The Bank of Canada is warning that an “abrupt correction” of Toronto’s overheated condo market could quickly spread to the rest of the housing market, threatening the broader economy.
The central bank reiterated its concern Thursday about a glut of unsold condominiums, particularly in Toronto, in a twice-yearly review of the health of the financial system.
Now, that sounded serious.
Canada’s real estate is literally on fire …
Toronto condo market could destabilize economy, Bank of Canada warns
High number of unsold units in construction phase pose ‘elevated’ risk to economy
The Bank of Canada is warning that certain overheated segments of the housing market could put Canada’s economy at risk and has again singled out Toronto’s condominium market as an area of particular concern.
In its latest assessment of Canada’s financial system, the central bank said that imbalances in the housing market and high levels of household debt still pose an “elevated” risk to the stability of the Canadian economy and are the two biggest risk factors on the domestic front — with the eurozone crisis presenting the biggest threat internationally.
It said that while house prices have stopped rising in most major urban areas and housing starts, resales and overall housing demand have slowed, there are still signs of overbuilding and overvaluation in some parts of Canada’s housing market.
The warning comes as Statistics Canada reported the price of new homes nationally rose 0.2% in April from the previous month. Economists had expected an a 0.1 increase.
House prices are high relative to income and housing affordability could become a concern when interest rates begin to normalize
The bank cautions that its unravelling scenario is not what it is predicting. In fact, it still expects the correction in the housing market to go smoothly.
“Nevertheless, simple indicators continue to suggest some overvaluation in the housing market; house prices are high relative to income and housing affordability could become a concern when interest rates begin to normalize,” it adds.
The continuing highlighting of household imbalances, despite noting that the risks have in fact lessened somewhat in the past six months, suggests the central bank remains worried that with interest rates likely to continue at near emergency low levels, the dangers of something going off the rails intensifies.
“If the upcoming supply of units is not absorbed by demand as they are completed over the next 12 to 30 months, the supply-demand discrepancy would become more apparent, increasing the risk of an abrupt correction in prices and residential construction activity,” the bank said.
Almost all of that construction activity is in the area of multiple-unit dwellings of the condominium variety.
The fallout would hit jobs, incomes, and consumption and eventually undermine bank loan portfolios, according to the report.
The bank’s assessment of the housing market echoes that of the Organization for Economic Co-operation and Development (OECD), which last week issued a report that identified Canada’s housing market as one of the three most overvalued among advanced economies.
Condo market dip could have ripple effect
The bank said Canada’s housing problem is particularly acute in Toronto, with a large number of unsold highrise units that are under construction or in the pre-construction phase. If these units are not sold over the next 12 to 30 months as they are completed, it could cause prices to fall and bring residential construction to a halt, the bank warned.
If investor demand has boosted condominium construction beyond demographic needs, this could make the market more susceptible to shifts in buyer sentiment, the bank said.
That, in turn, could blow back on other parts of the economy.
“Any correction in condominium prices could spread to other segments of the housing market as buyers and sellers adjust their expectations,” the bank said in its analysis. “Such a correction would reduce household net worth, confidence and consumption spending, with negative spillovers to income and employment.”
If the correction to the imbalances in the condo market is sudden rather than gradual, it could provide an unwelcome jolt that has the potential to reverberate not just in other segments of the housing sector but across the economy.
While borrowing costs remain low now, the spillover effects from a sudden dip in the condo market could “weaken the credit quality of banks’ loan portfolios” and result in tighter lending conditions for households and businesses, the bank said.
“This chain of events could then feed back into the housing market, causing the drop in house prices to overshoot,” the report said.
Sharp deterioration ‘unlikely’
The housing market could be thrown off by any number of factors, such as an increase in interest rates, an economic downturn or a deepening of the eurozone crisis.
RBC assistant chief economist Dawn Desjardins agrees that a sharp decline in the condo market could have a ripple effect.
“People see that market deteriorating — do they suddenly feel very concerned about whether it is going to bleed through the country? [Do they ask,] ‘Should I be selling or perhaps not buying as opposed to moving on with a purchase?’
“That’s the kind of trickle-through that we see in terms of a possible scenario, but I think it would have to be quite a pronounced deterioration in that one particular market for that result to actually occur.”
The bank’s scenarios, she says, are just that — and are different from its “base case” outlooks, which are much more about what the bank thinks will happen rather than what could happen.
