Toronto Real Estate Is SkyRocketing (Again): Will There Be More Intervention Coming Soon In 2022?

Toronto Real Estate Is SkyRocketing (Again): Will There Be More Intervention Coming Soon In 2022?

Real estate prices are skyrocketing again, and it kind of looks like a repeat of 2021, or even hotter. But this huge spike in a short period of time is concerning for many people – you want to get into the market but you might be worried about what will happen once you get in now.

A stable and sustainable real estate market is actually better for everyone in the long run and so big banks, regulators, and other real estate professionals are chiming in on this issue in recent days. There’s a lot of debate happening right now around what’s really driving real estate prices up so quickly. Is it demand? Is it supply? Is it because the Bank of Canada isn’t raising interest rates fast enough? Is it because of investors?

Is It A Supply Or Demand Issue?

We’ve been seeing these trends for the past 2 years. Freeholds have been outperforming condos, sales demand has been outpacing supply, there’s a divergence where prices are going up much quicker compared to rents, and there’s been extremely good performance in the luxury real estate market and properties further from urban centres. So what exactly is happening? 

Well, we all know Canada is a great place to live in and therefore attracts a lot of new immigrants. We closed off our gates during the early part of COVID, and immigration has recently reopened again, so we’re seeing a rush of new permanent residents come into Canada, primarily Ontario and the GTA, since the summer. Some people argue that a lot of these permanent residents were already in Canada prior to the pandemic, so the actual increase isn’t actually as high. Either way, immigration will continue to grow, and we definitely need to continue to increase supply to accommodate a growing population.

When new immigrants come, the majority of them will start renting first, which pushes up the demand for rentals. But what isn’t highlighted as much is the fact that we’ve seen more end-user properties converted into rental properties during COVID. Homeowners needed more space and many upsized their homes. At the same time, they remain cash-rich, so instead of selling their old homes, many kept it and ended up converting their old homes into rental properties because real estate makes a good investment and makes an even better investment when interest rates are at all time lows.

What this does is it ends up reducing the number of existing end-user properties and increases the number of rental properties, which has two effects. First, diminishing end user home supply naturally causes an imbalance and will push up the price of end-user properties. The second effect is good news for renters; since there are now more rental properties available for rent, this  slows down rent growth.

On top of this, we also have other homeowners who don’t move their homes but also want to get into the real estate action. What is important to understand here is that even though the number of rental properties has increased, the number of rental properties available for sale hasn’t increased. So with more real estate investor buyer demand but again supply not growing at similar rates, this also pushes up investment property prices. 

And, this cycle has been repeating itself throughout COVID. Low interest rates and high appreciation mean people are able to refinance existing properties to buy more investment properties, which continues to push up demand and prices.

How Does This Affect Real Estate In Toronto?

So, based on this information, do we have a supply or demand issue for real estate in Toronto? To answer this, we should probably split the properties into end-user vs. investment properties. 

For end-user properties, it’s most likely a supply issue. End-user homes were converted to rental properties, and they need to be replenished. Right now, that’s not happening fast enough because it takes a long time to build a home and builders are holding back on construction because of material and labour issues. 

On the demand side, even though end-user demand has been very strong, most people who want to upsize have probably already done so and prices have gone up so much already that things are getting out of reach. So when interest rates start to go up, this puts more downward pressure on their purchasing power and should naturally slow down end-user demand and price growth – which mainly affects luxury markets and suburban homes that have gone up a lot more the core Toronto. 

For investment properties, what’s the driving up prices is probably a mix of supply and demand. With a growing population, we do need more rental properties but it’s not as bad because we saw an transfer of end user homes being converted to rentals. And now, many argue that it’s not just a supply issue, but that a big spike in investor demand is a big catalyst for the recent fast price growth.

What Types Of Intervention Might Come Soon?

The big banks are chiming in recently and telling the Bank of Canada to raise rates soon because that’s causing unsustainable growth in real estate prices and makes real estate as asset class a lot more risky. BMO is saying there’s now excess real estate demand created by the overabundance of easy credit. CIBC is saying that we’re still in emergency interest rates, which makes home prices unpredictable.

