It’s hard to find solid footing in this real estate market: rock-bottom rates for too long, a global pandemic, a panicked buying spree, seven rate hikes in one year. Breaths are collectively held for the aftershocks, eyes are on every new release of data.
So what happens now? We still need supply -- are developers spooked? Is the investor class really “gone”? Where are the opportunities?
We spoke to five experts in academia, pre-construction sales, private equity, and a think tank for what to expect during the unexpected.
What happens when a real estate market stalls or drops like this?
William Strange is Professor of Economic Analysis and Policy at the Rotman School, editor of Journal of Urban Economics, and past president of the American Real Estate and Urban Economics Association. He isn’t ready to say the bubble has burst:
“There’s a couple of reasons why this is not likely to be as bad as it has been [in 2008, in the U.S.] It’s that kind of death spiral that caused problems in the U.S. …We are in a somewhat more secure position.
[Has a housing bubble burst?] I’m not prepared to go that far about what we’ve seen. Like the kinds of corrections that we have seen thus far still hasn’t brought us back to pre-COVID. So it’s hard to see it -- this could be the beginning of a long movement away from Toronto’s incredible boom market.
But I’ve lived in Toronto for 20 years, and since I’ve been here, every single time that the market has hiccup even a little bit, it goes down for a month. People say, ‘Oh, the boom is over and prices will be more affordable.’ And then all the people who’ve been locked out through the years just rush back in and try and buy something, because there’s so much excess demand for ownership housing. So as for this being a new era, I’ll believe it when I see it. I think the market has been strong for so long that I’m not prepared to say [the bubble has burst] yet.”
Debbie Cosic is CEO and Founder of In2ition, a real estate brokerage that specializes in sales and marketing for developers and builders. She’s not spooked by the market:
“Resale is a different animal and I’m not a resale expert. So I’m not going to comment of course. But in the pre-construction world, we’re still selling steadily and numbers don’t lie.
It’s very much a ‘return to normality’ market. There are some great deals to be had and I think wise buyers are taking advantage of that. I mean, we just launched The Grand in Pickering … we’re 50 per cent sold within three weeks, which is incredible in this marketplace. We haven't been dumping prices, what we’ve been doing is just offering more incentives, very well-packaged incentives. I believe that next year will be the same thing: return to normality, the year of incentives, and the year of levelling interest rates.
But again, we’re not overly concerned with interest rates in the pre-construction world because we’re selling futures. We’re selling two years out on low-rise, and on high-rise we’re selling up to six years out. We know that we won't have those interest rates.
I’ve seen three market downturns in my career, and they don’t scare us. We’ve sold through all of them.”
Karen Chapple is a Professor and Director of the School of Cities at the University of Toronto, and Professor Emerita of City & Regional Planning at the University of California, Berkeley. She says a pricing correction could bring buying power back to first-timers from the middle class:
“A few things are going on. One thing is that people are not putting their house on the market, right? Because they can’t make as much so they might as well wait. So what’s going on then is the rental segment is getting really overcrowded and so rents go up and up and up. We haven’t done a good job about building new rental in the region -- purpose-built rental is really a problem. So there’s going to be a lot of pressure continuing on the rental market in the short-term.
On the other hand, we do have some tapering of housing prices -- there was an estimate last week that it could be as much as up to a 25 per cent drop. So that’s great. I mean, we probably actually need more than that, because of the affordability crisis, but 25 per cent goes a long way towards bringing in some first-time homebuyers, at least in the middle-income sector.”
Josh Lerner is Senior Vice President of Harbour Equity, which raises investor funds and provides equity capital to developers. He doesn’t see a crash in the future, and predicts rents will get high enough to push people back into buying:
“It’s an interesting time. And I think some markets have dropped more than others -- it’s not uniform, some of the tertiary markets that went pretty crazy in COVID suffered more than probably core 416.
The market is dynamic and it has to find its equilibrium. I don’t think things are going to drop a crazy amount, because they can’t -- just from a cost perspective and inflation perspective.”
Listen, there’s 400,000 or 500,000 people a year coming into Canada. And you’re seeing now -- because of where rates are, people can’t qualify for mortgages -- so they’re renting and now rental prices are going up. And at some point, that equilibrium will shift back to where it’s like, ‘Hey, it’s cheaper for me to have a mortgage versus renting.’ That’s how the markets interact. At some point, that’s the calculus that every individual has to make: ‘Does it make more sense for me to rent or buy?’”
