Welcome to Part Two of Urbaneer’s Summer 2017 Forecast!
In Part One, I explored the current state of Toronto Real Estate on the heels of the Provincial Government’s policy intervention with the Fair Housing Plan. I also drew some parallels between the Vancouver and the Toronto real estate markets, to try to measure the impact of Government intervention, given that the Vancouver market has had about a year to absorb their similar policy changes.
In Vancouver, market activity has indeed transitioned, but there is little evidence that affordability is really much better with the policy intervention. The latest headlines in The Globe And Mail shout "Vancouver Condo Prices Surge Amid Apparent Thaw In Foreign-Buyers-Tax Chill". If Vancouver is immune to policy intervention thus far, the question is, can Buyers and Sellers in Toronto expect that the market will become more balanced and affordable - and stay that way?
The Latest Stats
As I discussed in Part One of the Forecast, market activity in Toronto has slowed (think tumbleweeds in a heat wave), while stats show prices in the Greater Toronto Area have slid down near 14%. This was inevitable. The market escalation wasn't sustainable, and prices over the past few years - particularly in 2016 - shot up beyond the economic fundamentals necessary for a steady stable economy. The filtering of housing stock for Canadians is essential in its importance, both as shelter, and as as an integral commodity of capitalism. It needs to be balanced, both to house Canadians (the priority, right?) and serve as an economic engine. Intervention had to occur.
TREB's recently released stats for June show a marked drop, to the tune of a whopping 37.3% decline in sales activity, year-over-year. The headlines that ensued contain a flurry of adjectives that are reflective of the drop: "Toronto Housing Slumps Fast After Move To Deflate Bubble", "Toronto’s Housing Market ‘Turned On A Dime,’ Real Estate Analyst Says", "Trouble Coming As Toronto Housing Market Cools: Report" and "Brace Yourself- A Perfect Storm is Brewing in the Housing Market". While values are up from this time last year, month-to-month prices are tumbling, with another decline of just over 8 per cent from May to June, building on declines from the couple of months prior. It certainly seems that prices are being pulled, however abruptly, back down to earth. In Toronto Life's "These Charts Illustrate Why It’s Not Time To Panic About Toronto’s Housing Market—Yet" compares the current market relative to 2016 which was a banner year for Toronto real estate.
Has the 'bubble' burst? Yes. Is there balance in the market? Not yet, but it's happening. Is this enough to keep housing prices more affordable in the longer term? Let's explore.
Will Policy Alone Hit the Mark?
A number of pundits and policy makers acknowledged multiple reasons property prices kept rising. This story: “The Housing Fix: Will It Stick?” addressed some of the factors that are contributing to price appreciation - including foreign investment and speculation - but as one interview subject suggests in this story, Toronto’s market was driven by 12 to 20 factors in a “Perfect Storm”. While the Fair Housing Plan helped cool the market - throwing a psychological wrench into market dynamics - it may be more challenging to take root in the longer term, because taxes and legislation really only address part of the market influence.
It would seem that the solution to the affordability question is tied to Buyers and mortgage debt. Mortgage debt needs to have context rooted in an affordable reality (i.e. your entire income shouldn’t be going to your mortgage payment). But most importantly, policy needs to limit the tool that has permitted the buying frenzy to gather steam over these last several years - specifically - access to cheap money. Let’s not forget the other force at play here, which is the psychology of emotion. I’m not talking about the 'fear of missing out' and the high-octane level of emotion that defined the Buyer experience this Spring in Toronto; rather that Buyers have long become desensitized to mortgage debt. For many, mortgage debt is simply 'the price of admission' to home ownership. And in a market where 'pay any price' has long been a common strategy - with Buyers fully willing to do it - the stratospheric rise in prices began impacting first time buyers, who were finding home ownership out of reach in Toronto.
In a market sizzling for decades plus, Buyers in Toronto, worn down from a lack of supply and weary from consistent bidding wars, became solely focused on their ability to afford a property based on monthly payments. Desensitized by a lender's willingness to loan massive sums of money, Buyers no longer think about the size of the debt. Instead they ask, "how much does it cost me each month?", a sum which ultimately dictates their comfort with 'affordability'. And because of this - where for years most of my Buyers have always said they ultimately weren't willing to borrow the amount their lender was ultimately prepared to loan them - they've still become immune to the long-term financial ramifications of carrying a huge debt. Why? Because in a scorching hot market that has long burned brightly the fallback position for most everyone has been, in a worse case scenario, to simply sell your property (in a bidding war) and come out financially ahead.
