Welcome to the Urbaneer.com blog that explores housing, culture and design in Toronto, Ontario, Canada!
I’m Steve Fudge and I sell Toronto real estate. Being a realtor and property consultant for over 3 decades, a year ago I felt the market shift. And eleven months ago I started expressing my concerns and recounting my experiences. In this newest blog, I continue that thread, providing some historical context on Toronto’s condo market, assessing its current state from the ‘real estate trenches’, and sharing what factors I’m tracking.
I’ve long felt the Toronto condominium market has always been one to watch because of its exponential growth since the 1970s (and a new housing typology since the 1960s in Canada). It’s also one to watch because – according to Better Dwelling’s “Canadian Cities Have Seen Investors Buy Up To 100% of Newly Constructed Condos“- it’s investors who own the majority of new condos that have been constructed in Toronto since 2016. This means the largest number of stakeholders of condominium housing 7 years old or newer (around 150,000 units) are not end users occupying these dwellings as their principal residences, but a market segment whose priority is the commodification of shelter – by buying, renting, and selling – in order to generate the largest profits possible. In their enthusiasm to acquire locks – not stocks (or perhaps both?) – they unwittingly now hold the key to collectively determine whether they propel this market forward, or whether it unravels through their own undoing.
Like all markets, real estate has its cycles. And during the 3 decades I’ve been on watch I’ve seen it ebb and flow but never spin out of control. But a year ago I got intuitively slapped by an alarming deja-vu that prompted me to write, When Dreams Of Domesticity Became Nightmares: A Recollection Of The 1989 Toronto Housing Market Crash. In this piece, I recount the collapse of the 1980s condo boom (and the market overall) and how many Mom & Pop investors took a heavy financial hit, and most real estate speculators lost everything. Is history now repeating itself? The answer is partly ‘Yes’ and partly ‘No’. Yes, a lot of fortunes built on a ‘deck of condos’ – or should I say ‘house of cards’ – are going to collapse (Here’s a piece in the Toronto Star called “‘HELP! MUST SELL IN 30 DAYS!’ Mortgage Brokers Report An Uptick In Forced Sales Of GTA Homes“), but because our ‘local’ real estate market (be it Toronto, Ontario, or Canada) is larger in size, has grown in global appeal, and has performed well by providing solid returns over the past 20-years, the degree of the fallout may be similar to 1989 but it will not be of the same magnitude.
This is because Toronto’s, Ontario’s, and Canada’s real estate markets are more complex now than they were. Factors include the number and motivations of competing interests pursuing land and property acquisition; the sheer amount of global capital that has been invested, snow-washed, or is circulating in the shelter economy at any given time; the speed by which information and technology have accelerated the momentum of the market and the volume of property traded; and the premium accorded real estate’s trifecta of value as a necessity (it accommodates our physiological need for shelter and safety); as a commodity (the built-in obsolescence of the construction industry ensures a predetermined demand for new buildings); and as a status-marker (lifestyle marketing promotes housing as a symbol of self).
However, despite all of this, the shift in our market felt eerily similar and included many parallels.
Back in 1989, over 18,000 condominium units were completed in Toronto, which was double the number from the year prior and accounted for 60% of all the condominiums built over the entire decade of the 1980s. This massive supply – which had been purchased mostly by speculators anticipating enormous rewards and Mom & Pop investors who bought as a hedge against inflation – was secured by most Buyers taking on additional debt. And it was a significant factor in the Toronto real estate bubble bursting because, over the following two years, a further 28,000 condominium units were completed, which tipped an already saturated supply and further fuelled the market collapse. This also coincided with the teetering Canadian economy sliding into a deep recession just as our federal and provincial governments tightened their own belts with austerity measures including funding and program cuts and fiscal budgeting (the Goods & Services Tax would be introduced in 1991). In fact, the 1990s recession saw the most dramatic decline in real household consumption of any Canadian recession since World War II. Inflation? Highly-leveraged investors? A shifting real estate market? Eerie similarities, right?
As we begin a new year, 2023 will see a record number of condos being completed, the majority of which were planned, approved, and started when the market was already frothy – 3 to 5 years ago. Stats from Urbanation indicate that it is expected that 32,000 new condo units will be completed in the GTA this year, eclipsing the previous annual high, which was 22,473 units in 2020. This means that there could potentially be a lot of similar inventory coming to market all at the same time, depending on how the next few months play out (which is a different – but related – can of worms).
Let me chat a bit about this.
