Since 2018 is just around the corner now, I've been asked a couple of times what I think the Toronto real estate market will look like next year. In short, the year starts out with more headwinds than tailwinds.
Known Headwinds <<<
First, in case "headwinds" is too jargon-y, a headwind is something that slows the momentum of something (think of an airplane). I've broken these down into known, likely, and potential.
1) OSFI B-20: The big known headwind is from the Office of the Superintendent of Financial Institutions (OSFI). Their Guideline B-20 had been in the works for quite some time (a revised draft was issued on July 6), so people had a good sense of what was coming. It was made final on October 17, 2017, and comes into effect on January 1, 2018. The big item in here is the introduction of a "stress test" on uninsured mortgages (i.e. those where buyers put down 20% or more), where you now have to be able to qualify at a rate of 2% higher than the contract rate (or the Bank of Canada rate, whatever is higher). The government had already introduced a stress test for insured mortgages (less than 20% down) back in October 2016.
I've seen estimates that this only affects anywhere from 5% to 20% of buyers so it's not the end of the market. I've also seen that 50%-60% of these people will be able to find alternative lending arrangements for which they qualify. Note that OSFI's guidelines only apply to federally-regulated financial institutions (FRFI), so credit unions (which are provincially regulated) fall outside. For that reason, as the RateSpy article points out, credit unions are expected to gain some mortgage market share this year. The Globe & Mail said this:
In the medium term – other things equal – this is bearish for Canadian home prices. Period. That said, borrowers will likely adapt within two to five years. And prices will ultimately resume higher.
Effect: demand will be reduced because some won't qualify, and those that do will be able to borrow less money (though not everybody borrows right up against the maximum they're approved for). TD Economics estimated that demand will decrease 5% to 10%, with a 2% to 4% drag on prices.
2) Affordability: I've added this one at the (very good) suggestion of one of my Twitter followers, @ForTheTweetz. The latest figures from RBC's Housing Trends and Affordability report, show the aggregate affordability index (or unaffordability, because the higher it goes, the more unaffordable housing is) for the Toronto area keeps hitting all-time highs and is currently at 78.4, meaning ownership costs are 78.4% of median household income.
You'll note that there are two very different sub-markets shown alongside that aggregate number. Single-detached is at 93.8, an all-time high. Could be worse, though: Vancouver is at 120.7! And condo apartments in the Toronto area are at 43.4, which isn't quite at the peak it reached in 1990.
Effect: This could mean lessened demand for detached houses as they are out of reach of many would-be buyers. It also could mean increased demand in the condo market, as buyers train their eyes there instead. We saw low inventory conditions all year in the condo market, which helped keep prices propped up even as the average detached prices fell from spring highs. Basically, until houses become more affordable, it is very likely more buyers will shift to the more affordable condo market. In the 416, condo sales are about 60% of the sales but that's been trending upwards for years (20 years ago they were 35%). Keep in mind that even if house prices and condo prices stay exactly the same as today, more condo sales in the mix will be a drag on average prices.
Likely Headwinds <<
3) Tighter credit: The Home Capital Group scandal this year got a lot of coverage. Then, earlier this month, Laurentian Bank said it uncovered some "problematic loans" due to "client misrepresentations". Some industry watchers are saying this is just the tip of the iceberg. Lending institutions know they're going to have more eyes upon them so I think they'll tighten up their underwriting practices.
Effect: demand will be reduced because some won't get credit under tighter scrutiny, and some that will get credit will be shown to be riskier and will have to pay higher rates (therefore having less money to spend on housing)
4) Higher interest rates: The Bank of Canada raised its overnight lending rate twice in 2017 - in July and September, each by 25 basis points (i.e. 0.25%). As you can see below, the July increase was the first one in 7 years.
Source: Globe and Mail, July 12, 2017
In December the Bank of Canada hinted at further rate hikes in the new year. Rates were about as low as they could possibly go, so they seem a lot more likely to increase than decrease in 2018.
Effect: Demand will be reduced with a rate increase as buyers will be able to afford less.
Potential Headwinds <
5) Government sanctions: There was a lot of government intervention related to the housing market in 2017. The one with the largest effect on the GTA housing market was the Ontario government's Ontario Fair Housing Plan (OFHP), which was announced on April 20th. If you look at the substance of what was in there, I think the market overreacted on the way down. But then again, it was overreacting on the way up too! It acted as a bit of a slap in the face of buyers, who finally seemed to check themselves (whether or not it was before they wrecked themselves is debatable). Potential future measures include a ban on "shadow flipping" as BC has done.
The City of Toronto also got in the act by passing regulations for Airbnb and other short-term rental sites. The most important thing was that now all units have to be registered with the City, and you can only rent out a place if you live in the unit as your principal residence. So you can still rent out a guest room in your own residence (or up to 3), but you can't Airbnb that basement apartment or that condo investment property you own. These regulations were put in to help address the seriously tight rental market. But if you were looking at buying a condo to use as a rental and had planned on listing it on Airbnb to maximize your revenue, you're going to have to adjust those revenue numbers down now, so you'll theoretically pay less for the place. Same for a house with a basement suite that you were looking at to offset some of your mortgage payments. Now it's going to offset less, so you won't be able to pay as much for the house. Potential future measures include a vacancy tax (like Vancouver's Empty Home Tax).