Paul Kershaw is Associate Professor at University of British Columbia’s School of Population and Public Health, and founder of Generation Squeeze, a think tank providing research and advocacy for generational equity. The organization just released a report that celebrates stalling home prices:
“We’re encouraging Canadians to celebrate [stalling prices] because many, many stories from many, many media [outlets], including the mainstream, will talk about the housing market being weak when home prices are not rising -- or the housing market is healthy when home prices are rising. But that absolutely conveys that we’re thinking about housing as an investment strategy, because if we think housing should be a place to call home, then it’s healthier when homes when home prices stall, even fall moderately, giving earnings a chance to slowly but surely catch up. And that is what we’re trying to celebrate in this report overall.
If you think [the market was in] a bubble, then what we have is a pinhole in it, and a little bit of air is escaping. But there’s absolutely no reason to think that it hasn’t levelled off at anything other than really unaffordable levels. So I would say, I know there’s no evidence that it’s bursting.”
We still need to build. How are developers reacting? What’s the investor mood?
In2ition’s Cosic isn’t advising her developer clients to drop prices:
"Developers that are experienced have also been through this many times, and [real estate] is too valuable to discount. They have upwards pressure of construction costs, that is not easing. There’s Bill 23 that's coming in but we still know it’s a long haul … to be able to expedite approvals and build the 1.5 million homes that the government is saying that we need. So demand is still extremely valuable. And there’s been massive inflation in construction material. So they’re not reducing prices. And we’re not advising our clients to reduce prices.
Wise investors are scooping up the incentives, scooping up the good inventory, they’re not spooked by interest rates. We’re selling futures so we know interest rates aren’t going to be 6 per cent five years from now.
There were projects that weren’t cashflow positive [for investors] -- or they were cashflow negative -- but now with these new rents, they are either revenue neutral or cashflow positive, which we hadn’t seen in quite a while. So that’s been definitely a benefit and an offset to whatever’s happened with the interest rates."
Harbour Equity’s Lerner says there are still opportunities for investors and builders amid the uncertainty:
“It depends on the investor -- different people have different risk tolerances and time horizons. But if you look at the alternatives, I don’t think people are enjoying being whipped around in the stock market. And, I think [there is] overarching belief in the market and positive immigration. If you look at the long-term trajectory of real estate and prices, if you draw it in a straight line, and then COVID has this big spike -- well, it’s going to come back to the trend. So I think that the long-term trend will continue, but just in the short term, there’s certainly volatility.
[For developers] I think it depends what market you’re operating in. I think a guy developing in Owen Sound is different than the condo builder in Toronto. I think it's hard looking at new opportunities, because we don't know what the costs are … and on financing costs, there’s certainly some concern about making sales in the short term.
But at the same time, I think there’s a belief in the market and opportunistic guys are happy to buy things that maybe have some entitlement and aren’t going to come to market for two, three years. And I think you’re seeing a lot more structured deals where the vendor gives a take-back mortgage or it's a deferred closing … It’s just a matter of structuring deals to reflect the current market conditions.”
Rotman’s Prof. Strange predicts a chill on development, however:
“Development takes forever. This is one of the things the province has been yelling about for a while -- we're not building enough houses. And one of the reasons why we’re not building enough houses is it’s a complicated thing to do. It’s just huge amounts of red tape, big condos will take four or five years in order to build. And so these these projects are going to be well underway. But if prices do go down, we should definitely expect to see less construction activity.”
UofT’s Prof. Chapple also sees a 'cliff' ahead in terms of building:
“It’s challenging on multiple fronts. We’ve had a great run, we’ve had a lot of housing starts in recent years. But now, there's going to be a cliff -- it’s going to drop off, and it’s going to take developers a while to get to get excited about building again.”
UBC’s Prof. Kershaw disagrees that developers would be discouraged:
“[Will new supply slow down?] I don’t believe that’s the case. I don’t believe there was any less reason to build housing in 2016 or 2017, or 2018, and we have home prices that are way, way higher than they were in those years.”
Is there an opportunity here? A silver lining?