But this is potentially going to change.
Interest Rates Increases + Stress Tests
Canada debt levels have stealthily continued to rise, pushed up in large part to the rise in housing prices, to the point where the vulnerabilities of indebted households are at ”levels beyond historical experience” according to the Parliamentary Budget Officer. We all know that more debt = more vulnerability in the event of an economic shock; what is eye-opening here is that they expect the first wave of economic shock not to be a major event, like a recession and job loss, but a modest rise in interest rates. When you are stretched mighty thin, it doesn’t take much to push you beyond the debt brink. This story in The Globe And Mail offers some sobering insights: “Financial Vulnerability Of Indebted Households To Rise With Interest Rates”.
The Federal Government - which hinted they'd be increasing interest rates imminently - is also poised to introduce another policy which may well tame (if not shift) the Canadian real estate market at large. In an effort to force prudence on Canadians, they're going to up the ante by spreading the reach of the mortgage stress test beyond first-time homebuyers to apply to all mortgage holders. Soon, everyone will need to qualify for their mortgage loan at 2 per cent above their negotiated rate. When you consider the increasing signs that there is an interest rate hike as well on the near horizon (beyond Poloz' frequent hint-dropping at press conferences), there could be a entirely new borrowing reality facing homeowners very soon. Click here to read David Rosenberg's commentary in the Toronto Star: "Why The Loonie's Rebound May Not Be Done Yet."
Although it will cause hardship for some home owners pushed to their debt ceiling (this seems significant enough to cause some fall out), a rise in interest rates, coupled with this new mortgage stress test are exactly how a policy can effectively cool a market. It's going to force reassessing affordability relative to the incomes and equity of the middle class (who are struggling to attain home ownership in the Toronto and Vancouver real estate markets), increase reliance on the Bank Of Mom And Dad for younger generations - and fuel a return for Warren Buffett's investment in Home Capital and other secondary lenders. Strategically I I see the wisdom in reducing the vulnerability of future borrowers and it;s objective in reining in runaway housing prices, but could it cause the market to stall and unravel the Canadian housing economy?
Interest Rates And The Missing Piece Of The Affordability Puzzle
The real culprit behind the continued rise in property prices has been, in part, the ability to secure mortgage debt. Here is a telling story from the Globe and Mail called "Canada's Home Prices Driving Up Mortgage Debt” which shows that, despite some slowdown exercised on the market from the Government policy introductions, Stats Canada shows that homebuyers continue to accumulate mortgage debt at breakneck speed. It is an interesting parallel to draw, that though supply increased and activity slowed, price appreciation continued until recently while affordability continued to erode.
This story, “Borrowing Costs Counteract Effects Of Government Measures, Home Capital Woes – Poll” discusses a recent Reuters poll of industry analysts who point the finger squarely at low interest rates as the engine behind high housing prices. It goes even further to suggest that continued low interest rates and giving people the ability to purchase more house is going to actually counteract the policy that the Government has introduced to the market. Says BMO analyst Sal Guatieri “Low interest rates are going to be oxygen ... that keeps the fire going in the Toronto and BC housing markets.”
Our go-to mortgage broker Mortgage Jake also feels that the answer to the price appreciation problem needs to be more directly linked to the ability to purchase, which may be made more difficult with the looming government changes and interest rate hikes likely on the horizon. He says in a recent note: “The problem is our house prices (notwithstanding the latest changes) have really gone sky-high and thus people can't AFFORD to buy what they want/need. So it's not like there's a magic potion here to lower house prices AND make it harder to qualify for the mortgages. In Ontario as we know the Provincial Government has done a good job of maybe temporarily slowing down our housing market and this new Federal change may help slow things down further.“
Here's two informative articles from Maclean Magazine (July 10th) which offer comprehensive explanations in "What Higher Interest Rates Mean For Real Estate, Debt And The Economy" - and - "Here’s Why Interest Rates Are Likely Going Up This Week".
The Window Has Opened
As the market continues cooling, the recent policy changes - and more importantly the proposed one - will reduce the purchasing power of a lot of people - representing the cold water splash which will inject a measure of sanity into what has been a run-away Toronto real estate market. With data showing a pullback, Buyers are taking a breather, along with a reality check of what participation in a record-smashing market means to personal finances.
