Tag: #realestate

Canada’s Supply Crisis Will Get Worse Before it Gets Better

It doesn’t take an evil genius to realize that the main thing driving housing costs so high in Canada around major economic centres is a lack of supply compared to the crazy demand we have. Last year we welcomed over 1,000,000 people to the country from immigration, international students, and most recently war refugees. Similar numbers are expected for 2023. The housing crunch will only continue to get worse because our pace of construction is not currently and likely cannot keep up with the demand anytime soon. There are a lot of things that caused these problems and continue to make it challenging to solve them, today I’ll discuss a few of them.

A study back in 2020 between Urbanation and the Federation of Rental Housing in Ontario was anticipating a rental unit shortfall of 200,000 units in the coming decade a new report published just 3 years later quotes the shortage at 300,000 units. The pandemic economy is one big factor that likely made these problems worse. The  momentum of building new housing slowed temporarily and construction costs exploded as inflation took hold. Followed shortly thereafter by the rapid increase in interest rates. This meant that simultaneously while costs were still high, the cost of money was also high. Causing many rental and condo projects to be outright cancelled or delayed. This means that around 3-5 years from now when construction was supposed to be completed on all these new pre-construction projects that didn’t sell this year, as well as rental housing projects that were stopped due to cost overruns. We will experience even tighter supply on the market due to the high interest rate environment we are currently experiencing.

Secondly, we stopped building rental housing through the 80’s and 90’s for a variety of reasons. Similar to today the 80’s were a period of very high inflation, construction costs exploded, and government policies were put into place which tried to transfer the construction of purpose built rental housing onto the private market. In 1968 the first condominium project was sold in Toronto. They were seen as a way for people to own the apartment they lived in rather than rent it. This aligned with the Canadian dream of “own your home” and made it easier for governments to justify slowing their investment in housing. As we’ve learned from decades of underinvestment and very exclusionary zoning bylaws. In a rapidly growing economy like ours turns out that solely relying on the private market to supply all the housing was not a great idea.

According to this report by the FRPO, Urbanation, BILD, and Finnegan Marshall published February 9, 2023. They state that purpose built rentals made up 9% of new rental housing supply in the GTA over the last 10 years and 90% of purpose built rentals were constructed between 1960-1979 (approx. 223,954 units). There is an interesting line in this report that bears quoting, “looking forward, more challenging investment economics should lead to a reduced share of condo investors who buy-and-hold and a lower level of new condo launches, placing more emphasis on the development of purpose-built rentals.” As is stands today around 59% of all condos in the GTA are purchased by investors. However, the report is essentially saying that as construction costs continue to climb, buying condos as investments will become a more and more challenging proposition as the number of units that cash flow positively on closing continues to decline. Construction costs quite sticky and often outpace inflation so it’s unlikely that there will be any relief to make condominiums affordable again.

One shocking and problematic statistic is that we are only on track to add 135,000 new rental units between condos and purpose built rentals, but we will still be short by 177,000 units. One of the biggest barriers to getting projects completed is the development timeline taking on average 100 months, which is about as long as it will take my to pay off my student loans. It will take a focused effort to shorten this timeline as a majority of the delays stem from paperwork, not actual construction. If a lot of red tape does get removed, I think there will be some very good opportunities for developers and people who understand how to re-develop properties into multi-units. They will be contributing to the rental housing supply, and it will likely become easier from a zoning standpoint to push these projects through.

Another interesting dynamic at play here is immigration. Canada was built on immigration, and we have an amazing culture and country that welcomes people from every part of the world to try and build a better life. Canada is a place where everyone should feel safe no matter where you’re from and everyone is connected by the fact that we are all Canadians despite our diverse and different cultures. From an economic standpoint without immigration we would have a declining population, which would mean fewer workers, and with baby boomers retiring the Canada Pension Plan would be somewhat screwed without new workers to replace the ones who are retiring and living longer than ever. So from a purely economic standpoint we need immigration. But one thing is clear, we’ve done a terrible job planning for it.