Rotman’s Prof. Strange hopes remote work prevents future overheating in Toronto’s market:
“I think that one of the things that COVID has done is it’s taught us we don't necessarily have to work at Bay and Adelaide. So that means that more distant locations in the GTA are now viable locations, even for people who work in the centre of the region. In the early 90s, we saw a lot of back-office activity move away from Bay Street, first to Mississauga, and then later on to somewhere else. Because Bay Street was expensive. And so I think there’s a silver lining of all of this, which is maybe we don’t have quite so much pressure on Toronto going forward. And if we don’t, Toronto’s housing prices won’t be crazy and getting crazier to the degree that they have.”
UofT’s Prof. Chapple says the timing is right for building more ‘super-resilient’ markets, and government incentives for affordable supply:
“With remote work, this issue of transportation choice has become more important than ever, because the premium properties are going to be the ones where you can drive, you can take the train, you can bike and you can walk. And so those are going to be the super-resilient places that are going make it through the downtown. So thinking about how we can get more of those places would be advantageous for the region.
And then there’s also the kind of the big picture here, which is that there’s an opportunity for the government to come in and build more affordable rental itself. There’s opportunities to subsidize developers to build affordable because, right now, a lot of residential projects that were being planned, are in the pipeline, and no longer penciling out. And so developers are really postponing a lot of construction that they had planned to be doing this year, next year, the year after. But what if the government stepped in here and helped the developers build? [If a share of the units were affordable, the government could] help cover that gap in the interest rate that is now killing that project.
There’s always that silver lining. You actually have the potential to enact some housing policies that address the affordability crisis at these moments. The government can’t really do much when the market is going crazy — and it maybe shouldn’t do much if it’s all working for the market. But if it’s not working for the market, this is the time that the government could step up.”
UBC’s Prof. Kershaw says a drop in prices still outweigh interest increases for those who haven’t entered the market yet:
“This is an opportunity for us to see that we can be okay as home prices stall, and fall, and that’s actually good for the kids and grandchildren in our lives. And it’s not causing a ton of undue harm to many others -- although I will feel sympathetic for those who are first-time buyers just in the past 12 to 18 months. They do face a challenge.
But I will also draw your attention to [news reports about] high interest rates ‘harming’ people in the housing market. [If a newcomer or young person is] trying to get into the housing market [for the first time], a 10 per cent decline in the value of housing in Toronto, now you’re talking about $100,000. So you add four percentage points to your mortgage … there’s still a real savings there that we’re not often talking about. The sticker price is coming down more than the interest cost to people trying to get in the market will be rising. That’s a positive for people thinking about getting into the housing market. Of course, it poses challenges for those who just bought recently for the first time.”
What are you predicting for next year?
In2ition’s Cosic anticipates a sane sales market returning, with more time and choice for buyers shopping in pre-construction:
"[I expect] 2023 is the year of normalcy, back to the old tried-and-true way of selling. Selling five units a week? We’re thrilled. Not selling 500 in a weekend, like we used to. So we’ve got normal sales, which is wonderful for the public, because they can actually come into a sales office and spend some time with the agent and really think about it. And then they can come back the next day and buy the unit, which is still there. [Before], we had to say that you need to decide in the next 10 minutes because somebody else wants the unit.
I think it’s going be the year of incentives, we’re going to see continuing incentives from developer clients. We’ve seen everything — stretch deposits, small bite-sized deposits, to things like ‘mortgage busters’ to maintenance-free [offers]. We’re coming back to the tried-and-true stuff from the past that’s worked for us in various marketplaces.
I don’t think interest rates will stay high the whole year. We know in 2025 there’s a federal election, they need to prep the economy for that.”
Harbour Equity’s Lerner says as the economy responds to a year of seven rate hikes, he expects policy moves to slow down and recalibrate:
“I think if you would have asked me a year ago, I don’t think I would have predicted 400 basis points in hikes, but I don’t think anyone did. Their job is to project a strong front, because if they tell people they’re going to start cutting rates, then we’ll just get back to inflation.
So I think that maybe there’s one more hike, but I think they have to kind of see how things settle. There’s a lot of people who have borrowed money at a personal and corporate level, and the impact of these rate hikes hasn’t really been seen yet in the economic data. I think that’s kind of what they’re waiting to see.”
