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Feb 28 A Tale of Two Cities: Condos & Family Dwellings

Posted by: Don Bayer, CFP

What an interesting year it has been! I had the opportunity in 2012 to stay at home during the holidays – ok, not a great opportunity – but I also had the pleasure of reading three newspapers a day and a few magazines as well.

If I didn’t know better I would have jumped off of my mortgage chair – bad news is everywhere and newspaper outlets have clearly established a mandate to reduce everyone’s home values. Headlines such as “Canada’s Housing Hangover” or “Ottawa’s $800 Billion Dollar Housing Problem” overstate the real issues that affect valuations here in Ontario.

Article after article repeating the same information with so little research and so much hype have really impacted the consumer psyche.

In 2012 alone, major newspapers wrote over 100 articles about Canada’s “looming housing bubble” – now we have senior business leaders within the academic community making very bold predictions – predictions we have all heard before.

The cover of the late 2012 edition of Maclean’s Magazine proclaimed “Inside- the Great Real Estate Crash of 2013“.

The Condo-Hotel Market

However you choose to interpret this growing phenomenon of negativity associated with the housing market, I hope you take a moment to consider a few other factors that may impact your decisions in 2013. The housing market is generally divided up into multiples and single family homes.

There are currently 147 high-rise buildings under construction representing over 56,000 new condominium units that will be absorbed into the Toronto market over the next few years. In addition, there is likely the same amount of units under consideration or at the early planning stages. There are a number of complicated issues around this particular segment of the market.

First and foremost, there is an oversupply of this type of product in the market that will and has forced prices down. The luxury end of this market – the quasi hotel/condominiums – has been affected the greatest. These are the stories that we all hear about – class action suits against the Trump Tower – negative feelings towards the Shangri-La development – and so on.

The whole idea and economics behind a condo-hotel has never worked anywhere in the world, why would it work here? At $1,000.00 a square foot, the Condo-Hotel market is an accident that is about to happen.

To make matters worse, banks have been told by the federal government to change their lending policies as they no longer want to inflate the market. In addition, the Canadian Housing and Mortgage Corporation (CHMC), has indicated that they no longer will support financing this type of real estate.

The concern is that the market is being driven by speculators, not families. This is the second problem associated with the condominium market. Once you lose the lending community it will drastically affect the pricing of a unit. All luxury condominiums including the Trump Tower are very difficult to finance because it is hard to value real estate that hasn’t traded in this range and is tied to a commercial venture.

There is one Canadian bank offering a 65% first mortgage against the current value – which has dropped during construction – at an interest rate that is 100% higher than the market rate (that is 6% opposed to 3%). The difficult constrictions associated with financing the Trump Tower puts considerable pressure on prices and no purchaser wants to catch a falling knife. The Canadian banks did learn a valuable lesson from the early 1990’s because they now require a 20% down payment on these units through construction, opposed to the 5% required 20 years ago; this should ensure the market can handle a correction between the start of a project and the five years it will take to complete a building.

Single Family Homes

The single family home business is still alive and well. We have purchasers that continue to bid on homes but it does appear the rush to buy and therefore push up prices is beginning to ease. There is a shortage of single family homes in Toronto.

The primary driver of this real estate market is strong job growth – December numbers of 53,000 new full time jobs was significantly better than the forecast by The Royal Bank of Canada of 5000 new jobs. November’s job growth was even better.

The second driver of real estate is of course affordability. No economist is predicting any interest rate increases other than a nominal .25% here and there to hedge their bet. Low interest rates are here for the foreseeable future as many countries’ economies would suffocate with higher interest rates. Low interest rates will continue to make borrowing affordable in 2013. The question now remains; will consumers listen to all the bad press and stay away? It won’t take very long to find this out!

Impact of New Lending Guidelines

Last but not least, a number of changes in lending guidelines have occurred over the past eight years. From the year 2004, the government (CMHC) lost sight of its original mandate and began to inflate the market with aggressive new rules that allowed Canadians to borrow more and pay it back over a longer period of time. Then the 2008 financial crisis happened and ever since that time the Canadian government has been pulling back and battening down the hatches to avoid a U.S. style housing problem.

If you are looking for a balanced viewpoint to the housing market, the Chief Economist of The Royal Bank, Craig Wright, offers these remarks,

“Our view of the housing market is one of cooling, rather than any sort of U.S. style crash. Our housing affordability measures are pointing to some signs of strain which, along with numerous rounds of regulatory tightening, suggest a softer trend in housing throughout 2013. We expect home sales to decline 2.5% and prices to recede by 1.5% in 2013.”

Toronto definitely does have two markets moving in different directions. Weeding through all the negative press coverage to try and understand the true facts can be difficult, and choosing whom to listen to and what information makes sense is very difficult. It will be interesting when the media chooses a different part of the economy to destroy in 2013. I almost miss the days of the European debt Crisis……

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