To be fair, some of it was unplanned, like the war in Ukraine. But even within the immigration which we control, we don’t seem to be managing it very well. There seems to be a consensus brewing that if we plan to welcome so many people, we have to have housing for them to live in. I’ve personally come across some crazy situations in my real estate work, one such situation being students who are living 7 people to a 1 bedroom apartment in Mississauga to keep their costs down while studying in Canada. I can hardly fault them for wanting to save money, but this is not what I would consider healthy living conditions and it is concerning that we are allowing people to live in those kinds of conditions.

There is no easy solution to this problem, but it is heartening to see all this data that is now coming out identifying real numbers on what needs to be done in order to correct course. It is also good to see many new government policies that are addressing difficult zoning restrictions and allowing up to 3 units on almost any pre-existing single family zoned lot, as well as easier application processes for “laneway suites”. We are also starting to see an emphasis on getting people to work in the trades, because even if we approve all these new construction projects, we need people to build them and surprise surprise, we don’t have enough. I could go on for hours about our trades problem as well as zoning bylaws. But for now I’ll leave the discussion here and you want to learn more about how these topics fit into this housing puzzle subscribe to my newsletter because that’s what I’ll be discussing in two weeks! Subscribe to newsletter here.

(Link to next post coming Dec 24, 2023…).

Thank you for reading and we’ll chat soon,

Oliver Foote

The Future of Interest Rates: Will They Fall in 2024?

The economy is like trying to steer a cargo ship but the captain is missing and all the wheels are the wrong size. If you change the angle of the ship heading by 1 degree, you won’t notice the subtle change for the first few minutes, similarly the Bank of Canada’s (BoC) interest rate decisions can take 12-18 months to show up in the data. Well here we are around 21 months since the first rate hike in March 2022 and we’re finally starting to see those decisions showing up in the economy. 

I’m not going to pretend I can predict the future, but I do want to talk about some economic signs that I’ve been reading about recently that point towards the next step in the BoC’s rate setting to be more holds and eventually a rate cut. If I’ve learned anything about this past interest rate and inflation cycle, it’s that things take longer than most forecasters had predicted.  

To being the discussion I wanted to talk about the most recent Monetary Policy report from the Bank of Canada published October 2023. It indicates slightly negative GDP growth in the second quarter (Q2) of 2023 and a return to positive growth in the third quarter (Q3) of 2023. (*Note: Statistics Canada recently reported Q3 GDP as declining 1.06% and revised Q2 up from -0.2% to +1.4%) Their overall projection for 2023 is positive GDP growth. However, the per capita GDP declined 1.6% compared to last year. In my opinion per capita growth is a better indicator of the direction the economy is heading since Canada has a rapidly growing population. This effectively means that on a per person basis spending is declining and our economy is slowing. Additionally, businesses aren’t borrowing as much money to fund their capital expenditures because of the high interest rate environment; more business investment generally indicates a growing economy.

Secondly, the most recently reading of CPI inflation from the Bank of Canada was 3.1% in October 2023 which is getting very close to the BoC’s target range of 1-3%. A decline in gasoline prices was the largest contributor to the lower inflation reading. This also happens to be one of the more unstable components that make up the Consumer Price Index (CPI). Depending on what is happening globally energy costs can be very volatile. On the flip side the BoC has stated that supply chain issues have very significantly improved compared to this time last year. As a result, the bank will likely want to wait and see how things play out in other sectors of the economy in the coming months before making any more rate decisions. I don’t anticipate their decision will come quickly since there are still large components of CPI like energy, and rents which are continuing to be inflationary.

Thirdly, as it relates to housing. The housing market has seen a significant increase in supply over the past 3 months with the fewest number of sales for an October period since 1999 according to an Urbanation based on TRREB data. Due to the higher interest rates many people are opting to rent rather than purchase which has put a significant amount of upward pressure on rental prices. We are entering a seasonally slower time of year where many people tend to put off looking for new housing until the new year, so there has been a bit of a short term softening in rental prices.

