The Affordability Challenge

 Though market experts predict Ontario’s housing market will start to lose steam over the next two years, it will be a soft landing. 

Analysts forecast a modest pullback will mark a return to balanced market conditions in 2016 and 2017. Sales will be strong in select areas of the province, but there are early warning signs that Toronto and Ottawa could be headed for trouble.

And while the new housing sector might not be as strong, there will be opportunities within the three Rs: renovation, resale and rental.

Ted Tsiakopoulos, Ontario regional economist for the Canadian Mortgage and Housing Corporation, says housing construction in the province will remain elevated in the short term, with 65,000 starts expected in 2016, roughly the same as 2015. But “we do expect a pullback by 2017,” when Tsiakopoulos expects new home starts to drop to just below 60,000 units. Those figures are well below the projected long-run demand based on Statistics Canada census data.

Diana Petramala, economist for TD Bank Financial Group, says in the first half of 2016 the winding down of pent-up demand created by interest rate cuts in 2015 will result in a gradual slowing of the market. “We will see a more balanced market in Ontario as the market moves back to more sustainable levels,” she says. 

“I think low-rise will remain stronger than condo housing,” adds Petramala, who says even though the population is aging, many older homebuyers still prefer low-rise living to high-rise, although townhouses and stacked townhouses may have appeal to the boomer generation.

The Canadian Real Estate Association predicts the national average resale price to edge higher by 2% to $442,400 in 2016. Price growth is forecast to be strongest in Ontario (up 2.8%) due to an ongoing supply shortage of listings for low-rise homes in and around the Greater Toronto Area. Tsiakopoulos, however, reports that Ontario average home prices will grow at a slower rate than they have in recent years—ranging between $435,900 and $513,500 in 2016 and $410,000 and $551,200 in 2017—the expected decline due mainly to the easing of demand for more expensive housing. Ontario sales, he notes, will range between 193,000 and 225,000 units in 2016 before easing off to between 175,000 and 220,000 units in 2017.

Demand for resale homes will hold up better versus new construction due to affordability. 

INFLUENCING FACTORS

Tsiakopoulos says the expected long-term decline is mainly due to both lower demand and an underperforming economy.

“Job growth has not matched what we’ve seen prior to 2008,” he explains. “Jobs are important and shape consumer confidence and housing demand, and that’s one reason why we are seeing construction levels remain below the long-run average.”

Inventory of unsold new homes is slightly above average as well, with half that inventory in Toronto and a little more than 18% in Ottawa.

“Interest rates are starting to trend higher and when you look at inventories, it’s more of a condominium story—they have edged higher,” Tsiakopoulis says. “It’s not alarming or problematic at this point, but it’s one of the things we hope the industry takes into consideration. We’re thinking builders will channel buying activity to existing inventory.”

The aging demographic is another influence. Most growth in Ontario households and spending comes from 55- to 64-year-olds, who contribute more than 40% in all growth in household formation. “This group is big, and over time they are less mobile,” says Tsiakopoulos. “Part of it has to do with aging. Part of it is they are comfortable in their community and don’t want to move away. And part of it has to do with listings in the price range they’d be looking at in terms of a next move. Whether it’s Toronto, Hamilton or Ottawa, listings are fairly tight and there’s not a lot of choice.”

Immigration is another factor, and while Ontario is still gaining immigrants and not losing as many people to the west, net migration has dropped close to a 20-year low and has been slipping from 2012 to 2014, says Tsiakopoulos. “Ontario is capturing a smaller portion of immigration and we are still losing people to other provinces. It used to capture 60% of migrants, but it’s now sitting around 38%-40%. The housing market doesn’t feel the impact of immigration for three to five years, but that will eventually be felt.”

Home ownership will slow as affordability continues to deteriorate and prices will rise sharply in and outside of Toronto, cautions Petramala. However, “we keep underestimating pent-up demand, but those people might turn to rental instead.”

Tsiakopoulis expects markets bordering the GTA such as Hamilton, Barrie and Durham Region will fare well due to greater affordability. Southwestern Ontario will also outperform most other areas of the province due to affordability and improving economic conditions. “Windsor is also very hot and is going to benefit from the low dollar and with manufacturing picking up,” he says. “The north and east are not growing as much. Northern Ontario has been hit by commodity prices, and in Ottawa, public spending restraints are taking steam out of consumer spending.” 

Petramala cites Kitchener, Guelph, Hamilton and Barrie as hot markets, as well as Kingston to the east. She says while there has been a huge shift to city living in recent years, and Toronto has outperformed other markets in Ontario, that coincided with the rise of the Canadian dollar and a decline in manufacturing. Although the GTA has more than 30% of the province’s jobs, it’s possible that trend might reverse, she says, with our weaker dollar helping the export market.

