices for apartments in modern condominiums are much higher.
SINGLE-FAMILY HOMES
Speaking about the purchase and sale of real estate, in 2018 two trends were clearly visible in Toronto, which were fundamentally different from each other. This refers to the market for single-family homes and townhouses, on the one hand, and the condominium market, on the other.
In the single-family home market, after the introduction of a 15% tax on foreign home purchases in the summer of 2017, a sharp tightening of mortgage rules, and a series of increases in the bank lending rate, there was a noticeable decline in activity and a slight price correction. What did the correction consist of? For starters, prices stopped rising at a high rate. Of course, no price drop occurred – as many expected, they even grew last year, but they became more realistic. At least in 2018, people paid for homes what they were really worth – many owners who needed to sell their property moderated their appetites and did not try to sell it at astronomical prices, as was the case a couple of years ago.
From my experience last year: everything good sold fairly quickly. Owners, if they lowered the price, did not do so significantly. On the other hand, if a house had noticeable defects, owners would agree to a substantial price reduction, and the house would take a long time to sell, if it sold at all. But this is what I always write about – when buying, do not look for the cheapest option, turning a blind eye to defects; they will come back to bite you when you sell later. Especially in times like these.
Judging by published statistics, the average transaction price for detached homes decreased by 4.3% compared to the previous year. However, this information should not be misleading.
You must understand that this refers to a decrease in the average transaction price, not the value of homes. Given that in 2018 the share of transactions in the luxury housing sector significantly decreased, this affected the average figures. If we talk about the average home price, it rose by about 3% in Toronto over the year. Naturally, this is not the 12-15% of previous years, but growth is still there.
On the other hand, activity noticeably dropped – there were far fewer transactions in 2018 than usual, making it the worst year since 2008 in this regard. The reason is simple: owners are not putting their properties up for sale. Compared to 2017, the number of properties listed for sale decreased by 12.7%, and in December 2018 it was 32% less than in December 2017.
Buyers are waiting to see if prices will fall, so they are in no hurry to buy. Also, many were deterred by the new mortgage rules, which are now much harder to obtain than two or three years ago, and potential buyers hope the rules will be reversed if they just wait a bit.
Sellers, in turn, are also not rushing to list their homes – no one wants to sell them for less than they are worth, especially when there is no urgent need to sell. Moreover, even if they sell a home at a good price, what will they buy in its place? Because supply on the market has sharply decreased, finding a replacement for what was sold is now quite difficult.
This state of uncertainty shapes the current market situation – everyone is waiting to see which way things will tip and who will blink first.
CONDOMINIUMS
In the condominium market, the picture in 2018 was completely different from that of detached homes and townhouses. Here, there were active sales and high price growth, averaging 9% per year. There are several explanations for this situation.
First, the price difference between condominium apartments and detached homes was significant. While detached home prices grew very rapidly in recent years, the same could not be said for condominium apartments, which hardly grew at all. In 2017, detached home prices reached a level where many buyers simply could not afford them. These buyers massively shifted to condominiums, where prices were quite affordable.
Second, due to an acute shortage of rental housing and rising rents, it became profitable to invest in condominium apartments, and investors turned to this market, creating additional demand.
There are several other factors explaining the heating up of the condominium market, but ultimately it all comes down to a catastrophic shortage of housing, especially quality housing, in Toronto, while the need for it is constantly growing.
OUTLOOK
As for the outlook for 2019, the following scenarios are visible.
In the condominium market, we can expect a slowdown in activity and a deceleration in price growth. The reason is that apartment prices have already reached a level where it is now more profitable to buy a townhouse in the near suburbs than a small apartment downtown.
It should be noted that the cost of apartments in new condominium developments will only increase, as taxes rise, construction materials become more expensive, and construction costs themselves increase. The rise in prices for apartments in new homes is an objective process, and no matter how much builders want to build affordable housing, they simply cannot do so in principle.
At the same time, prices in the secondary market will also be pulled up, as the need for housing in Toronto is very high. However, sooner or later there will be a shift in buyer psychology, and they will switch from condominium apartments to houses and townhouses – both in the suburbs of Toronto and within the city. And while houses may still be unaffordable for many under current conditions, townhouses are in an acceptable price range. Therefore, I think that in 2019, high activity will be observed in the townhouse market, with the highest price growth for them.
As for the detached home market, the situation will improve. I think that very soon there will be a psychological shift among buyers; they will get tired of waiting for prices to drop and will start acting much more actively. It is quite possible that the trigger could be the return of Chinese investors to the Toronto market.
The fact is that in recent months, there has been a resurgence of their activity – either they have come to terms with the 15% tax, or they have found some schemes to get it refunded, or there are some other compelling reasons. This may be related to changes within China and the tightening of domestic policy, the slowdown of the Chinese economy, and China's confrontation with the US and Western countries in general. At least, the level of emigration from Hong Kong at the moment is comparable only to 1997, when Britain handed it over to China.
In any case, the first signal of market improvement and the start of price growth will provoke a new surge. Because the market has been frozen and prices have been rising very slowly over the past year and a half, a backlog has already accumulated that the market will sooner or later recoup. Usually after such a lull, there is a sharp spike in activity and prices – in particular, this was exactly the case in 2009, after the lull of 2008.
But all this will happen if the government does not do something else, starting with further tightening the screws or, conversely, lifting previous restrictions and deregulating the market. And any such intervention will lead to the realization of a completely unforeseen development scenario, the probability of which is far from zero.
Therefore, I will repeat – so far everything suggests that the Toronto real estate market, primarily the market for single-family homes and townhouses, will actively emerge from stagnation, but the danger of "black swans" makes me cautious in my forecasts. As I see the situation, this year will be full of uncertainties, and one must be prepared for any changes in the market.