However, if housing prices continue to remain elevated while interest rates are high, rents will also continue to climb. Sellers are having a hard time coming to terms with the value their home will sell at right now because there is so much competing inventory on the market. People who took on variable rates during 2021 and the beginning of 2022 are the ones who are hit the hardest right now with their borrowing costs more than doubling since then. Banks have been very accommodating to borrowers in some cases extending amortizations to 40 years or beyond in order to keep people in their homes, which has kept mortgage delinquency rates near all time lows and partly why we haven’t seen any significant increase in bank sale homes or general fire sales.

Continuing on the resale housing side of things, the average selling price of a resale home has increased from this time last year. This is mainly due to a skewing in home sales towards higher priced homes and a significant reduction in activity in the first time buyer category. Move-up buyers are finding homes more affordable comparatively to a year or two ago. Meanwhile, first time buyers are finding themselves priced out because purchasing power has declined 40% from the low rates at the end of 2021. An interesting development in the downtown Toronto core (C01) market is that condos are now oversupplied with 7 months of standing inventory. Part of the explanation for this could be that many investors took on variable rate mortgages during 2021. Since 40% of condos in downtown are investor owned if they bought at elevated prices its likely they are now negatively cash flowing and spending a good chunk of money every month to own their investment which partly explains the flood of inventory. 

This presents a very good opportunity if you are a first-time buyer and want to break into the downtown condo market. Finding a tenanted property could provide more of an advantage to getting a good price. Due to many other buyers purchasing as investors they will likely want a vacant property and will not want to take on a tenant because the rents will likely be too low to carry their new mortgage and applying for an above guideline rent increase in a rent controlled unit can be challenging.

If you earnestly plan to move into the condo and live there for at least one year you can give the tenant 90-day notice and have them move out and move in yourself. Then down the line if you were to move out you might be able to hang onto the property and rent it for market rates and use it to leverage into your next property. If my prediction that interest rates will come down in the coming years turns out to be correct, your property will likely see accelerated appreciation as rates get cut, as well as lower mortgage payments if you were to take on a variable rate mortgage.

In a few years you could refinance and lock in a fixed rate then take out some of the equity from the property to the point where it would can cash flow neutrally. You can then use that cash to put a down payment on the next property, rent out the old one, repeat. Even if you don’t want to refinance, I think a lot of would-be investors and first time buyers don’t quite understand the opportunity that this market presents with the ultra slow sales, pick of the litter (lots of supply), and a consensus view that rates will be coming down. The market is essentially giving potential buyers an easy lay-up to make their investment work in long term in exchange for short term pain. Obviously there are risks to this like anything, but barring anything crazy like another pandemic, I think we are very very close to a market bottom and I believe that people will look back on this time and say “I wish I had.”

Fourth, there is a somewhat concerning development. According to Urbanation new construction home sales have hit a 10 year low which does not bode well for the future supply of housing. One of the only ways that new housing supply gets built in the Greater Toronto Area is through new construction condos. However, there is a slow development happening in the purpose built rental space. Governments at all levels are beginning to put real money towards building this type of housing again, but it will take years for this to make a significant dent in the housing supply.

In the meanwhile the housing supply outlook is somewhat grim for the next decade or so. If the replacement cost of a condo continues to remain much higher than the current market value of a similar unit, investors and end users are unlikely to see the value in purchasing new construction which could cause a noticeable slowdown in new housing starts (construction) which will constrict housing supply even more. On the flip side, developers are providing an unprecedented amount of incentives, including rental guarantees for multiple years, zero development charges, and very extended deposit structures in order to try stimulate sales. 

In conclusion, the housing market is showing signs of a slowing as rates stay high. Pricing remains elevated due to a lack of overall supply in the market, the rate of population growth in the GTA as well as the resiliency in employment and accommodating banks. The continuous influx of new people to Canada could potentially slow the decline of inflation compared to the US. Ultimately, people still need a place to live which should continue to stimulate a floor level of sales until the interest rate environment loosens a bit at which point home sales a prices will likely stabilize and begin a slow climb upwards. Although inflation is coming down, the bank will likely not make a decision on rates until the less volatile or “core” components return back to normal levels. Expect things to continue to move slowly like the freighter ship with a slow return to a normal inflation levels as very slow rate cuts in the new couple of years.

Talk soon,

Oliver Foote