In my opinion, raising interest rates is more effective for curbing end-user homes, but it might not be enough to cool the investment property market. If we assume there’s a 3.5% net rent yield and a 5% appreciation, minus a 3.5% interest rate, after 4.2 times leverage, you’re still looking at a very attractive 21% ROI. So if appreciation remains higher than that with the Canadian real estate Association actually forecasting 11.5% in Ontario for 2022, real estate will look very attractive and investors aren’t going to back down.

It seems like more and more are telling regulators to look into curbing investor demand, so what’s happening at the same time now besides rate hikes is that the CMHC mortgage regulator is reacting and looking into this.
In their Fairness in Real Estate Action Plan, they’re going to be “developing policies to curb excessive profits in investment properties, protecting small independent landlords and Canadian families, and reviewing the down payment requirements for investment properties. We are targeting the issues the market is facing from multiple angles.”

I want to highlight the downpayment requirement, which I think will be pretty effective for lowering real estate investor demand. If you go back to our ROI calculations, if the downpayment was increased to 25%, then instead of 4.2 times in leverage, it’d be 3.5 times, which means the ROI would go from 21% to 17.5%. For a $1.2 million property, instead of $282,000 of capital, you’d need $342,000. And if you’re pulling out extra equity from an existing property at 75%, this means your property price would need to go up by almost $456K. 

In other words, this will definitely make it much harder for investors to get into new investment properties too quickly. Then if this manages to cool demand, we might see appreciation come back down to more regular levels of say 4% per year, and if that happens we’d be looking at an ROI of 14% per year instead. This is actually still a very decent investment return, but for sure it won’t attract as much attention as we are seeing right now.

There are also other ideas floating around, like not being able to use HELOCs as a downpayment, which would make it an even harder barrier, but that’s probably not even needed yet. Nobody knows for sure what’s going to happen, but targeting investment property purchases may be a key tool to help stabilize our real estate markets.

What Does This Mean For Toronto Real Estate Investors?

The first thing is that stricter borrowing will likely soften real estate prices, but that doesn’t mean real estate prices will tank by a lot. If you look at what happened in 2017 when they imposed the non-resident sales tax to slow down the super hot real estate market that was getting ahead of itself, detached homes in general dropped by 10% in a few months but if you look at the condo market for starter freeholds, there wasn’t actually a drop but rather a slowdown. After the softening in 2018, starter freeholds in Toronto went up 10% in 2019, and another 6.5% in 2020. Condos went up at a similar rate with 6% in 2019 and then almost 9% in 2020.

And now, if there’s going to be tougher downpayment requirements, then investors will continue to flock to more affordable condos and starter freeholds and also markets that haven’t shot up as much (i.e. urban centres like Toronto), so we’re likely to see a similar lower volatility environment in these markets in the short to medium term. The reality is that population growth plus a lack of land in Toronto means that fundamentally real estate will go up steadily in the long run and I believe Toronto will continue to outperform the rest of Canada. Just remember that real estate is not supposed to be a speculative class of investment, and a good balance of rental income and appreciation is a reliable formula for good, stable, long-term investment returns. 

If you are looking for better leverage, this is a heads-up that things might change soon for investment properties. The CMHC has had a track record of tightening financial requirements for investors. In 2010, Canada raised the minimum requirements for investment properties from almost no down payment to a minimum of 20 percent. In 2016, they took away default insurance, which increased the borrowing cost of investment properties. And so, it’s possible that they continue to increase things like downpayment percentage or even capital requirements to taper investment demand moving forward.

How We Can Help

We’re big believers in long-term real estate investing, and if you want to chat more about this, we’re ready for you! We can look at your requirements and preferences and then match you up with the best investment property that fits your needs. After we help you buy it, our team also provides renovation guidance, leasing and property management if you need it. Just connect with us if you want to learn more about our services!

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