Toronto condo boom stirs bubble fears

Market watchers warn 20% to 30% return on investment is unsustainable

When is a bubble not a bubble?

That’s the big question Toronto economists and developers have been trying to answer in regard to the red-hot condominium market in the city.

Toronto, with high-rise condo towers sprouting like last decade’s Dubai, looks like a bubble ready to explode, but there are plenty of local pundits who say, "Nay, this city can handle every condo unit coming its way."

Here’s what’s going on: In 2010, about 15,000 condo units came into the market, and this was followed by a record year in 2011 with 18,000 more condo units opening up.

The market is really just gearing up. "We will average something closer to 20,000 units over the next couple of years," said Shaun Hildebrand, senior market analyst for Canada Mortgage and Housing Corp.

It gets better.

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"We will end up 2011 with a record of almost 27,000 condo sales, that will be about 3,000 more than the previous record in 2007," said Ben Myers, executive vice president of Urbanation Inc., a Toronto condominium market research firm.

What’s happening to all those units coming on line? Most are being rented. According to Myers, the vacancy rate for condominium rental units stands at an extremely low 1.1 percent.

All that good news caused a full-frothing frenzy among developers. Myers estimates there are currently 43,000 condo units under construction.

Those kinds of numbers make others a little nervous. Francis Fong, an economist for TD Economics, has cautioned that the Toronto region is at risk for a correction. And a report by Bank of America Merrill Lynch Global Research warns the Toronto condo market appears to be overheating and flooded with excess supply.

These people don’t know what they are talking about, said Myers. "Whenever people see these numbers and all the cranes, they assume it must be a bubble or oversupply. A lot of these people are not really in the market and don’t understand what’s happening. They like to look at rent-income multiples and draw conclusions (based on) a few variables. It’s not the case here. We are getting tremendous investor purchasing."

That’s what worries me. Of all the residential sectors, the most capricious is the condominium market. A condo is generally cheaper to buy than a single-family home, easier to rent, and more subject to flipping. As a result, condo markets are prone to a lot more price movement up and down.

All this is exacerbated by investor interest as opposed to buyer/resident purchases, because the latter is more stabilizing.

Investors are a quirky, skittish group and at the first sign of market destabilization they will flee the investment sector en masse faster than an avalanche in the Canadian Rockies.

What makes the Toronto condo investment market even dicier is that a lot of buyers are foreign, who tend to come on strong in a given market — then when things start to slow they move elsewhere.

Even Hildebrand, who remains bullish on the Toronto condo market, sees there might be limitations ahead.

"The way it works in Toronto," he said, "is developers will offer their units at preconstruction sales centers to investors or brokers that represent investors in order to generate a high sales threshold in order to get construction loans.

"The goal is to sell as many units a possible. Anecdotally, a lot of the investors are from the Asian community. The number of units selling at preconstruction sales centers is very high — in fact, probably unsustainable."

Toronto pundits should look at what happened in Richmond, Canada, in the province of British Columbia, where a year ago Chinese investors piled into the Vancouver suburb making it the hottest residential market in North America. Then when prices soared into the stratosphere, the buying mania just petered out.

So far, the Toronto market has been able to absorb all the new construction with the number of unsold units very low, Hildebrand said, concluding that "in the absence of another recession, we should continue to see a stable demand for condos."

What’s probably going to happen, he said, is that with supply growing at such a rapid clip, price appreciation will slow down considerably.

"The days of seeing a 20 percent to 30 percent return on your condo investment within a few years are gone," he said. "We will see a much slower rate of price appreciation. Investors that are betting on speculation probably shouldn’t be in the marketplace now."

Pricing hasn’t gotten out of control in Toronto, Myers said. "Prices have gone up moderately, 7 percent to 9 percent, and the rental market has been moving up at the same pace, 7 percent to 8 percent. As long as those stay in line and unsold inventories stay low, we are not anticipating any kind of major correction."

It should be noted that the one thing Toronto has going for it is population growth. Net migration to the Greater Toronto metro is close to 70,000 people a year, said Hildebrand. "There is a strong demand for new housing."

Myers puts the migration number at 100,000 new people moving into the Toronto area every year.

"Some reports say this is the typical amount of apartment formation, but there has been a real switch to condo living," Myers said.

"We are not building any new roads into the downtown (highway infrastructure development in the Toronto has been extremely laggard); commuting is a problem; people are getting married later and staying single longer; and because of greenbelt legislation there is a lot less low-rise housing. All those factors are increasing our household formation and pushing people toward condos."

All good arguments, but is it enough to prevent an economic bubble situation? Only time will tell who is right and who is wrong. "Eh?"

Steve Bergsman is a freelance writer in Arizona and author of several books. His latest book, "Growing Up Levittown: In a Time of Conformity, Controversy and Cultural Crisis," is now available for sale on Amazon.com.

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