A Shifting Toronto Real Estate Market
There is an emerging dynamic in the current market that is making the housing ecosystem much less favourable for investors; namely higher interest rates and declining housing prices. It’s going to put a squeeze on them.
Although it’s not just investors who are affected by higher rates. As I wrote last month in Topsy Turvy: Insights From The Toronto Real Estate Trenches, it’s harder for most Buyers to qualify based on Mortgage Stress Test interest rates, but in the pre-construction condo market it’s particularly acute. In many buildings that are approaching occupancy there is a growing number of investors looking to extract themselves from binding Agreements of Purchase & Sale in advance of completion, because not only does the Mortgage Stress Test diminish the amount of mortgage debt they qualify for, but their lender’s appraisers aren’t valuing their condominiums for the sums that they paid. Unfortunately, this means many Buyers are scrambling to come up with additional cash to close their purchases.
As this year unfolds Toronto real estate investors will likely face a large issue when it comes to profitability. Higher mortgage rates mean the cost of carrying a property goes up; and even though landlords can charge premium rents (and yes, rents have continued to climb significantly, given the tight vacancy rate), there is frequently a cash shortfall larger than anticipated. This ultimately erodes the profitability of property investment, which may also be impacted if a significant number of these new condos are promptly relisted for sale, whether by the developer who will sell them and then pursue recovering any financial loss from the original buyer, or the original buyer themselves.
Urbanation tabulated that in Q3 of 2022, the average cost of owning a condo was $3,506 a month. The average rent was $2,733. That means on average, investors had to come up with $773/month to cover that shortfall. This means negative carry is up dramatically from years prior, where in Q3 2021 the average shortfall was $235, $196 in 2020 and $17 in 2019. This shows a steady and sizeable bite being taken out of many investors’ bottom lines.
For background on these stats and more, check out this Globe and Mail article: “Record Number Of Condos To Flood Toronto Market In 2023“.
The Dangers Of Relying Solely On Escalating Property Prices For ROI
Given Toronto’s real estate market was scorching hot until recently, for years there have been a swell of Buyers banking on riding the wave of escalating values more so than relying on the fundamentals of cash flow. What’s more is that as interest rates stayed low – and then dropped even lower during the pandemic (thanks BoC!) – many of these folks leveraged their existing portfolio to extract capital in the form of HELOC’s to amp up more real estate acquisitions. Here’s my past post called –> The Number Of Owners With Multiple Properties Is Increasing In Toronto. Here’s Why!
This approach to property investment, and one that conservative investors – playing a long game – cautiously employ is fraught with risk. Which is why the risk-averse place substantial down payments on their purchases so that the rental income generated by their investment properties covers all, if not the majority, of their expenses (which should include mortgage principal and interest, common fees, property taxes, repairs and maintenance, vacancy allowance, management fees, and capital improvements). And they do this to mitigate the risk of an unexpected change in the market, such as the unanticipated 8 increases in interest rates we’ve seen within the past 11 months. In my post, Turning A Blind Eye To The Real Costs Of Toronto Real Estate Investment Properties, I question why so many investors have been banking on future price gains to offset their existing cash shortfalls, when the metrics of a return on investment (ROI) is the total sum of your initial investment + the increase in net equity annually + cash flow. It’s because this is what speculators do – not conservative investors.
And our current shifting market is about to reveal who the investors are, and who the speculators are.
In 1990, the bank rate was 13.04%, the long-term Canada bond rate was 10.85% and the few real estate investors who were willing to buy were seeking a cap rate of at least 10 per cent. The bursting real estate bubble in 1989 actually deflated values over a 6 year period by as much as 35% in the downtown core, and it wasn’t until 1996 that the Toronto real estate market started gaining momentum in the volume of real estate being traded. Towards the end of the 90s – nearly ten years after the bubble burst – homeowners who had purchased 10 to 12 years earlier were starting to break even or generate a small profit. Can you imagine waiting a decade to just recover your buying and selling costs? Meanwhile, Canada stumbled through a deep recession, with persistent high unemployment rates through much of the 1990s. It wasn’t until 1997; when interest rates dropped to 7% for a 5-year term; Toronto was reinventing itself with a post-industrial transformation; Canada started leaning towards becoming an asset based economy; and global capital began flowing into our City that real estate prices started to escalate. And the more Toronto boomed (it really took off in the 2010s), the more it incited investors to take smaller returns and build larger portfolios, so that the cap rate of 10 percent in the 1990s had become cap rates of 3.5 to 4 per cent on a resale multi-unit income properties investors seek today.