“It’s just kind of food for thought and to direct people’s attention to areas where there’s possible trouble down the road, but in no way is it imminent — and, quite likely, won’t happen at all,” Desjardins said.
No Bubble In Sight
The Bank of Montreal weighed in on the debate Thursday, accusing people of “bubble mongering” and exaggerating overvaluation fears. In a report, senior economist Robert Kavcic acknowledged that prices aren’t cheap in Toronto and elsewhere, but he said the real-estate market is still “miles away from the severe bubble conditions of the late 1980s.”
Despite its warning about real estate, the Bank of Canada concluded the risks facing the financial system “have decreased somewhat” in the past six months, according to the review – the first issued from the bank under the watch of new governor Stephen Poloz.
Outlook more positive than 6 months ago
Desjardins says the bank’s June assessment is not that different from its earlier report in December and is overall more positive in tone, painting a picture of a less-threatening environment than six months ago.
Indeed, the bank said in its analysis that “recent developments in the housing market have been encouraging” and that it expects the housing market to correct itself gradually.
The household debt picture is also improving, with the pace of debt accumulation now “broadly in line with the growth rate of disposable income,” although a rise in interest rates could still leave some households vulnerable, the bank said.
The risk to Canada’s economy from a eurozone still in recession remains “very high,” with economic activity in the region “constrained by fiscal austerity, low confidence and tight credit conditions,” the bank said.
Weak economic activity, a fragile banking sector and vast differences in competitiveness between the countries that make up the currency union are a drag on the eurozone’s recovery efforts and pose a risk to the stability of an interconnected global financial system, of which Canada is an important part.
Economic growth in Canada picked up in the first quarter of 2013 after a weak last quarter of 2012 but is still being dragged down by “deficient demand” in the global economy, the report said. The economy also faces some risk from the prolonged period of low interest rates, which has led to increased risk taking.
Europe Could Be The Culprit
The bank cited an easing of short-term risks in the United States and Europe, the modest global economic recovery – and a “constructive evolution of imbalances” in Canada’s housing sector as the growth of household lending has tempered. The bank noted, for example, that household debt accumulation has continued to slow and is now “broadly in line” with growth in disposable income. It also said housing starts and prices have stopped rising in many markets.
The report warned that housing prices in this country could be subject to “a sharper correction” than the so-called soft landing now under way, stemming from the globe’s chronic economic problem child: Europe.
The bank drew a line from Europe to Canada by warning that if the euro zone can’t find a way to proceed with badly needed fiscal and structural reforms – an area where “little progress has been made” – it could mean a prolonged return to financial health for the area’s countries and banks.
That in turn could “undermine the political will” to proceed with needed reforms and expose the region to “an adverse shock [that] could have a significant impact on the Canadian financial system through financial, confidence and trade channels” and spread to the balance sheets of Canadian banks and the domestic economy overall.
“The most important risk to financial stability in Canada continues to stem from the euro area,” according to the report.
Over all, the Canadian financial system “remains robust” as Canadian banks maintain healthy balance sheets and have an abundant access to low-cost funding and corporate leverage “remains near all-time lows,” the Bank of Canada said. But given the risks from abroad as well as the domestic housing situation, the overall level of risk is “high” by the bank’s assessment.
What Now ?
Well, they say try the small little (and mostly “rotten”) bungalows instead ?
In Toronto, the market’s sweet spot is the humble bungalow
CAROLYN IRELAND The Globe and Mail
The “cute little bungalow” has long occupied a popular niche in Toronto’s real estate market, but in the past it was usually considered a starter home for couples who would move up to something bigger as soon as they built up a bit of equity. This spring the popularity of the circa-1950 post-war bungalow seems more conspicuous as so many buyers go after it while other segments stagnate.
Geoffrey Grace, an agent with Re/Max Hallmark Realty Ltd., has observed the extreme demand for bungalows and often nudges buyers toward them. He is even thinking about the day when he might buy one as an investment property himself.
“If you’re selling a penthouse for $15-million, how many buyers are out there?” asks Mr. Grace.
Mr. Grace points out that builders like to buy bungalows and either top them up or tear them down. The traditional first-time buyers continue to seek them out, and downsizing baby boomers often prefer them to condos.
Buyers of real estate should always think about the size of the potential target market if they eventually decide to sell, advises Mr. Grace.
