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). 
http://estat.statcan.gc.ca/cgi-win/cnsmcgi.exe?Lang=E&EST-Fi=EStat/English/CII_1-eng.htm
(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.