However, even a cap rate of 4% doesn’t appear to be a widely-accepted rule of thumb in the pre-construction condominium market. In fact, it’s the popularity of negative carry – where an investor buys a property knowing there will be a shortfall between the expenses and its revenues – that appears to be a common and accepted practice in this market segment. And it may be many investors’ undoing, depending on how highly indebted they are, how easily they can access emergency capital, and – quite critically – the terms and conditions of their mortgage debt. After all, not many of us anticipated the Bank of Canada would increase interest rates an unprecedented 8 times (totalling 425 basis points within a span of 11 months) and tie the current overnight rate with the earlier two-decade high. Furthermore, the BoC has said that if inflation doesn’t get under control, then further interest rate increases will come. Which would be grim, given at this time last year most Variable Rate Mortgages were under 2% and HELOCs were 2.95%, compared to today where some Variable Rate Mortgages are cresting over 6% and HELOCs are 7.20%. Ouch!
I empathize with the younger inexperienced generation of investors who, through no fault of their own beyond the kool-aid poured for them to drink, will find themselves sinking under mounting mortgage debt at these higher interest rates. Fortunately for them, those who lose their fortunes still have their youth and time to build wealth more conservatively, plus after navigating and surviving this sort of defeat most will never find themselves in that situation again. But might there be other more mature pre-construction condo investors who are also financially spread thin? Absolutely. The Toronto real estate market has been consistently going up in value for 25 years which is a really really long time in a world of shrinking attention spans. In fact, after decades of FOMO it became easy to believe a correction in the Toronto real estate market was unlikely, if not impossible. But it did. And it’s going to be very painful for some.
To add some real-time context to this post, the very credible Ron Butler @ronmortgageguy recently shared that multiple brand name real estate developers are pushing the speed dials on their phones to their pals perched in the positions of power in the Big Banks & Credit Unions asking them for lists of lenders willing and able to facilitate closings for their pre-construction Buyers. And they’re wise to be doing so, because the sooner these Buyers close on their purchases, the sooner the developers can receive the funds to repay their own debts and extract their profits. Beware the state of the New Homes Market – which I was actively engaged from the mid 90s through to the 2010s – is not simply a case of Buyers losing their fortunes, because the risks of a property market in decline impacts all the players, professions, services and trades associated with property development, sales & marketing, real estate finance, and construction while causing a ripple effect in the resale market and sinking the demand for household goods and services.
Pre-Construction Condo Buyers Are Trying To Assign Their Units
There has been a surge in media reports that more pre-construction condo Buyers are trying to extract themselves from firm and binding Agreements of Purchase & Sale with developers. Here’s a recent piece from the Toronto Star: “Agents Report Surge In Home Buyers Desperate To Get Out Of Deals As Rates Continue To Soar”
As the media trumpets these headlines and we witness the flood of assignment sales coming to market at heavily discounted prices, the byproduct is that many Buyers actually become more suspicious and reticent of the New Homes Market, prompting both end-users and investors to turn their attention to the resale condo market where there are also favourable deals. And in many ways I get that. The resale condo market is easier to understand and assess because one can walk into an existing established condominium and see, touch, and feel the quality of the product, engage with the staff and ask current residents if they like the building and the neighbourhood, and analyze the building’s operations, finances and reserve fund study to predetermine the condition of the corporation before they purchase.
Of course, the resale condominium market isn’t immune to what’s happening in the New Homes Market, especially if pre-construction Buyers and developers start loading a lot of brand-new just-completed inventory into the pipeline over the next few months. And if you’re a regular reader of my blog, you know I genuinely try not to be alarmist, but it’s important to start paying attention to the sheer number of condominium units in Toronto that are approved or in the approvals process, how many of these are already purchased pre-construction, and whether Developers start cancelling projects before they dig the hole (which would actually help existing investors and end-users because a drop in supply can stop values from dropping). The key at this very moment – and for the next 6 months – is seeing the degree to which New Homes Buyers (and Developers) are impacted by the recent escalation in interest rates hikes, and the extent of the fall out. There is potential for a significant impact on the market at large.
As you know, I’m a fan of Ron Butler because he tells it like it is. Recently he shared how a new condo building was delayed being transferred from the Developer into a registered condo corporation because 62 of 462 Buyers did not complete their purchases. Although it’s not unusual for 2 or 3 per cent of new condo Buyers to face issues meeting a completion date, having 10 to 15 per cent face delays portends trouble. Is this instance of pre-construction sales straddling the highs and the lows of the market a one-off or a sign of things to come? It remains to be seen exactly what kind of stew the higher rates, lower prices, and problems qualifying for mortgages will create once it’s simmered for a while.