“We might see more manufacturing jobs come back in areas outside the GTA and that might help support housing markets elsewhere.” 

POTENTIAL TROUBLE SPOTS

Toronto, though, is showing signs that trouble could be brewing, according to CMHC’s fourth-quarter Housing Market Assessment (HMA), a report that identifies potentially problematic conditions in the Canadian housing market in 15 Census Metropolitan Areas. The report is based on overheating of markets, acceleration in growth of house prices, overvaluation and overbuilding. In particular, there was strong evidence of problematic conditions in Toronto and moderate evidence in Ottawa due to price acceleration and overvaluation. 

Recognizing the need to rein in control, the Federal Government, effective Feb. 16, will institute a hike from 5% to 10% for minimum down payments for the portion of a home mortgage in excess of $500,000.

“In Toronto, things have been driven by homes at the upper end of the price spectrum and single homes, as opposed to condos,” says Bob Dugan, chief economist for CMHC. “Houses in the $1 million+ range have had stronger growth than lower-priced homes.”

The third Ontario market included in the report, Hamilton, has little risk for looming problems, as home sales grew faster than the number of new listings and strengthening employment helped to support home ownership demand.

Dugan says the aim of the CMHC report is to promote market stability by acting as an early warning indicator to get the message out on overbuilding before a crash in prices is inevitable.

What could also ease the risk is a moderation in price growth and a strengthening of fundamentals such as income growth, says Dugan. Weaker economic growth in other parts of Canada has stemmed some of the migration from Ontario to the western provinces, and that, in turn, will create population growth in some Ontario centres.

“The prices are growing faster than the fundamentals, but the fundamentals are improving,” says Tsiakopoulos. “We are starting to see some job growth and that’s one possible way to resolve the imbalance. We are calling for a pretty significant decline in house price increases. But certainly the migration story and employment story are positives.”

Even though Toronto’s market has been identified as being at risk, “the fundamentals are pretty good, but we are running a little ahead of what the fundamentals can support,” says Dugan.

A rise in interest rates would create problems for many Ontario markets. “There is no major drop in interest rates going forward and the risk is a possible rise,” says Petramala. “If the Federal Reserve (in the U.S.) raises rates, longer term Canadian rates will go up.”

THE OPPORTUNITIES

Tsiakopoulos is bullish on resale, renovation and rentals. With mortgage carrying costs expecting to trend upward, resulting in declining affordability, there will be a shift to more affordable houses. That’s not just condos, but resale homes and rentals, he says.

“We see a lot of potential in the resale and renovations market, and though we don’t officially forecast the reno market, that doesn’t mean we don’t track it,” Tsiakopoulos notes. “If current conditions persist, it could represent a $26.5 million annual market in Ontario.”

The resale market is a major driver for renovation spending, Tsiakopoulus says, and resale activity hit new records in 2015, “We know that within a year of purchase, most resale buyers spend to upgrade their home. Even though existing home sales will ease somewhat next year, it doesn’t matter, as reno spending will carry momentum through 2016.”

Tsiakopoulos says the most common renovation is remodelling of rooms, with most of the focus on kitchens, bathrooms and basements.

And with many 55- to 64-year-olds (who supply most of the growth in households and spending) opting to stay in their current homes due to declining mobility and lack of housing choice, they will change their homes “in a way that makes sense for them.”

Wealth also plays a role in the reno market, and the share of home equity is growing, particularly for that older demographic. 

The number of echo boomers, the second-most influential group in household formation, is also growing, but more of them are choosing to rent rather than buy in expensive markets, contends Tsiakopoulis. “Builders and investors are responding to this growing demographic and declining affordability and bringing forward newer rental projects,” he says. “However, they are not the first out of the gate. Pension funds and big institutions have been investing heavily post-9/11 in purpose-built rental units. Then small condo investors got into the game. And now you are seeing developers bringing new rentals on stream. Rental starts in Canada are currently at the highest level since the 1990s.”

Petramala also expects more people gravitate to renting due to affordability. However, while she cites a balanced state of rental vacancy as 3%, the current rate is just 1.8%. With vacancies  that tight, the rental return rate is high for Toronto and Ontario—good news for builders of rental buildings.

“The younger group doesn’t see any stigma in renting—perhaps unlike previous generations,” says Tsiakopoulos. “It’s a lifestyle choice. And with 86% of rental stock built before 1979 and new buildings coming on stream, landlords of older buildings will respond to the competition and support renovation spending.” 

Comments

No comments have been posted yet.

Add a Comment

Your Comment:

Your Name:

Your Email Address: (Won't be published)

Your Website: (If you've got one)

Sponsors

Mercedes_
Enbridge_c
Union-gas---ohba-sponsor-2012---160x80
Rogers_tm_rgb_-_for_laurel_oak
Savaria-logo-green_r_web_160x80