Thoughts on the Toronto Condo market: crash or soft landing..?

Just reading a Globe and Mail article on the Toronto condo property boom:

resale statistics suggest that most of those investor-purchasers are holding their units for long-term gains rather than flipping them for quick profits…..“Tal, like many economists, believes that Canada will come in for a soft landing, not a crash. But Toronto’s condo industry still feels uncertain.”

The first comment, of course, is a throw away line and means nothing.  The second is arguably incorrect and ignores some key dynamics that could well lay the ground work for a crash.

In the stock market where securities are usually easily traded, marginal demand and supply quickly establish prices at which people buy and those who want to sell can sell.   Stock markets can and do crash.  But usually it is because a) valuations are too high, b) economies are at cyclical turning points with significant structural imbalances, c) the ratio of short term to long term money (in asset plays), key in elevating marginal supply/demand dynamics, is high, and d) the higher element of leverage that accompanies point (c). 

Property markets usually tend not to work that way, at least not initially for a number of reasons: properties are not short term transactions (you live in them or buy them for the cash flow), they take time to sell and you cannot usually sell off a portion of that property, so it lacks the dynamics that are associated with crashes.  It therefore usually takes a while for prices to fall and for demand and supply to come back into balance.   Crashes are usually associated with more liquid markets.

But leverage changes this to a degree, and the degree it changes it depends on the amount of leverage and the composition of the ownership of the market: investors are taking up large positions in the condo market and I would have thought that most “investors” in the Toronto Condo market are leveraged.  

But whereas the homeowner will tie leverage to income, the capital appreciation investor will tie leverage to price.  Where leverage is tied to equity and equity underpins the loan, falling asset prices create an imperative to sell. 

As the market turns more properties are likely to enter it if the market has more leveraged “investors” focussed on asset price gains, even if there is an allusion that rental income (which is currently very low relative to prices) provides support – “low” rental income relative to price mostly only helps cover the cost of the loans and the maintenance fees.  Asset prices, where there is a large element of speculation, are key to decisions to sell.  

Leveraged short term investors are more likely to sell when asset price support for their loans is falling.   Longer term holders will usually hold, but unemployment, inflation, interest rates and wage increases will will influence sales at the margin.   Cyclical economic risks are usually associated with a soft landing, providing the economic slowdown is shallow and short.

But the Toronto Condo market also has considerable supply dynamics which make price movements more sensitive to leverage and speculation.   Tie this into an economy with its own significant consumer debt, significant economic uncertainty, and we have all the components in place for a market crash. 

  1. Highly leveraged investors taking significant stakes in condo properties: one of the key risks for a market collapse is the ratio of short term investors to longer term investors, since this increase the potential supply of sellers and buyers at key points.   
  2. Significant new supply coming into the market place that increase the sensitivity of the market to leverage and short term investors + cyclical economic risks – marginal supply dynamics are already operating at the margin.
  3. Highly leveraged consumers, tightening lending standards and a slowing economy are taking away traditional supports, focussing marginal price movements on points 1 and 2.

But, what really interests me is the impact of a condo market crash on the price of property across the GTA.  I do not know about you, but one of the weaknesses of the urban sprawl we see in Toronto is a lack of viable communities: far too many houses exist in areas without easy access to restaurants, bars, nightlife, activities, subways etc.  In Europe you may well have the urban sprawl, but every area has its own vibrant hub.  A collapse in the condo market here would quite likely reverberate throughout the GTA.  Being close to the subway and close to vibrant communities with lots to do has appeal and value to me, even if, at the moment, price and supply are well out of whack.

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