Furthermore, although out-of-country parents sending their students to universities in Canada can take advantage of the intentional loophole in paying the 25% Non-Resident Speculation Tax on real estate purchases – as I wrote in Shades Of Duplicity In The Foreign Buyer Tax For Canadian Housing, as of January 1st, 2023 –> “Canada Banned Foreigners From Purchasing Most Real Estate‘- specifically residential real estate having 3 or less units – which means Developers can’t turn to a global investment company and bundle any potential units at risk of not closing and sell them.
Is The Timing Right To Purchase A Condo?
While the market is certainly experiencing stress, the resale condominium market is showing itself to be fairly resilient partly because they’re the most affordable housing type. The most recent stats from BILD issued in November 2022 (not sufficiently recent to rely on IMO) show that, although market activity is slower, new home housing prices have pulled back typically across the board, and 80 per cent of the total sales were of condominium units. Similarly, TRREB’s December Stats show that condominiums were the only housing type to post year-over-year gains.
However, right now we’re operating in a market whereby the value of any property is worth what a Buyer is willing to pay and a Seller is willing to accept. This means that while recent comparable sales of other similar dwellings in proximity to the property being considered are indicators of value, what a property is truly worth isn’t determined until the motivation of both parties is established during negotiations and the parties to the transaction create a ‘meeting of the minds’. For example, there are long-time owners of older centrally-located condos who are now cashing out to move into Private Care Homes. Since Private Care Homes are costly, these Sellers are highly motivated to sell, and because they’ve owned their units for decades (and they recognize they’re statisically near the end of their lives – not to be grim, here), they’re more comfortable accepting a lower sum than someone who may be trying to climb the property ladder into a more expensive purchase. So they accept a price where the Buyer has actually built-in further room for depreciation in our shifting market. Of course, this sets the precedent for the next sale in the building, and it also causes a ripple effect potentially impacting the value of similar units in surrounding buildings. However, just as we saw in the pandemic, there were buildings where owners stuck firm on their prices and eventually – with patience (and the market rebounding) got their price. Are you patient? Can you afford to wait or do you have to sell (or buy) now?
For the next few months, I anticipate we’re going to see some buoyancy in the Toronto real estate market, which may fall under the definition of a “Bull Trap / Return To Normal” whereby a declining market reverses after a convincing rally or pent-up demand, and then stalls after that demand is absorbed and returns to its decline. Given we’ve been building substantially fewer freehold dwellings in the city than condos (and those that have been built a expensive), the pent-up demand is strongest for freehold resale houses, and the recent price drops have opened the doors for Buyers previously shut out of the market of their ideal dwelling type (for example, houses that would have sold for over $1,000,000 now being accessible to high-ratio Buyers who are capped at a purchase price of $999,999 or less). There is also the group of end-users who are fed up with living where ever they are (we have one client who has been evicted 3 times over the past 3 years from their rental condos because the owners have elected to sell) who simply want to pull the trigger and buy a place they can call their own. All of these Buyer segments are planning to live 5 to 7 years in their next purchase, and because buying a ‘home’ is their priority over return-on-investment, they’ve reconciled that their purchase may decrease in value for a period of time before it goes up in value. But do investors think that way?
There are a few indicators that are worth watching moving forward into 2023. First, does Canada slip into a recession? Second, do employment stats signal a rise in unemployment? Does Canada’s annual inflation rate ease (It was 6.3% as of December 2022 and is expected to decline significantly in the months to come, but if it doesn’t it portends another interest rate)? How these macroeconomic factors play out are important. However – before you call me a Debbier Downer – let’s also remember there are aggressive immigration targets set by the Federal government over the next few years, which means the appetite for housing will be healthy, both for purchase and for rent.
Protecting Your Real Estate Investment
As I constantly yell from the rooftop, the best approach to real estate investing – whether that be purchasing your primary residence or building a real estate portfolio – is to approach with caution. Patience, prudence and strategy are your guiding lights. And don’t fall for the ‘Buy Now Get Rich Quick’ mentality that often accompanies FOMO. Remember, people who bought real estate in Toronto at the beginning of the 90s were breaking even, at best, at the end of the 90s. Are you ok if that were to occur again?
In Dear Urbaneer: How Can I Be Smart About My Condominium Wish List?, I share my roadmap to choosing the right property which meets your wishes, wants, and needs while hedging against potential shifts in the real estate market. As I share in this post, your initial purchase should always include assessing it trough the lens of future Buyers. That means paying attention to location, amenities and unique in-unit amenities that make the unit stand out. In this context, the more “different” your unit is (in a good way, not because it faces a brick wall), the more desirable it will be – and will give you the leverage to draw renters and future buyers in and charge more.
