The Millennial Effect
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 After 2016’s record-setting sales and resale home prices, and an almost decade-high record for new housing starts, Ontario’s red-hot real estate market will begin to cool in 2017. Slow job growth, deteriorating affordability and fewer households being formed are among the influencing factors, not to mention new government rules that tighten criteria for borrowers of insured mortgages.

But the news is not all negative. While home prices won’t increase at the same rate they have been, they aren’t expected to drop and will continue to grow marginally in many Ontario markets. 

Ted Tsiakopoulos, Canada Mortgage and Housing Corp. regional economist for Ontario, forecasts housing starts in the province will taper off over the next two years. “When we look ahead, we are obviously talking about moderation,” Tsiakopoulos cautions. 

Single-detached starts will slow in 2017 and drop further in 2018. But multi-unit starts should increase slightly next year. 

On the existing home front, independent housing analyst Will Dunning expects sales of resale homes and new houses to drop. He foresees a slight drop in low-rise new home starts and a jump in the number of GTA condo starts.  

Pricewise? In 2016, the average MLS price in Ontario was expected to range between $420,000 and $466,000. That range is expected to move slightly higher in 2017.

Factors affecting the market

Ontario is Canada’s export leader and trade accounts for a significant portion of the province’s Gross Domestic Product. If the Canadian dollar climbs higher (making Ontario goods less attractive to our trade partners) and oil prices increase, the province’s growth may slow. And when the economy slows, that affects another factor influencing the housing market: job growth, says Tsiakopoulos.

Job growth in Ontario is forecast to increase by a modest 1.2% in 2017 and 1.0% in 2018, Tsiakopoulos says, down from 1.3% in 2016 and down from an annual average of 1.7% during the pre-recession period (before 2008). 

Affordability is a third factor that could impact the market, says Tsiakopoulos. It’s eroding and, coupled with the new mortgage rules, that’s going to affect first-time buyers’ ability to afford a home.

Fewer households are also being formed. The annual household formation count in Ontario has averaged 67,000 households a year in the past three census periods (2001 to 2011). CMHC estimates that an average of 65,000 households a year have formed from 2011 to 2016.

 “The reason (for fewer households) is that the economy is not generating as many jobs,” says Tsiakopoulos. “People are putting off the decision to start a household and the gap between housing starts and formation has widened. Housing starts need to gravitate closer to household formation numbers.”

Invariably, many young adults who are potential first-time buyers are opting to continue living with parents or sharing accommodation with others.

New mortgage rules

The federal government’s new rules governing insured mortgage lending will also make it more difficult for first-time buyers to get into the housing market. Don Campbell, senior economist for the Real Estate Investment Network, gives this example of a family with a household income of $100,000 and a down payment of $40,000. Under the old rules, they’d have qualified to buy a $665,000 home. Now, they can qualify to buy one worth $505,000—in a market where prices are accelerating.

“People will stay renters for much longer,” says Campbell. “It will put the brakes on some people moving into the market.”

The rules have created a financial dam, explains Campbell, with a huge cohort of millennials (27% of the national population) who were getting close to homeownership now behind that dam. “The new rules are just moving the upward pressure a couple of years down the road, and it’s a big problem,” says Campbell. “They haven’t changed basic human nature—these people will eventually have to have a house.”

“My gut and analysis tells me that the mortgage-change rules will have a bigger and more serious impact than most people are expecting,” says Dunning. “The common view is that market activity will be reduced by 8%, and that’s bearable and not bad in a hot market, but the risk is that there could be spinoffs that cause damage.”

Dunning says the substantial condo investment sector in the GTA could be the big story. “It likely will be reduced. There is a lot of housing under construction and we will continue to see new rental condos for a while (those condos bought by investors for the purpose of renting out). But by 2019, it will fall off and it’s going to be harder to get financing. If the market is negatively affected, investors will be more cautious about buying something.

“The changes in mortgage insurance rules are not friendly for buyers of individual units,” Dunning adds, “whether they are investors or homeowners.”

Tsiakopoulos says as the policy is new, it’s difficult to evaluate its impact on the housing market. Buyers who don’t pass the new stress test could come up with a higher down payment by borrowing from alternative sources, such as family, settle for lower-priced homes or delay buying altogether.

“It may not be a bad thing, though,” Tsiakopoulos says. “It’s to ensure Canadians don’t bite off more than they can chew and are making rational decisions.”

Warning signs

In late October, CMHC issued its first-ever red warning for the Canadian housing market. “We now see strong evidence of problematic conditions overall nationally,” advised Bob Dugan, CMHC chief economist. “This is fuelled by overvaluation, meaning house prices remain higher than the level of personal disposable income, population growth and other fundamentals would support. This overvaluation, coupled with evidence of overbuilding in some centres, means that growth in house prices will slow, while housing starts are expected to moderate in 2017 and 2018.”

CMHC identified Hamilton and Toronto as two markets with strong evidence of problematic conditions and overvaluation, and price acceleration is spreading to neighbouring communities. 

