I think the first time I heard about the “housing bubble” in Toronto was about 5 years ago. Since that time, real estate prices in Toronto have increased substantially… Past bubbles have always burst. So saying that that will happen is pretty much a no-brainer. But to have any accuracy in predicting when is more than a little bit tricky – just ask those who were predicting a crash in Toronto real estate values as long as five years ago. There is no way to get even a bit of a handle on this without trying to understand what the underpinnings of the recent gains have been, and when they may be likely to change.
Looking at the situation in simple terms, it’s all about supply and demand. If there is greater demand than there is supply, prices go up. Generally, that results in an increase in supply, which can be sold at higher prices. At some point the two go into equilibrium and prices stabilize, demand decreases and prices decline. That is the normal cycle. When I look over the GTA and see all of the cranes and all of the high rise buildings going up, it is a little hard to see how there is not enough supply, but obviously, there isn’t. It seems to me that the single most important reason for what has been going on with housing prices is interest rates (and mortgage rates) currently being as low as they have ever been.
While building is booming and supply is increasing, the fact that mortgage rates have fallen so much over the last number of years has had an exponential effect on demand. It’s all about interest rates. I do not see any significant decline in real estate prices unless and until interest rates increase, not substantially, but enough so that those who are now barely able to afford their mortgage payments will no longer be able to do so. I think it will only take two or three rate hikes by the Bank of Canada to get us to that point. When will that be? That is another difficult question. Governor Poloz has consistently said that a rate hike is not imminent. As the Canadian economy does seem to be picking up, at least modestly, his view may change. His other dilemma is how to react to what the Fed has recently done and likely will continue to do. There has been one rate hike this year, and there could be more. If that happens and the BoC does nothing, we will probably see our dollar drop to around 70 cents. Would that be enough to make the BoC rethink its strategy? Only time will tell.
There has been a lot of talk in the media lately with respect to how to “cool down” the market. I will have more to say on that a bit later. Why is there such concern about how a free-market system is operating? I have not heard any talk about putting any dampers on, say, equity markets. Maybe it stems from the fact that some people think it is a civil or human right to own a house or a condo. Actually, believe it or not, that isn’t the case.
In theory, addressing the problem is simple: bring supply and demand into balance. Much of what I have been hearing lately focuses on the supply side. Anybody with any common sense at all should realize that while the problem could be addressed in that manner there are two obvious problems: first, the building process to allow supply to meet demand would take many years; and, second, where are all these houses and condos going to be built? Whether the plan is to build out or build up, the opportunities are very limited.
In addressing the demand side, that is easy in terms of reducing demand for real estate: increase interest rates. Very simple in terms of the real estate issue, but the collateral damage would be absolutely enormous. First of all, that would mean that there would be many people simply walking away from their properties. While I believe the impact in Canada now would be much less than it was in the U.S. in 2006, it would cause widespread pain. Also keep in mind that much of consumer spending in recent years (a major factor in the health of our economy) has been funded by the massive growth in wealth due to real estate values. The vast majority of most Canadians’ net worth is based on the value of their house. This whole scenario would set off a domino effect that would be very damaging for many Canadians and for the economy as a whole. I think there is no way that the BoC would raise rates in response to real estate prices.
So, if we take the obvious means of reducing demand off the table, what do we have? Well, there have been a number of ideas floated by local and provincial government. I have seen many comments from members of various governments to the effect that “housing in Toronto is not affordable.” That reminds me of the old Yogi Berra quote: “nobody goes there anymore, it’s too crowded.” Let’s be clear, if no one could afford to buy a property there would be no demand.
I know that legislation has been enacted in B.C. with respect to taxing foreign owners of property in that province. Obviously the focus of that was primarily Vancouver. We will see how that plays out, but I suspect that the foreign buyers who have been targeted will not defer contemplated purchase simply because of the new tax regime. While I am hardly a real estate expert, I do think the situation in Toronto is quite different. According to the Toronto Real Estate Board, about 5% of buyers recently have been foreign, and 80% of those either occupy the properties (or members of their immediate family do) or they are rented out.
Nothing will change until housing truly becomes unaffordable. That will happen either because of continuing increases in price or higher interest rates or both. Once that happens, the housing market will adjust. My view is and has always been that the catalyst will be interest rates. Will they go up in the future? Yes. They will as a matter of course and not specifically to address any real estate pricing issues, but rather in response to general fiscal and monetary policy issues.
President, HG Partners Limited
Director, Private Client Group &
Senior Financial Advisor,
HollisWealth Advisory Services Inc.
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