If you are considering selling your property, the question to ask is: “Who are you competing against?” Before you sell, sleuth out the competition and analyze the recent comparable sales. Looking at buildings as a whole, it’s important to be cognizant of the number of suites, and their unit mix, particularly in a large complex. The more suites there are of a similar size, layout, and condition in a tower, the more prone a unit can be to value fluctuations. For example, if a 30-storey complex has ten suites per floor, and four of them are one bed + den layouts and you purchase one, your future market value is dependent on the most motivated of sellers of the other 119 units at any given time. This can serve you well when negotiating a purchase but be more problematic when selling.
When purchasing a unit in a larger complex, I recommend buying the units which have more desirable qualities – like those I listed above. Think unobstructed protected view, a good aspect for natural light, a terrace (some units on lower floors will have terraces on top of a podium portion of a tower), or an intelligent efficient layout. For example, I always favour a unit where the ‘den’ is a separate room and not just some imaginary square footage in an open space plan, or what used to be called the ‘foyer’.
Also, there can be the benefit of purchasing a unit that has been substantially upgraded or one that is tired and ready for elevation, if either has been priced at a discount due to a Seller’s motivation –> Dear Urbaneer: How Do I Boost The Value Of My Condominium?.
Also, look beyond the building and explore the neighbourhood you’re choosing. What other buildings could tempt potential renters or buyers? What features do they have that might be considered more or less desirable? Is it an established neighbourhood or one that is under redevelopment? Could it become saturated with too many condos? I always prefer my clients purchase in urban village neighbourhoods where the condo is located on a Main Street arterial road surrounded by low-density housing. You’ll see examples on College Street west of Spadina Avenue, Dundas west of Ossington Avenue, Danforth Avenue near Woodbine, but there are many locations where these exist.
When a real estate market presents challenges, it also presents opportunities. But it’s also important to keep in mind the factors that have contributed to the market shift. The Toronto real estate market has long been subject to investor confidence and speculation, such that Toronto condo values no longer align with the basic fundamentals of income to expenses unless you have deep pockets. Instead, new condo Buyers have instead relied on the assumption that its future value will ultimately generate a profit that offsets their negative carry.
Which begs the question: Is this approach still reliable?
The answer genuinely depends on what you’re purchasing, where it’s located, and how much money you have.
Want to have someone on your side? Since 1991, I’ve steered my career through a real estate market crash and burn; survived a slow painful cross-country recession; completed a M.E.S. graduate degree from York University called ‘Planning Housing Environments’; executed the concept, sales & marketing of multiple new condo and vintage loft conversions; and guided hundreds of clients through the purchase and sale of hundreds of freehold and condominium dwellings across the original City of Toronto. From a gritty port industrial city into a glittering post-industrial global centre, I’ve navigated the ebbs and flows of a property market as a consistent Top Producer. And, I remain as passionate about it today as when I started.
*Title Image by Ryan Funt – Yonge & Eglinton Condos Shrouded By Fog
Here are some additional posts to enhance your condominium search:
Rising Interest Rates And The Toronto Real Estate Market
Topsy Turvy: Insights From The Toronto Real Estate Trenches
An Overview Of The 2020 Toronto Condo Market And What Lies Ahead: Part One & Part Two
Why Does Homeownership Remain A Priority For Canadians, Despite The High Costs?
Dear Urbaneer: What Do I Need To Know About Buying A Condo Preconstruction?
Dear Urbaneer: Unpacking The Metrics Behind Toronto Condo Fees
Five Points To Ponder Before Buying A Toronto Condominium
Animal House: Buying a Condo Your Dog Will Love
Dear Urbaneer: How Do I Boost The Value Of My Condominium?
During times of uncertainty, it is even more essential to examine the path ahead through the lens of experience and data-driven strategy. It’s our pleasure to share knowledge gleaned from decades of experience in the real estate trenches to help you realize your real estate goals.
Thanks for reading!
– Steve & The Urbaneer Team
The Urbaneer Team
Steven Fudge, Sales Representative
& The Innovative Urbaneer Team
Bosley Real Estate Ltd., Brokerage – (416) 322-8000
– we’re here to earn your trust, then your business –
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*Love Canadian Housing? Check out Steve’s University Student Mentorship site called Canadian Real Estate Housing and Home which focuses on architecture, landscape, design, products and real estate in Canada.