Certainly - from my experience in the Toronto real estate trenches - my Buyers, who only 10 weeks ago were willing to pay towards the top end of their budget in bidding wars, are taking a wait and see approach. And it's not only my first time Buyers. Clients looking to climb the property ladder, make a lateral move, or down-scale are each observing the dynamics of the market cautiously. As they each say "If Sellers are finding it hard to secure a Buyer, why on earth would I want to make a purchase and face a similar fate?" My investors are asking me to look 'for deals', and my builders (who want to keep working), are even more discerning in what they'll consider purchasing, as it has to be Triple AAA in terms of location, site features, and opportunity).
It's certainly stalling the market. A recent Nanos poll shows that confidence in the housing market pulled back significantly in only mere weeks after the market began to show some effects from the Fair Housing Plan when “Canadians Faith In Real Estate Fizzles As Toronto Sales Plunge”. TREB also conducted an Ipsos Reid poll, which showed a resounding change in market perception, especially from a Buyer standpoint. TREB's Economist, Jason Mercer said in a release, “The recent Ipsos survey results suggest that home buying activity in the GTA will remain strong moving forward. The year-over-year dip in home sales we have experienced over the last two months seem to be the result of would-be buyers putting their decision to purchase temporarily on hold while they monitor the impact of the Fair Housing Plan. On the supply side of the market, it certainly looks as though buyers will benefit from more choice in the second half of 2017 compared to the same period in 2016."
No question, there's a lot going on to shake Buyers’ confidence. The recent fear-mongering collapse of Home Capital injected more uncertainty into the market. Dangers of borrowing without checks and balances applies to personal finance just as much as it does to corporate finance. This story from the Financial Post, “Toronto Bidding Wars Turn To Homebuyers' Remorse As Market Gets Nervous” discusses this shift in Buyer sentiment and how it casts a decidedly different shadow on the market.
As Buyers physically and emotionally step to the side of the market, and Sellers list their properties for sale in an effort to cash out (as prices soared a lot of Torontonians began crafting an exit strategy based on X dollars in profit, many whom would still like to sell), the Government has found the opportunity to rein in future mortgage debt and home prices at the same time. Will this happen at the BOC's Next Rate Announcement On July 12th 2017? Stay Tuned!
What’s in store for the next few months? While there may be a mini-rush as Buyers with pre-qualified mortgage approvals try secure property before rates jump, it will be countered by continued Buyer resistance, a modest decline in prices, and more listings - as Toronto returns to a balanced market. What does this market look like? It's one where we may start seeing purchases conditional on financing, inspections and even on the sale of a Buyer's existing dwelling. And is there anything wrong with that? All the more power to prudence, due diligence, and caution is my opinion. Certainly, it seems that Buyers and Sellers are digging in their heels during a summer standoff which may provide more substantial balance.
However, given the size of Toronto this won't be the case for every buy and sell. As a realtor working in the original City of Toronto there remains far less inventory than elsewhere in the GTA - so prices won't drop by as much, or as quickly, as the suburbs. In fact, anticipate the market - and prices - to become highly specific to geography - like a patchwork quilt based on neighbourhoods. This will not only be due to fewer listings, but also because the downtown freehold housing stock offers a greater variety in size, age, condition, style and price point - all within a smaller geography than it does in the swaths of suburbia - where you'll find greater homogeneity in product across a larger area. Typically in the central core there's only a handful of similar type houses for sale in any given neighbourhood (I cover 42 neighbourhoods) which helps support values, whereas in the suburbs there's more competition of near-identical product, which means there is both more choice, and likely more motivated Sellers competing for the same Buyer, which allows Purchasers greater negotiating power to drive a better bargain. In Central Toronto, good houses offering the trifecta of size, condition and location, when priced close to market value, could still go into bidding wars - and some neighbourhoods may not be impacted at all, whereas others will. The supply issue in the downtown freehold market (which is shrinking, rather than growing), will always be in demand - but it will truly be a factor of what's for sale where at any given moment in time.
In a market becoming layered with property specific complexity, being armed with knowledge, information, and preparedness will ultimately serve you well. More than ever, take your time and choose your property wisely.
Miss Part One of my Forecast? Here's Urbaneer’s Summer 2017 Toronto Real Estate Forecast Part One!
May my team and I help?
~ Steven and the urbaneer team
Steven Fudge, Sales Representative
& The Innovative Urbaneer Team
Bosley Real Estate Ltd., Brokerage - (416) 322-8000
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