This is the second part of a Blogpost that responds to research findings reported through a recent Globe and Mail article that states condo rents are declining.
This post will address the validity of the claim made that
“the Toronto rental market may no longer absorb supply as it comes on-stream,
resulting in lower rents and increasing cash outflows for landlords…”
The first part to this blog post addressed the more glaring
issues related to the quality of the research conducted that found condo rents
are declining.
Condo rents are not
falling
As mentioned in Part
1 of the blog post on this topic, Urbanation tracks condo rental activity
through the MLS system, which we estimate covers at least two-thirds of the
market. We marry transaction data with
our own proprietary database of square footage measurements for condo units,
first taken from developer plans and then verified post-registration from surveys
submitted to the land registry.
Our data shows that
on a per square foot basis, average rents in the third quarter grew by 4.2%
from last year. While a rising inflow of newly completed units with above average
rents per sq ft are helping to push this level higher, our same-sample analysis
(using only buildings common to Q3-2012) still shows rents are growing, albeit
at a slightly slower pace of 3.5% year-over-year. This reflects a market that
is starting to balance out following three years of exceptional growth in rents.
But note that the rentals-to-listings ratio remains elevated at above 70%,
which still supports further growth in rents.
Demand will be able
to absorb new supply
We expect that the
emerging trend towards more balance in the rental market will gradually
continue over the next couple years. As more units come to completion, more
investor-held units will be listed for rent. But it’s important to recognize
that rental demand is currently running at a 20-year high, driven by such
factors as reduced ownership affordability for first-time buyers, strong growth
in the population aged 25 to 34 and migration into the core. This, combined
with the lack of growth in conventional rental supply, is why vacancy rates
remain near historic lows despite the growing supply of condos — which made up
85% of the growth in rentals over the past 10 years.
Assuming a flat profile for household formation and
ownership rates, the number of net new renter households will average around
10,000 per year out to 2016. Over the same period, condo completions are expected to average 20,000 units per year. Assuming 60% of these units are
owned by investors and 3/4 will list their units for rent, we will see an
average of roughly 9,000 condo listings per year from new completions. While supply
can also be added from older condos (as owners hold onto their units after
moving out) and some new purpose-built units, the point is that demand and
supply should remain at similar levels.
This isn’t to suggest that the market won’t change — we
firmly believe that more balance is on its way. Realistically, there are likely
to be short-term periods of weakness experienced in selected areas of the market over the next few years. But on the whole, the market should not
experience a pervasive decline in rents. However, this may not be enough to
keep some investors from looking to sell their units. It’s no secret that cash
flow margins on rental units have become squeezed, and they will remain that
way as higher priced units enter the market and rent growth slows. But with
vacancy rates expected to remain low, the equity accumulation inherent in
having a steady stream of rental income go towards mortgage costs and principal
repayment will continue to encourage most investors to hold.
Condo investors recognize the advantages that leveraging a
low-cost mortgage brings, as well as the sense of security in owning a piece of
property, which is particularly shared among new immigrants who tend to be big
purchasers in the market. So it’s difficult to assume that because unlevered
cap rates are below financial market dividends that investors will begin to
suddenly change course.
History has taught us that supply tends to direct itself
towards where demand is strongest. The exceptions being when owners are forced
to sell because they can’t close on their homes or can no longer afford their
mortgages — neither scenario should have enough prevalence to impact the
market. Should the economy remain stable and interest rates remain low,
mortgage arrears will remain near historic lows (0.31% in Ontario as of August
2013). As a greater volume of units come to completion, there will naturally be
more reports of buyers struggling to close on their units, but they will
continue to represent a very small minority. The vast majority of units set to
complete have deposits paid of at least 15% (equal to around $60,000 on a
$400,000 unit) — buyers will do whatever they can not to lose their investment.
They have also been pre-qualified to close – something banks require before
advancing construction loans (despite reports of the contrary).
The market will be challenged by resisting forces for price
and rent growth over the next few years, but should remain stable in the
absence of any strong deterioration in confidence. The media can help to
prevent this by, at minimum, offering readers a more balanced selection of
informed opinions on the market.
Part 1 - Do Condo Rents Look Poised to Fall?: http://urbanationinc.blogspot.ca/2013/11/urbanation-response-part-1-do-condo.html
Part 1 - Do Condo Rents Look Poised to Fall?: http://urbanationinc.blogspot.ca/2013/11/urbanation-response-part-1-do-condo.html
