As a child I often played the Monopoly Board Game with my family. The game of Monopoly is a real-estate trading game that was developed in the first half of the twentieth century. The premise of the game is that eventually, due to market forces simulated within the game as properties are bought, sold and leased, a monopoly will eventuate. The person owning this monopoly is then declared the winner.
This early introduction to capitalism probably played its own small part in how I learned one can build wealth in real estate. This admission also reveals I'm entering mid-life, as there's probably a certain set of readers who might not know much about this game. Popular in the age before computers, video and electronic devices you can tell this game is old, because there's a luxury tax and rich people can go to jail!
Welcome to Part 2 of Urbaneer.com's Summer 2012 Real Estate Forecast.
As always, urbaneer.com continues to follow the media, not just to determine what is happening in the market, but to more accurately predict where it is going. In Part one of our Summer 2012 Forecast, we examined the dangers with the potential oversupply of condominiums. Did you read Part 1? If not, click HERE for that installment.
Over the last several weeks, the headlines have continued as the news cycle continues to churn, focusing on the potential vulnerabilities that may be beginning to expose themselves in a super-hot Toronto housing market. Among these market soft spots is the ongoing fear of oversupply in the condominium market (a fear which seems to have gained new momentum), as well as concern surrounding a potential disparity between what homeowners own, and what they owe. The crux of the recent US subprime mortgage crisis was shaky lending practices, and real, consistent steps need to be taken to make sure that this does not happen here.
In the last few weeks, Canada's Minister of Finance Jim Flaherty, has stepped in front of this speeding housing train, armed with tighter lending restrictions, with the intention of mitigating some of the lending risk as it is associated to property values. Read on to hear our thoughts on what these new lending restrictions might do to our market, and potentially to Buyers as well.
Change is Good?
Another vulnerability currently present in the housing market is the growing debt load that many Canadians are carrying (recent stats put debt-to-income ratio at a shocking 152%). Politicians and policymakers alike are sounding alarm bells, and introducing new mortgage lending rules (Jim Flaherty admits that latest round of mortgage restrictions was brought about in part by what he referred to as an “overheating Toronto Condo market”). The latest round of mortgage changes, which will take effect today July 9, 2012 will, according to economists, do much to cushion a potential free fall in housing prices by mitigating (and hopefully neutralizing) threats that could poke holes in the market with disastrous consequences (think US subprime mortgage crisis). The changes include a reduction in maximum amortization from 30 years to 25 years, a reduction of the amount of equity homeowners can take out of their homes for refinance (from 85% down to 80%), the removal of CMHC Insurance backing on homes over $1million, and a reduction in the debt service ratios that are used as the basis of lending qualification and amount criteria for Buyers.
Urbaneer.com tends to view the latest round of mortgage restrictions (there have been four rounds in four years) as a visible show of support and strength in the Canadian lending system, which is inherently stringent, and is bolstered by some of the strictest lending policies in the world.
These changes are intended to remove “fringe” buyers from the homeownership pool (those for which homeownership would not be a financially prudent move because they would be extremely vulnerable in the face of any kind of personal finance or interest rate change), but there is often the less desirable side effect of pushing some groups, for whom affordability is an issue, to the sidelines (HERE is a story in the Globe and Mail that discusses just that). This holds true in an area like Toronto, where property values have escalated for several years.
First-Timers May Shoulder Impact
As to how this will impact our local market specifically, urbaneer.com believes that the stricter lending criteria on debt ratios and shorter amortization periods, will hit first-time home buyers the hardest already stretching to purchase their first condominium. In my experience, first time buyers have been more likely to utilize the longer amortization period on their first purchase, so that they don’t become “house poor”, with the intention of reducing their amortization periods on subsequent properties over time, as they climb the property ladder. In an expensive property market like Toronto, the first time buyer has often extended herself to her limit in order to squeeze into the housing market. These new rules will definitely shut out, or delay, the acquisition of real estate in the short term, and will have bearing on the demand, and market values, of affordable condominium housing.
Count on it specifically impacting the single buyer market. From my experience, while single women are typically more prudent, and have larger down payments than men, they earn less than single men. And single men, who may have a smaller down payment than women (because they tend to buy cars, and more electronic toys and gadgets), typically leverage their higher incomes to acquire more expensive property than single women. However, both of these target markets are required, by virtue of high values, to purchase as much, or close, to their maximum limit. As of late this sum is typically in the $350,000 to $425,000 price point. These new rules will impact their ability to pay sums this high.
The Self-Correcting Market?
