In its recently released Financial System Review, the
Bank of Canada once again flagged the Toronto condominium market as a key risk.
Given the high level of attention this has received in the media, Urbanation
felt it necessary to provide responses to their messages:
Of course it does. Construction in the Toronto condo market
adjusts to changes in demand with a 12-18 month lag because the majority of
units that start construction are sold well in advance during pre-construction
sales campaigns. That means the slowdown in sales activity over the past year
will work down construction volumes in the year ahead. But don’t expect a
dramatic slowdown as roughly 30,000 units were in pre-construction at the end
of Q1-2013 and were collectively 60% sold.
The total number of units under construction will continue
to remain above its long-term average because there has been a dramatic shift
towards high-rise at the expense of low-rise development in recent years. Since
high-rise projects stay under construction for a lot longer than low-rise
homes, the total housing supply under construction is ultimately boosted
relative to historical averages or the population.
“The number of unsold high-rise units in the
pre-construction and under-construction stages has remained near the high
levels observed since early 2012. If the upcoming supply of units is not
absorbed by demand as they are completed over the next 12 to 30 months, … [it
increases] the risk of an abrupt correction in prices…”
Unsold condo inventory numbers are the most misunderstood
statistics about the market. It’s very important to understand that the
majority of unsold units are in projects that are still in the pre-construction
stage. If these projects haven’t sold enough units to meet their conditions for
construction financing (typically 70% or more), they won’t begin construction
until they do, or will perhaps be cancelled. So, most of the unsold inventory
reported today will either never materialize or have several years to be
absorbed prior to completion.
The projects that are under construction remain 89% sold —a
figure that hasn’t changed over the past year. While the number of unsold units
has risen with more projects under construction, this represents little risk to
the market. The construction process is lengthy and by the time the average
project arrives at the completion stage, it is 95% sold. Even if sales stall at
the 85-90% mark, the developer will generally turn a profit by this point and
can be more aggressive with its incentives or opt to hold onto the units after
completion and rent them out. As of Q1-2013, there were about 600 unsold units
at recently completed projects – a level that is virtually zero in comparison
to the size of the market and one that can withstand increases without
threatening prices.
“If the investor component of demand has boosted
construction in the condominium market beyond demographic requirements, this
market may be more susceptible to shifts in buyer sentiment.”
Tough to argue with that. Investors have likely
purchased about 60% of units that are under construction today. If they all
came to completion in a short span, the majority decided to sell and
demographic requirements declined, prices would no doubt fall. It’s possible,
but not likely.
In the absence of an economic shock, household formation in
the Toronto CMA is likely to continue averaging approximately 35,000 households
per year (as it has over the past three census periods). With low-rise housing
seemingly capped at 15,000 units per year going forward, a 20,000 unit gap is
left for high-rise to fill. Based on historical trends, capacity constraints
and construction progress to-date, it appears unlikely that many more than
20,000 condos per year will be completed over the next few years.
Furthermore, most investor-held units are likely to continue
flowing into the rental market, where demand is currently running at a 20-year
high, vacancy rates remain close to 1% and very few purpose-built rental
apartments are being constructed. There is little reason to believe there will
be a major shift towards investor flipping – if short-term speculators were the
majority of buyers, there would have been a much stronger run-up in prices than
7% per year over the past five years (In the previous cycle, condo prices
increased by 170% from 1985 to 1989).
It’s true higher investor involvement in the market raises
risks to prices because they are more prone to shifts in sentiment, and there
is no way of being certain that the economy and demographic demand will remain
stable. While it’s important to continue closely monitoring the market, these
risks appear to be well contained at this point. Actually, without higher
investor involvement, the market today may have been facing a different – and
perhaps more difficult – set of problems. Supply would be much more
restrictive, causing prices (and perceived overvaluation) to be even higher and
a severe shortage of rental properties.