Dunning says overbuilding is not a problem in Toronto, however. In fact, it’s the opposite problem. The GTA will continue to suffer from lack of supply, and inventory as of early November 2016 was less than 2,000 units, according to Dunning, with provincial policies limiting the supply of serviced land for development.

“The Toronto area has a longstanding problem with not enough housing supply and not everyone has been able to buy,” Dunning says. “We need to build a lot of housing—100,000 units more than we actually have today—and the demand is continuing to grow.”

Immigration continues to be a key driver of that increasing Ontario population and accompanying demand. About 300,000 immigrants arrived in Canada in 2016, with most settling in Ontario—mainly in the Toronto area. According to CMHC’s fourth quarter Housing Market Outlook report, net migration to Ontario will rise to more than 118,600 people by 2018, up from 96,000 in 2015. 

CMHC’s Toronto area analyst Dana Senagama points out that Toronto is a two-tiered market (detached and condos) and there is a supply issue. She says the slowdown is going to take longer in Toronto. “Prices will still be high, but the rate of growth will slow in 2017 and 2018.”

Tsiakopoulos agrees there will be a dampening of sales activity, but prices won’t decline. The only way that would happen is the evolution of a buyers’ market happens, and that doesn’t appear likely for some time.

Based on the level of sales and listings in Ontario in the third quarter of 2016, “you would need a 50% correction in sales, and that would need a significant trigger, such as a financial shock or economic downturn along with a shock to interest rates,” says Tsiakopoulos. “I think interest rates will stay stable, though. The cost of funding will increase for some lenders, but interest rates will likely remain at their current levels.” 

Geography

By 2018, the GTA market will start cooling off more than other parts of the province, suggests Tsiakopoulos. “You will see communities bordering the GTA holding up better.”

Tsiakopoulos believes Hamilton will continue to be a hot market along with Kitchener-Waterloo, as those areas are attracting buyers who have been priced out of the GTA market. St. Catharines and Niagara will continue to outperform, and Guelph is one is of the hottest up-and-coming markets, he notes. Eastern and northern Ontario, meanwhile, “will be the middle of the pack.”

Don Campbell, a founder and senior analyst for the Real Estate Investment Network, sees areas outside the GTA that have attractive lifestyles as doing well. Brantford (between the hot markets of Hamilton and the Kitchener-Waterloo-Cambridge technology triangle), Barrie and Orillia (where Hydro One has acquired Orillia Power Distribution Corp. and will construct new facilities) are good bets. And the extension of Highway 407 has been “a game-changer” for Durham Region, Campbell says, since it reduces commuting times to Toronto and other areas of the GTA. 

Opportunities

While factors such as new mortgage rules and housing supply issues may be putting a damper on the new housing market, there’s still opportunity. The three Rs that were solid performers in 2016—resale, renovation and rental—continue to offer promise in 2017, along with an M, for mortgage lending.

Tsiakopoulos expects the resale market to hold up well in 2017, given that new housing starts are easing and resale homes are more affordable. 

Renovation spending will continue to grow. In 2015, it was a $25-billion industry in the province, and CMHC expects reno spending to advance to between $25 billion and  $27 billion in each of the next two years.  Renovations will be especially popular among homeowners in the 55- to 64-year-old age bracket, he says. 

“They are not in a position to downsize yet and most want to age in place,” Tsiakopoulos says. “They are not as mobile as they were and are looking to make changes to make their homes more user-friendly. They have a lot of equity, and are not as sensitive to changing interest rates, and are not carrying the same kind of debt as younger households.”

Many prefer to renovate their current home to suit their needs, rather than pay a realtor, legal fees and land transfer taxes to purchase a different home, he says. According to historical data, more than 80% of homeowners 55 or older choose to age in place.

Hot Reno and Rental Markets

According to CMHC’s Renovation Report of September 2016, southwestern Ontario (areas such as Windsor) will have the biggest potential for renovation spending, while the GTA, where there will be modest job growth, lesser affordability and a younger population than the provincial median age, will have the least potential.

Rental demand will also continue to grow, predicts Tsiakopoulos, particularly among 25- to 44-year-olds, who will find it increasingly challenging to buy a home. 

“This bodes well for new investment in that sector, as the pool of potential renters is growing and there is not the same stigma about renting that there used to be a generation ago,” he says. 

Opportunity exists both in new condo units offered as rentals by small investor buyers as well as new purpose-built rental apartment buildings. There were more than 6,000 rental housing starts in 2016, a level that hadn’t been seen the 1990s, says Tsiakopoulos. “We are seeing organizations that haven’t been in that space historically, such as pension funds and institutions, partnering with builders.”

Immigration is also driving the rental market, as two-thirds of all immigrants coming to Canada—including international students—move into rental immediately. 

But the vacancy rate is low and will continue to trend downward, says Tsiakopoulos. “Ownership affordability is being stretched and people have to live somewhere.”

But the new government mortgage rules and affordability challenge might actually present another opportunity for builders: as lenders. 

