Monday, 16 January 2012

2012 - Bubble Bursting or Rising Balloon?

There has been a lot of talk lately from various sources that the Toronto Real Estate market will have its bubble burst before this year is over. We are reminded of what happened in the late 1980s to early 1990s when there was a drastic correction and prices fell to about one-half or less of their peak price, especially in high end properties. Many people lost their properties and others walked away from deposits on new homes to be built. Is this same thing going to happen in the near future?

The current forces driving the real estate market and increasing prices is quite different than what happened in the late 1980s. At this time, the Toronto market was experiencing increasing demand despite increasing interest rates. There was a large influx of external demand related to the fear that Hong Kong would be taken over by China in 1999, which led to speculative investors from Hong Kong looking for safe havens, such as Toronto and Vancouver, to place their money. These investors perceived Toronto real estate values as undervalued compared to real estate in Hong Kong, resulting in a tendency to build up real estate prices. They came here to buy, but not necessarily move into, these properties. Their strategy was to hold these properties in order to hedge against losing their properties and businesses back home. The rest of the Toronto market incorrectly perceived this as an ongoing trend, and also jumped on board to continue the speculative buying spree, which included new homes to be built. Unfortunately, when many of these new projects were completed, there were no subsequent buyers to absorb the excess supply. As mortgage rates were very high, above 12% in the late 1980s and peaking to 13.3% by 1990, holding onto vacant properties was a losing proposition, until such a time that the excess supply could be absorbed. Many speculators had no choice but to sell their properties at a loss.

Table 176-0041 - Financial market statistics, as at Wednesday unless otherwise stated, computed annual average (percent unless otherwise noted) (graph), CANSIM (database), Using E-STAT (distributor).
(accessed: January 16, 2012)

The current market situation is quite different from what occurred in the late 1980s and early 1990s. Demand for housing from new immigrants continues to exceed available housing supply, particularly in the Greater Toronto Area (GTA). As well, lower interest rates allow more entrants into the housing market both as users and investors. In addition, these low rates allow investors more flexibility to ride out extended property vacancies. Lower rates are expected to continue as the Canadian economy continues to remain stable relative to other countries. This is making Canada attractive for foreign investment, which brings in more capital and keeps interest rates low. 

Eventually, prices will reach a point at which entry into the market will not be affordable. Correction in prices will likely be a slow process. As long as new construction does not exceed demand, prices will stabilize. With all these factors, I see the Toronto real estate market as a slowly rising balloon rather than a bubble ready to burst. 

Wednesday, 4 January 2012

2012 Resolutions - Buy, Sell, or Hold

2012 will present some challenges for those investing in condos. Timing the market has never been easy. Personally, I am not comfortable with condos as an investment. However, many of my colleagues and clients have made considerable profit investing in condos over the years. When I look at an investment, I prefer to see a profit or return on my initial cash outlay. On a yearly basis, the net income from condos does not yield a high return. If interest rates were higher, some of these condos would even lose money. The greatest return on condos has come from capital appreciation. The Toronto market continues to support increasing prices year over year. Can this continue?

New condo developments in downtown Toronto are coming out with prices starting at $700/sq. ft., which does not necessarily include parking or lockers that can add another thirty to fifty thousand ($30-50K) to the price. When I started practicing real estate in 1991, condos in nice neighbourhoods could have been purchased for slightly over $100/sq. ft. So what are the forces driving prices upward?

According to economic theory, price is a function of supply and demand. From the demand side, Toronto, as well as Canada, has been experiencing an influx in immigration. In 2010, there were about 280,000 immigrants to Canada, compared to 250,000 in 2006.
(Citizenship and Immigration Canada). About 92,000 of 2010 immigration came to the Greater Toronto Area (GTA). If you assume that for every two new immigrants, you require one residential unit, the demand from new immigrants would require about 46,000 additional residential units in the GTA. From 2006 to 2010, the number of housing starts in Toronto ranged between 26,000 to 37,000 units per year, while housing starts for the rest of the province ranged from 22,000 to 31,000 units per year, as shown below.

Source: Statistics Canada

However, the number of immigrants coming to Toronto has been on a decline since 2001, yet has shown a 12% increase from 2009 to 2010.(Citizenship and Immigration Canada). Nevertheless, unless the number of new housing starts per year, including new apartments, grows considerably, the demand from immigration alone will continue to exceed the new supply of housing.

Another factor affecting demand is the mortgage interest rate. The lower the interest rate, the more affordable housing becomes. However, I expect prices in the Toronto market to continue to increase until the cost of carrying debt on housing becomes too great a percentage of disposable income.

I have also noticed that the size of starter homes and condominiums has been getting smaller over the years, as the price per square foot of the properties condtinue to increase, especially in the more desirable areas of Toronto. The question becomes how small a property people are willing to live in before they stop buying.

As an investor, I would focus on the smaller units, as these will be easier to resell, or to cover the carrying costs as rental income units. To play it safe and maximize my returns, I would resell the units as soon as possible after occupancy or registration, depending on what is allowed in your agreement with the builder from whom the property has been purchased.