Just last week, the Toronto Real Estate Board posted statistics that revealed condominium sales declined 18 percent in June compared to a year ago, when that segment of the market had registered a gain of five percent the month earlier. The bulk of this slowdown came before Canada's Finance Minister even announced the mortgage changes on June 21st. Is it a self-correcting market? Click HERE to read some press on the matter.
Whether it's seasonal, a change in the psyche of Buyers, or the government's intervention to stabilize, or soften, market values, a stabilization or minor drop in values could be just what first time buyers need to level the playing field of affordability. The ongoing escalation in market values for several years, fueled by speculation and foreign investment, had begun to push out the ability for many of the resident population to participate in the market. If the gap of affordability continues to widen, an urban market like Toronto could see more volatility based on how much foreign capital is being invested, or extracted, from its real estate economy, and materially impact how local buyers and sellers operate.
However, if these new rules ultimately help slow the market, urbaneer wonders if it may stop existing homeowners from selling and buying because they won't have built up enough equity to cover both the expenses associated with making a move, in addition to making the profit necessary to climb up the property ladder. Additionally, would a price stabilization will allow more locals to make their first purchase in a less competitive process which would keep real estate trading on the property ladder? Remember, a healthy market requires the on-going filtering of housing stock to go up and down at all price points in order to remain balanced.
Like any pundit making a forecast, it's all about one's points of view. Given every cloud has a few silver linings, how will these changes impact Toronto's real estate market?
In our opinion, the primary mitigating factor for a healthy housing market is ultimately the relationship between how stable a city's economy is relative to the earning power of the local population and the affordability of its housing. If an economy falters, the risk that a large number of property owners will default on their debt and the fear that the whole 'house of cards' will come tumbling down, often creates an atmosphere of uncertainty and tension. We don't see the government's decision to try regulating this as negative, given the market dynamics have been suggesting property values are becoming increasingly susceptible to a downward correction.
Where Do We Go From Here?
We believe that when it comes to housing, slow and steady wins the race, and that much of the future health of the Toronto property market will lie in freehold housing. As has been evidenced by consistent housing stats for the GTA, freehold housing continues to rise in value at a moderate, sustainable pace. Not just that, demand continues to present itself as well. While supply and demand are still slightly out of whack in this category, the mechanics lend themselves better to a sustainable price increase.
Furthermore, what has sustained the downtown Toronto housing market in the past and will continue to support it in the future is the tried and true mantra of location, location, location. Proximity to green space, public transportation and village-shopping environments will still be major drivers in the value of urban property. In fact, we're not terribly concerned about the Freehold Housing Market in the original City of Toronto, With condominium housing now the dominant type of dwellings, freehold housing is becoming elevated into a 'boutique luxury market' with price points to match. In fact, if you want to own a house downtown, you should probably make that purchase sooner than later, as there could well be a significant gap in values between freehold housing and the condominium market. With an extremely limited (and in fact diminishing) supply of houses countered by an unrelenting demand fueled by both a population explosion, our pro-urban love for the city, and our genetic disposition to own a homestead with land, freehold houses are your best long term investment providing you're prepared to manage the maintenance and repairs associated with our aging housing stock.
As we wrote in Part One, when it comes to making a condominium purchases, buyers need to seek property under the following criteria: a well-designed floor plan with features that are special or unique (high ceilings, desirable views, abundant light, an outdoor terrace, gas cooking, two-car parking, etc.); the unit must be in a stable, reputable, primarily owner-occupied building that is ideally at least two or three years old; location has to be stellar (facing the lake, a city vista, or being in a neighbourhood setting like St. Lawrence Market, Queen West Village or College Street).
While we acknowledge the seasonality of the Real Estate cycle, and therefore feel that, based on past experience the real measure of the market will not appear until the fall, when Buyers and Sellers refocus their collective attention back towards the market. Historically, in the autumn, the market revives full tilt, and prices increase accordingly. Will that happen again this fall? We’ll have to wait and see. Regardless, urbaneer.com still believes that there are some risks inherent in the Toronto condominium market in its current state, so prudence and informed decisions should be the guide when considering a purchase.
Property owners never lose money in real estate unless they have to sell, or they chose to liquidate in order to place their capital in a preferred investment. If you make an intelligent purchase that can serve your needs for an extended period of time, you can weather any economic storm while keeping a roof over your head. In our opinion, that makes it a better investment than stocks or bonds. But we're realtors, so perhaps one shouldn't be surprised by this point of view. Have you read our newsletter called "Locks Or Stocks, Which Should I Buy?" Click HERE to link to it.
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