“Baby boomers have a lot of capital and are looking for alternative investments, such as secured lending or mortgages,” says Campbell, who believes builders could consider offering second mortgages with small payments to buyers who have a down payment, but no longer qualify under the new rules to buy the home they wanted.”

There’s little doubt that new home builders will feel the pain as sales slow in 2017 and housing supply continues to be a problem. But there is still ample opportunity in the three Rs or for builders willing to be creative. 

That could mean getting into the financing business, as Campbell suggests, or offering lower-priced products to first-time buyers who now qualify for smaller mortgages.

“People will start scrambling over the dam,” says Campbell. “There will be pent-up demand and builders have to start thinking about how to attract millennials. They want nice finishes, they want fibre optics and they are going to want to grow food on their deck or balcony.” 

WHO ARE THOSE GUYS?  DEFINING THE MILLENIAL
With about 4 million in Canada, or 27% of the population, millennials represent the home building industry's next big opportunity.  There are 1.5 million of them in the Toronto area alone.

But many in this 19- to 34-year-old age group aren’t in any rush to buy a home, due to affordability and lifestyle factors. And their priorities and values are much different than their elders’. 

While their parents, many of them immigrants who came to Canada seeking a better life, believed that hard work, endurance and getting ahead was important, their kids have a different mindset, says James McKellar, professor of real estate and infrastructure at the Schulich School of Business at York University. Many millennials are well educated and will enjoy good employment prospects and they’ll gravitate to Toronto or other large urban centres where the majority of knowledge-based jobs are. 

They value being able to work and play close to where they live and realize they will likely change jobs several times during their working life.

“Millennials are very shrewd and want to be where the jobs are and don’t want to have to change their lifestyle or their residence if they change jobs,” says McKellar. “They realize upward mobility or success often comes with changing jobs quite often.”

The car holds little fascination for this group, who would rather use public transit than deal with traffic congestion. And they are well attuned to the shared economy (where services such as Uber have become popular), says McKellar. They don’t see a need to own a car and they don’t want the expense. That’s why urban locations or close to transit lines are their resounding choice. And they’ll gravitate towards condos or rentals because of affordability, walkability and the proximity to transit. 

“Location is a prime issue,” says McKellar. “They want to walk to work or be on a subway line. They are looking for a situation where they work until 6, have dinner and can go back to work (if need be).”

That’s why most will choose to buy a downtown condo or rent an apartment—at least once they move out from under mom and dad’s roof. According to Don Campbell, senior analyst for the Rein Estate Investment Network, 52% of people aged 20 to 29 in Canada are still living at home with their parents. 

Young single women are more inclined to move into a place of their own than young men, says McKellar, and they like downtown condo living for proximity to their jobs and friends and the safety a building with security offers.

Urban neighbourhoods are also popular because millennials value face-to-face contact—that’s why coffee shops have become so popular. They also value experiences such as shopping at local markets, says McKellar.

But will they eventually give up their downtown lives for low-rise living in the suburbs? McKellar cautions about assuming that most millennials, like their predecessors, will couple up and have children. “There is no evidence all of them will have kids and the reverse is likely true. They may have a child, but the divorce rate is high and you have a lot of single parents. It’s a whole different ball game.”

If they are going to buy property outside of the urban centre, it will be on a transit line, in places such as Vaughan (where a new subway link will open soon), or Kitchener or Guelph, where GO service will be extended, says Campbell, or in Durham Region, where the 407 extension has made commuting easier. 

But millennials will stay renters much longer than the previous generation, says Campbell, and the new mortgage rules will further delay any buying plans they have. Many will stay in the city. McKellar says condos are still relatively affordable and in good supply (the average Toronto area condo price was $415,643 in September 2016, according to Toronto Real Estate Board stats). 

“Once you live downtown, the appeal of going out to the grassy fields is no longer there,” says McKellar. “It’s an ‘alienation’ lifestyle to them. Where do you walk, where do you bike? They are not going to add 18 kilometres to their commute to have a house with a lawn. If they buy a low-rise house, it will be downtown, where they are creating the demand in old city neighbourhoods.”

Many millennials will remain renters. McKellar notes the resurgence of new purpose-built rental buildings, many offering the same type of amenities as condominiums. And those sorts of attributes are critical, says Campbell, as millennials have far more discriminating tastes than their parents. They want a high standard of finishes, nice amenities and high-speed internet and wireless networks. Millennials make their spending decisions based on what they see online or through social media and their use of YouTube, Instagram, Twitter and Snapchat is growing.

These types of millennials are what McKellar calls the “haves”. There is a divide between those who are well educated and those who are not, who tend to fill low-paying service jobs. 

“The unfortunate part of the story is that people without education struggle in this new environment and can’t afford to live downtown,” he says. “They live further away where rents are more affordable, buy an old car and have long commutes. If the city and province don’t wake up to this fact, we’re not going to have a city.

“We have to find ways to house the people we depend on,” McKellar observes. “There’s a growing disparity and it’s going to be hard to find good workers.” 

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