* Updated August 9, 2019
It’s no secret the Toronto Housing market has been booming for a decade now. The question we’re so often faced with as investors and end-users alike is, “can this price appreciation continue”.
So, is Toronto in a housing bubble? A relatively straight-forward question. All of the data for the underlying fundamentals are thankfully public; historical sales statistics, new home supply, net population growth, absorption and so on.
Historical Toronto Housing Graph Index:
1. Housing Bubble Example Graph
2. Historical Detached & Condo Median Price in Toronto
3. Supply: New Homes Sold per year
4. Demand: Immigration into Toronto
5. Average Detached Home Price vs Inventory
6. Average Condo Price vs Inventory
7. Mortgage Stress Test Impact
8. Condo Rental Rate inflation graph
It’s important to point out that, naturally, all investors are “speculators”. Unless you get a kick out of loosing money, the only reason you’d even consider investing in a given asset class in the first place is based on you ‘speculating’ that the market is going to go up. Therefore, by definition, all property investors are speculators.
The question, then, is do we have too many speculative investors – moreover, too many investors who are so leveraged that should mortgage rates increase, they’d topple.
Secondly, and equally important – is the housing market appreciation fueled by supply and local demand, or are there external factors driving up competition and prices.
Comparing Toronto’s Price History To A “Housing Bubble Example”
Welp, obviously we’re in a housing bubble then, right?! There’s no denying that the detached price trend looks identical to the example here of a bubble. Interestingly, most of the media commenting on this comparison fails to point out that the condo market actually saw a price increase and an inventory decrease through the detached dip.
Firstly, I think it’s important to note the obvious – a graph is a reductionist way of conveying data in a visual and simple format.
Graphs showing Toronto’s median home price history, historical mortgage rates, inventory levels, so on and so forth – do a great job of conveying one or two data-sets in an easy to digest way. They do not, however, show the underlying fundamentals of how the price got there – or why the price dipped.
The example graph above depicts a housing bubble. What you see there is a spontaneous dip in price, followed by a momentary return to near-peak prices, before the bubble ‘pops’.
In Toronto, however, the detached price started to dive at precisely the time that the Fair Housing Plan was announced. It then regressed further as the Mortgage stress test was announced and subsequently implemented. There’s nothing spontaneous about a market change following closely after the government rolls out new legislation taking aim at the housing market
The Fair Housing plan and the Stress test were the catalyst, or rather the trigger to the price decline in the detached market. (1)
Interestingly, the condo market did not suffer the same price regression. In reality the condo market has been bullish since 2016, whereas the detached is only starting to pick up steam back up in 2019. Why is that?
We’ve graphed the housing prices in Toronto below, showing the gap between the median condo price and the median detached price.
You can see how the gap grew aggressively as it became considerably more expensive to own a detached than a condo – only to reverse trend after the fair housing plan.
This is what people so often get wrong with the property market. Segments matter. Looking at the housing benchmark median price is highly reductionist, and really should only be used as that – a benchmark.
Condos are an entirely different segment than Detached, in the same way Hamilton is an entirely different market than Toronto. A $1.5M detached is an entirely different buyer pool than a $500K condo – and often, those markets will perform differently. They will perform exceptionally differently when you introduce legislation that forces 20-30% of the detached buyer pool into the condo segment overnight by reducing their buying power (mortgage stress test).
The graph below is the one commonly sourced for the ‘housing bubble’ debate – but it makes this exact mistake of lumping condos and detached together to average them out.
In order to analyze the differences in the condo vs detached market, we have to look a level deeper than price – and look at the fundamentals that drive the price.
Low Supply + High Demand = Housing Appreciation
Also known as Economics 101. Most markets are driven by simple supply and demand at their core, and the housing market isn’t much different.
In Toronto, our rapid condo appreciation has been entirely at the hands of a stagnating supply and an exponential growth in demand.
1. Supply: New Condo & Home Completions
Housing Supply is more readily measured and more absolute than demand, naturally – being that it’s simply a question of how many new homes were constructed/completed and added to the market pool in a given year.
The graph below shows new pre-construction condos sold each year. A couple thousand get cancelled a year, and additionally, a few thousand detached get built as well.
2. Demand: Immigration Growth
Toronto and the GTA in general sees a ton of immigration every single year, primarily from out of the country but also intra-provincially.
Immigration is by far the strongest indicator of demand. The need for housing increases proportionately to the net population gain – everyone needs somewhere to live.
Ryerson just recently did a study – and the results are wild.
In 2018, Toronto saw some of the highest net population gain in North America.