Even as real estate sales in the Greater Toronto Area slumped 9.7 per cent in the first two weeks of May compared with the same time last year, some bungalows in popular neighbourhoods were attracting multiple offers.
In Don Mills, a three-bedroom bungalow with an asking price of $588,000 sold for $670,800 after one day on the market.
Mr. Grace was tracking one bungalow listed for sale in Parkview Hills, which is a secluded pocket in East York, just across the bridge from the coveted community of Leaside.
“Some people are getting priced out of Leaside,” says Mr. Grace. In that popular neighbourhood, bungalows sell for more than $1-million to builders who immediately tear them down.
The house Mr. Grace was watching was listed with an asking price of $599,900 and sold for a little less than $700,000 with at least four offers.
Mr. Grace was keeping a close eye on the deal because he was preparing to sell a house on the same street that started life as a bungalow and was later topped up.
That’s also a good strategy for first-time buyers, says Mr. Grace, because bungalows can be expanded and renovated in ways that semi-detached houses and townhouses can’t.
They also tend to have larger lots and a private drive whereas a semi may have no parking at all.
Empty nesters buy bungalows because they don’t want to move again years later when they can no longer climb stairs.
“For the downsizers, they are really targeting the bungalow because they want everything on one level.”
For investors, a good strategy is to buy a bungalow and rent out the basement to one renter and the main floor to another.
“It’s something I have my eye on for an investment down the road,” he says.
Mr. Grace points out that the diminutive houses are becoming a rare breed in Toronto as they’re replaced with larger houses. Most of them were built after the Second World War when troops were returning from overseas and the baby boom started.
Mr. Grace was evaluating one such bungalow when he met one of the original owners on the street.
“The lady two doors down said, ‘I bought mine for $3,500.’”
And here is a tip on how to win bidding wars …
How a real-estate pro fights a bidding war
RICKY CHADHA The Globe and Mail
Question: We’ve lost three bidding wars for semis in Leslieville in the last four months and we’re getting a bit depressed. I thought the market was slowing down? What gives? Is it just Leslieville?
Answer: At first if you don’t succeed; try, try again! Then move to the ‘burbs.
Your experience is a common theme in today’s Toronto marketplace. And no, it isn’t just Leslieville – several communities in the core from High Park to Roncesvalles to the Beaches have real estate action that’s just as competitive.
Many reports say the market is slowing down, and while that may be true in some areas, there are many Toronto-area neighbourhoods where resale housing continues to be red hot. This is especially true in the coveted $400K to $600K range. And it isn’t just downtown – I’ve seen and been a part of bidding wars happening in suburban locations such as Pickering and Ajax too.
That said, even though prices are at record highs in the city of Toronto, there has been a general slowdown in the number of houses sold year over year. But I still don’t think its’ a good idea to try to “play” the market. Sure, prices may be high but the cost of borrowing is still at record lows. If the market does cool, the opposite will hold true for interest rates. This effect will essentially nullify any such price drops.
For example, take a house priced at $500,000. With a 5% down payment and a five-year fixed rate mortgage of 3%, your monthly payment would be about $2,250. If there happened to be a price drop of 10% on the home’s value and an increase of 1% in interest rates, your monthly payment would be virtually the same.
In one of my previous columns, I discuss some specific strategies when going into a bidding war. Have a read for some input on how to deal with conditions when putting an offer on a home. I specifically talk about the home inspection clause, but a similar strategy would hold true for including a financing condition.
In short, the only way I would forego the financing condition is if I had absolute assurance (in writing) from my lender that my financing would not be a problem for a specific home at a specific price.
The next piece of advice: Try to keep your emotions out of the offer process. I know this is easier said than done, but I’ve seen countless situations where potential buyers throw caution to the wind and start throwing out numbers that artificially inflate the value of a home. All strategy, budgeting and reasoning goes out the window in the heat of the moment. You need to set a hard cap on what you are willing to pay, and stick to it. I mean, absolutely stick to it!
Following my advice, you may lose a couple more bids. Just know that the right house will eventually come to you. Your patience will be tried and tested at times, but you will end up with the piece of mind that you acted rationally and made a sound financial decision.
Ricky Chadha is a broker with Royal LePage Estate Realty in Toronto, and specializes in applying social media and other digital tools to the business of real estate. You can find Ricky on Twitter @your416 or at his website RickyChadha.com.
Oh, boys … that’s kind of tough, isn’t it ?