Why Toronto Condo Prices Will Absolutely Totally Go Down in 2012

Because I say so. And I’m only being partially facetious.

The base creation of property value is supply and demand. As long as demand exists beyond supply then the value of condominiums will remain static or grow. But that’s only part of the story for Toronto.

In Toronto the super vast (some reports over 80%) of pre-construction condos are investor purchased. Investors, versus homeowners, are looking for fiscal return. Cash. Money. Income. The Jackpot. The Dream. Investors are looking for a growth in their financial portfolio.

As long as there are three factors in housing their investment is good: (1) demand over supply and (2) revenue exists between purchase and sale (3) the perception of “need” to buy now exists in the market.

Let’s look at point 1: Toronto is about to bring on more units in the next two years than ever before. It is unknown if there will be enough population growth (and demographic movement) to create demand for all those units. While condo prices in Toronto have “always risen”, we have never seen this much inventory come on line over 3 years.

Point 2: Rents in Toronto have topped out at the moment. While the costs of condos have continually grown, the ability to rent them at a reasonable percentage of purchase price (about 6.25% of value per year) has not kept up. Rent levels are well below this ratio. This means its great value for renters, but returns for investors don’t exist on rental income.

Point 3: Perception of “need to buy” – and this one is important. If buyers think the market is hot (whether this is the Toronto area in total, or just the building they are interested in) they will pay the bucks and pay them now. Buyers who see competition for their “perfect” home will often become irrational about the purchase price. Investors and sellers love that. But as people like me (and I’ve blogged several times about my worry about Toronto prices),the Globe and Mail, the Financial Post (indicating a 15% Toronto correction), banks, and economic reports all start talking about an economic slowdown in condo prices – then buyers start believing that. Not only do they start believing it, they start acting on it. They start thinking at they might just be able to wait, or another awesome condo may come on sale slightly cheaper. Perception slows the market. That’s why in part Real Estate Boards always issue the most positive statement about demand. They are in the business of supporting good housing valuations – meaning larger commissions to their agents.

So when I say Toronto housing prices will go down because I say so, it’s because I’m part of the group of people writing about the downturn in prices. The more people writing with this opinion, the more housing prices will stagnate and likely drop. And I think there are going to be a lot of people writing about a downturn.

And those people who believe foreign investors will save housing prices – as foreign investors believe that Toronto is reaching a peak, or just growing slowly, they will sell and move their investment to the US for better returns. After years and years of depressed housing prices, newspapers and pundits are starting to whisper “the long US housing burst may be bottoming”. If there’s one thing that a good investor knows – buy low and sell high. So even if there is still growth in Toronto – there’s likely bigger growth south of the border.

Bad News – Toronto Has Become a Developer

I wrote an article about how the Collingswood NJ municipality decided to become a condominium developer and ended up holding the bag because the condominium market crashed. I restate that municipalities should never be residential condominium developers.

The role of a municipality is to direct the desired developments through zoning and legislation, and to leave the risk associated with the project with the developer (see recent crash in US housing to confirm risk exists).

Municipalities should never be in the business of risk. They should be in the business of service and infrastructure, not gambling – as in “gambling if the condo market will still be good in six years”.

Six years is the projected timeframe it will take to complete the – now largest residential planned condominium – development.  The project, which will be 20% city owned and 80% Tridel owned, is a 75 story development at York and Harbour, near the railway tracks.

Mayor Rob Ford said the new joint venture represents a creative way of solving the city’s financial problems. Cities don’t need creative – they need solid and sustainable. Rob’s brother, Doug Ford – who also is elected to council – sits as vice-chair of the Build Toronto, the city arm that is spearheading this initiative. He says the opportunity represents a cash windfall:

When there is that much profit sitting on the table, we wouldn’t be very prudent business managers if we turned our head on this opportunity

To add, the Build Toronto’s chief executive Lorne Braithwaite is quoted as saying:

The market is hot as a pistol and we are about to generate funds for the city and create a fantastic new development

So now we have “a creative response” that “represents a sure thing” that relies on a condominium market that in six years remains “hot as a pistol”

I haven’t heard such a combination of positive will and high risk since friends told me to buy RIM at $140/share just three years ago. Thankfully that sure thing in a hot as a pistol telecom market panned out. In only three years it’s lost 88% of its value. One can only hope it keeps performing as well for the next three years!

I didn’t buy any RIM, and I don’t buy into a municipality becoming a developer.

Follow Up To Post “Toronto Condo Sales Are Freaking Insane”

While the post was just two days ago, there have been two great articles that back up my concerns, and add a few more. For good reading (what I see) on the likelihood of a Toronto condominium bubble burst – check out the following:

Troubling Signs for Toronto’s Condo Market

Absorption Rates

While I do shout concern about a correction in Toronto, I don’t think it’s anywhere near Miami’s folloy, where prices dropped 50% from their peak. While Toronto shows the same investor levels for pre-construction purchase (70-80% in Toronto, and then in Miami) – Toronto has two things that would help mitigate some drop: it is a financial centre (financial center condos will always outperform the rest of the market), and it’s not a snowbird getaway – it’s a primary residence location.