Even the federal government got into the act via the Canada Revenue Agency (CRA). They finally started looking into money they were being cheated out of from a lack of record keeping around flipping of pre-construction condos. Going after real estate transactions has been an area of increased focus in recent years, and I expect that will continue. If people know real estate transactions are being watched more carefully and there's more likelihood profits will be reduced after taxes, an investor won't pay as much for a property.
Effect: All of these lower demand going into 2018. It remains to be seen if any further regulations are coming, but there won't be less regulation coming anytime soon.
6) Foreign buyers: The so-called "foreign buyers tax" affecting the Greater Golden Horseshoe (GGH) area seems to have lessened foreign demand. Adding a 15% tax certainly couldn't help demand. So versus last year we're likely going to see a reduced demand impact from foreign buyers. Of course, if the Canadian dollar tanks, suddenly prices look a lot better to foreigners.
Effect: Reduced demand.
7) Market Psychology: As mentioned above, people were acting crazier than they should be before the April 20 OFHP, and overreacted on the way down too. Market psychology had people going all FOMO up until April. This is hard to predict because it's not always rational, but going into the year I feel like buyers and sellers are both in a bit of wait and see mode (buyers waiting to see if prices will come down further, sellers waiting for things to improve in the spring). So I think there won't be much price movement in the next couple of months. Due to the quality of offerings on the market, average prices decline in December, then increase slowly through the spring (though the "February bump" is always pretty large). The following numbers aren't at all scientific, but just for illustrative purposes, here's what TREB's average price looks like if the November 2017 price of $762K holds all through 2018:
The news media likes to focus on year-over-year (YoY) price comparisons. Note what happens in February through May if the average price stays at $762K: double-digit price decreases. I know the headlines are going to talk about how prices are plunging, and I think that's going to affect the market psychology. The thing is, the prices have already dropped. Basically the $762K in November is within 1% of the $771K in January. What happened through 2017 was that the market giveth (average prices climbed to a height of $921K) and the market taketh away - but the net effect is that we're right back where we started. Prices are not plunging - they already plunged. If you look closely, in the last 5 months (July through November) average prices have been at $755K, plus or minus $25K. While there's definite value in that, the headlines. But headline writers like to sensationalize, so even if prices remain exactly the same for the next 6 months (meaning 11 months in a row around $755K), you're not going to hear about steady prices - you're going to hear about plunging prices based on the YoY comparison.
I think transactions will very likely be a lot less YoY in the first few months, due to a combination of a pull-forward of demand into 2017 (to beat B-20) and just the fact that early 2017 transaction volumes were so high it will be a tough comparison.
Effect: Demand could be lessened, as my basic thesis is that the media contributes a bit to self-fulfilling prophecies via their headlines.
>> Potential Tailwinds
So there's a lot that is going or may go against the Toronto real estate market. Is there anything that supports price increases? Well, yes there is.
1) Land constraints: They're still not making any more land here :) So supply will always be constrained. This affects houses more than condos as they're still building thousands of new condos.
2) Immigration: This is made up of two primary factors - New Canadians and inter-provincial migrants. Canada has increased its immigration targets for the next few years, from 300,000 in 2017 to the following:
2018: 310,000
2019: 330,000
2020: 340,000
2021: 450,000 (recommended by the federal government's Advisory Council on Economic Growth)
Interestingly, the share that settle in the Toronto CMA has been declining (green line):
Source: Scotiabank Global Real Estate Trends report, December 15, 2017
Still, even it dropped right down to 20%, that's still over 60,000 new people in the Toronto CMA every year from Immigration alone (and if it's closer to 30% that means 90,000 people). The second factor, inter-provincial migration, had Ontario looking popular last year (dark green line). But this factor is more volatile , due to economic factors (e.g. if oil in Alberta is booming or not). This influx of people should help keep the demand fires burning.
Source: Scotiabank Global Real Estate Trends report, December 15, 2017
3) Low interest rates: While rates climbed a little last year, and may climb some more this year, they're still very low historically, and that helps demand.- - low interest rates historically
4) Tight rental market: Continued low vacancy rates, and increasing market rent prices would make buying investment properties (mostly condos) more attractive. Though the OHFP did put some rent controls in place for condos, which would make buying for investment purposes a little less attractive.
In Summary
I think the year will start out slowly for the Toronto real estate market, both in terms of sales and prices - especially when compared to last year, as there are a lot more headwinds than tailwinds. The big X-Factor on top of all the above is the economy (local and national). Everything above is based on the status quo (i.e. moderate GDP growth as we've seen from 2010 through this year). If it ever goes south, then I think we'll see a pretty sizable correction.
*NOTE* I am not at all saying don't buy real estate in Toronto right now. This market has a lot going for it, and if you're buying for the long term everything will work out fine. If you see a house today that you really like in an area that you like and it's within your budget, go ahead and buy it and enjoy it. I do think specuvestors are in a lot riskier place right now, though (especially considering it's really hard to find cashflow positive properties in the GTA so most purchases are made by banking on profits from appreciation).
About Scott Ingram CPA, CA, MBA
Would you like to make better-informed real estate decisions? I believe knowledge is power. For that reason I invest a lot of time researching and analyzing data and trends in the Toronto real estate market. My Chartered Accountant (CPA, CA) side also compels me to perform a lot more due diligence on properties my clients are interested in purchasing. If you have better information, you should have less risk and be in a position to make better decisions for your hundreds of thousands of dollars.
Your home is the single largest investment you'll make - trust it with an accountant.
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