Monday, May 14, 2012

Is the Sky Falling? Real Estate / Bubbles

We put out our Q1-2012 press release last week at about the same time that CMHC released their housing starts data, both generated a plethora of news stories on Toronto real estate, especially the 'overheated' condo market (overheated being the media word, not Urbanation's).

We were truly shocked at how many different newspapers, magazines, and other online sources picked up the story or enquired about the data. Nearly all of these articles included the word "bubble" in their pieces, many with dire warnings of oversupply of units and unsustainable prices. Now Urbanation has commented several times that we do not think the market is experiencing bubble conditions based on the definition of the word, but we have issued our own warnings about the increasing level of unsold supply in the new condominium market and the potential for as many as 25,000 to 29,000 condominium apartment completions in 2013. Our question regards the media's treatment and/or coverage of the info. Is their inclusion of the word bubble in every article just good reporting, a review of a topic that is on everyone's mind, or is it typical media sensationalism?

If you read the comments posted under these articles, you will see that most of the people that comment believe the market crash is imminent. The worst thing is, there appears to be a lot of people that are actively rooting for it! Perhaps we are reading too much into it, but there appears to be a hatred for condominium investors, with commenters hoping for these people to "crash and burn". If you take extreme pleasure in the financial failure of others and actively root for the explosion of your own housing market (so you can afford a unit), then we think there is seriously something wrong with you! If the housing market crashes, there will be a lot of misery, a lot of lost jobs and a lot of losses in the financial markets that would likely hurt these people as well. Be careful what you wish far, not all people that are successful had it handed to them, some worked very hard to get there.

There are no shortage of these folks on the internet, and a great place to find them in on the websites of the notorious market bears. Urbanation has been accused of being biased positive towards the market, that we are a market bull (a mouthpiece for the industry, one person wrote online), despite the fact that we put plenty of 'negative' points in our press releases, and issue our own warnings about the condominium market in the Toronto CMA. Media feeds people's fears and we would be lying if we said we try to put a little fear in the minds of our clients so they feel the need to keep reading our reports (sorry folks)!

In addition, if these market bears were so unbiased, would they be trying to sell you their book, would they be selling advertising on their websites? Sensationalism leads to website clicks and book sales, they can't deny that. This is a debate for another day, but the point is that it is very difficult to be 100% unbiased, especially when there is a financial incentive to take a specific angle.

As long a prices continue to go up in the new condominium market and buildings continue to break ground we will continue to see these articles in the news, however slanted they may be. The problem is that without sufficient data or limited data it is easy to make up a believable story about what is happening out there.

A great example is a story that an bank economist has been telling lately that the rising prices in the new condo market has made almost all investor held units cash-flow negative and they will flood the resale market with units and depress pricing for everyone. Sounds plausible right? The first part is actually based on truth, but the conclusion is based on no factual evidence. If an condominium investor is putting a minimum 15% to 20% down, then yes, they are likely to be in a monthly negative cash flow situation based on their carrying costs (we'll skip all the details). However, based on many of my discussions with agents, brokers, developers and mortgage insurers, many investors are putting much more down when arranging their mortgage, or others are 'adjusting their financing' to put themselves in a positive cash flow situation. In reality, when we ran the numbers on recently registered buildings (past 6 months), only 10% of the inventory in those projects were listed for sale on MLS in Q1-2012, compared to 12% in Q1-2011 and 13% in Q1-2010 and Q1-2009 based on the same metrics. Contrary to what most people would think, the increased level of investor activity in the market has resulted in LESS units listed for resale upon building registration! The minimum down payment investor must have disappeared because the condominium rental market is as hot as ever and there is no rush to sell these units by investors.

A second article warned of foreign buyers snapping up the new condominium units and causing prices to be elevated for everyone! Ban foreign buyers was the conclusion, keep prices affordable for Canadians (it wasn't Don Cherry that wrote it by the way). We have estimated that approximately 10% to 15% of new condominiums are being purchased by foreign buyers, but in a recent television interview, 70% foreign buyers was thrown out by the reporter! This is beyond false and irresponsible journalism. In reality, these foreign buyers are creating more supply in the market and keeping prices down! Foreign investors buy in a condominium projects during the pre-construction phase and help developers reach the 65% to 80% pre-sales required to secure construction financing; they also create a sense of urgency to purchase in these developments when people see how fast the units are moving. Without these foreign investor buyers, many of these projects would not have gone ahead, as many end-users are sceptical about investing in pre-construction and don't have the 15% to 20% to put down. These foreign buyers help these projects get sold in a financially viable time period and hold the units for end-users until registration (or 3 to 5 years after registration), so these end-users can purchase them with 5% down in the resale market.

For an aside to the point made above, the majority of the foreign investors plan to hold and rent their units. So let's do the math. About 20,000 new condominium sales in the CMA, so 3,000 are purchased by foreign investors. So if they sell all 3,000 at registration, then that wouldn't lead to an increase in prices, the extra supply would lead to a decrease in prices! Now if they hold and rent all 3,000 units, would that lead to an increase in Toronto prices? - that really depends on where they set their rents and how they compete with other investor units, but in reality the additional supply of suites would likely depress prices, not increase them. If we had a foreign company come in and build three 500 unit rental buildings in Toronto, one in North York, one in Mississauga and one in Markham, would anyone really care? - the response would likely be very positive!

In closing, be wary of who you trust when reading these articles, there is always another explanation, or another angle to be explored with every story (but look for statistical back-up to their claims). We will try to bring you some of these alternative angles on this blog and in our articles in the New Condo Guide.


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