The bigest take away from all these articles recently – $800+ psf is definitly already gone, and it looks like reasonable top end cost is about $700 at the moment, and a 20% reduction or bubble pop would put top costs at $560-$600 psf.

Toronto Condo Sales Are Freaking Insane – Still Think it is Speculation Driven

Toronto is Hot Hot Hot baby! The National Post is reporting – for only January through August 2011 – 18,055 new (NEW) condo units were purchased for $8.1 billion. That’s about $449,000/unit. Like I said – HOT!

We know that more than 50% of those are investor (non-resident) purchases which run highly leveraged (usually 25% down) . The Financial Post runs a good article where one of the showcased examples is an investor with seven properties – holding 2 million in value with 700k equity.

Based on some averages, the investor is spending about 100k/year on mortgages, condo fees, insurance and tax. The investor – if 100% rented all the time is likely pocketing about 34k/year. The game here is the investor is hoping the 7.5% yearly appreciate in condominium value for the last 15 years continues. With that, he’s pocketing and extra $150k/year. Not bad for the risk – $185k/year in income and equity.

So here are the concerns.

For the full year, Toronto may add upwards of 27,000 new condo units on top of current inventory. That’s 45% more than any other year on record. There is also that much inventory slated to be added each year for the next 3 years.

Second, real estate is hot because US, Europe, and many other jurisdictions are facing or have experienced a housing crash with no certainty of recovery. While New York announces the most expensive pre-sale units in history, large multi-story developments have been shelved right left and centre. If Europe tanks, housing prices are going to go low, low, low. With that, international investors have been buying Canada because of our stable economy and the start power of Mark Carney.

When local markets pick up in the US and Europe the money parked in Canadian real estate will flee back to their home countries.

Finally, even in the Canadian banking town Toronto (and I’ve said that banking cities will always perform well for real estate compared to the rest of the country), incomes are flat and the middle class is being squeezed (Bank of Canada indicated last month that income disparity grew significantly last year). That means there is a question if rent levels (which equal investor cash flow) can be supported – or if they will stagnate.

If we are lucky, because Toronto is our financial capital, we could see Toronto continue to appreciate every year until we have prices similar to New York. It’s not out of the question. But investor money is fickle. Both foreign and local money is sensitive to price change, and a slow down in Toronto cost per sqare foot will create a feedback cycle that would be vicious.

When Investors Abandon Units Owners Suffer Greatly

Ten weeks ago, Bank of Canada Governor Pat Carney warned that housing prices are now 4.5 times average household disposable income, or 30% higher than the 3.5 average of the last quarter century (In Vancouver they are 9.6). Further, he indicated that this is being driven by greed among speculators and investors. In Toronto, 60% of construction sales are by investors.

If the market value of condominiums comes down and as such triggers lower rental rates, investors will abandon under-water mortgages and incomes that don’t meet their bills. It’s hard to see this in the active market we have now, but all overly inflated values must mute, or drop, in value at some time.

Legislation in many regions of North America fail to do a very good job protecting owners in multi-residential dwellings when other owners stop paying their condominium fees, triggering a foreclosure on the deliquent units in order to recover the owed money to the corporation. For palces with poor legislation, when a unit is foreclosed on, the proceeds of the sale first go to the mortgagee, and not the condominium. The causes a chain of events that only further depress the value of the units, and jeopardize a large number of other owner’s homes.

For West Meade Condominium complex in West Nashville Tennessee, the chain of events has happened – 57 investor owned units in a 112 unit complex stopped paying their contributions, leaving the condominium $355,000 short on budget and repairs. Because there isn’t the money for maintenance, the building (and the value of all the units) is suffering. Because of decreased property value, the 57 units which have been court ordered to sell will likely garner less than the mortgage values. This leaves 55 upstanding owners in the hole for that sum on top of their own commitments to the corporation.

West Meade Condominium, without the owed amount, will be unable to meet ongoing insurance and utility bills, forcing the condominium into bankruptcy. Imagine as an upstanding owner having to move out of your home because of another owner’s fiscal imprudence.

In better jurisdictions, the condominium has first standing to collect fees owned. That means before the banks, and even before back taxes, the condominium gets paid out of the proceeds first. This is a fantastic situation. By giving the corporation first standing in a foreclosure (and also creating generous legislation allowing condominiums to bring their units to foreclosure on non-payment of contributions), the government protects the other owners from fiscal ruin, from non-maintained buildings, and from spiraling downward housing prices.

Good legislation for condominiums is important – especially given the fact that some owners can cause unchecked misfortune to others due to the nature of shared housing. With housing being a primary equity and destination of most people’s productive lives, housing requires more thorough consumer protections.

Banks are a form of commercialized savings. Housing is a form of self-directed savings which has significantly more public equity than all the banks combined. We’re willing to create massive legislation to protect bank based savings, we need the same friendly legislation for the most common and accessible public form of savings as well – people’s houses.