So, we built 35,000 homes but we gained 77,000 people?
It gets a little crazier still. 35,000 homes is for the GTA – but that 77,000 population growth number? That’s exclusively the City of Toronto – not the GTA.
Just to quickly recap: We build roughly 35,000 homes per year but gain 125,000 people.
This puts us at a deficit of about 90,000 homes per year. After you account for things like purpose built rentals and other minor sources of supply, we’re still looking at a deficit of 80,000+ homes in 2018.
Toronto is in a housing crisis, and we have been in some time – we’re in a supply crisis, or a demand crisis depending on how you look at it. Watch this video for a full summary.
3. Historical Toronto Housing Price vs Months of Inventory Chart
In Real Estate, we have a convenient little market metric called Months of Inventory. It’s exactly what it sounds like – a measurement of how much inventory is on the market, and how quickly it’s selling.
To put it in perspective: if the market sees 1000 new listings each month, and each month 250 listings sell, you have 4 months of inventory.
1000 Listings / 250 Sales = 4 Months of inventory.
Under 4 months is a Seller’s Market – Prices increase
Over 7 months is a Buyer’s market – Prices stagnate or decrease
Simple – easy to understand, and it’s the perfect metric to look at versus historical prices to understand how supply and demand affect the market in real time.
You’ll notice that months of inventory inversely correlates directly with average price. When we see months of inventory spike, we see prices dip, and vice versa.
Clearly – right at the time of the Fair Housing Plan, and shortly after the Stress Test, we see the Detached market swing very quickly from 1 month of inventory to 3-4 months of inventory.
The detached buyer pool halved, literally overnight, causing that sharp decline in prices.
4. The Mortgage Stress Test Impact
The Mortgage stress test bit a 20% chunk out of your buying power with higher qualification standards – that’s a ton. It impacted the detached market negatively, and the condo market positively.
At a household income of $150,000, you’d be qualified for a $1M detached home prior to the stress test.
After the stress test? $835K – you’re now in the condo market, or you’re looking at a much longer commute.
The stress test was introduced to cool the housing market – the intention, was actually to help out first time buyers – but it did the opposite. (2) Not only did it make it much harder to get qualified for a mortgage as a first time buyer with no existing home equity, but it also increased the demand in the Condo market, which is where most first-time buyers are looking.
5. Detached Home Prices in 2019
It’s fairly self-evident that the Stress Test & Housing plan triggered the detached price regression. With that said, the condo-to-detached price gap had grown to nearly 2.5X, so it makes a lot of sense that the condo market cruised through it.
When you look at Toronto’s housing price history, or New York’s for that matter, you’ll find that two is the magic number for the condo-to-detached price multiple.
Meaning if the average condo will run you $500,000, the average detached should cost around ~$1,000,000.
For much of our history, that’s where the multiple was. In 2013 through 2016, the detached housing craze hit. The increase in demand caused the detached prices to inflate rapidly, while the Condo market appreciated at the normal historical 5-6%.
Before long, the median multiple was 2.5X, making condos an exceptional deal.
Now that the dust has settled and we’ve seen the full effect of the Stress Test, we’re sitting right at the 2x median multiple – so we anticipate the detached market to continue to pick up steam into 2020.
What Causes Toronto’s Housing Supply Shortage?
I’ve heard the line “the government needs to do something about this” a few times when discussing the rapid appreciation in Toronto.
Well, they tried – and they failed, twice. Government is not the answer. If anything, less Government regulation is a part of the answer to improving the supply side of the equation.
Why do we only deliver 35,000 homes per year if we could easily sell 70,000? It’s not because the Developers don’t want to – it’s because they can’t afford to.
In Ontario, and Toronto especially, we have one of the most expensive, lengthy & arduous condo approval processes. It can take 2 to 5 years in many cases for a Developer to go from purchasing a piece of land to getting construction started.
In addition to that, the city has raised Developmental charges nearly 300% in the past 5 years.
The fair housing plan is a great example of why the Government should not meddle in the market – the primary goal of the fair housing plan was to slow the rental rate inflation in Toronto by slapping rental controls on Landlords. The result was the exact opposite of the intention – median condo rental rates in Toronto increased 25% in two years.
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1. Ontario News, Ontario’s Fair Housing Plan, retrieved from https://news.ontario.ca/mof/en/2017/04/ontarios-fair-housing-plan.html
2. Tess Kalinowski, Is the mortgage stress test making Toronto’s housing crisis worse?, retrieved from https://www.thestar.com/business/2019/06/10/is-the-mortgage-stress-test-making-torontos-housing-crisis-worse.html