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Has Toronto’s Condo Market Hit Its Peak?

When it was announced that the iconic World’s Biggest Bookstore was closing its doors, likely to make way for even more Toronto condos, residents were upset that yet another unique Toronto landmark was being torn down. But now, with Toronto having more skyscrapers than any other city in North America, investors also have reason to fear those buildings going up every day, and the large number still in the works to be developed. Veritas Investment Research has just written a report on Toronto’s rental market and, for those investing in it, the news is not good.

“We believe the rental market may be at an inflection point,” says Veritas Investment Research analyst Ohad Lederer in the report. “Our weekly review of condo ‘for rent’ postings on craigslist.org indicate an approximate doubling of the number of condo listings in late 2013 versus late 2012.

“We believe recent claims of robust rental market increases should be taken with a grain of salt. We looked at 47 buildings for which we were able to compare current ‘for rent’ postings to the data we collected as part of our October 2012 data sample. Within those 47 like-to-like buildings, controlling for unit size where possible, per square foot rents declined 1.6 per cent.”

And numbers like that indicate that it’s the Toronto investor that’s going to suffer the consequences – such as negative cash flows each month of more than $200, says the report.

“New condo landlords in Toronto today can expect going-in unlevered cap rates around, and often below, the dividend yield on a typical bank stock or residential REIT,” continues the report. “Investor owners are accepting returns below available REIT yields despite the illiquidity, lack of diversification, and operational risks of owning a unit directly.”

It then goes on to say that because investors won’t be seeing the returns they were expecting, they’ll sell those condos, resulting in even more inventory on the market, and bigger problems overall.

“In one possible scenario, the Toronto rental market may no longer absorb supply as it comes on-stream, resulting in lower rents and increasing cash outflows for landlords, who then decide to sell, at first in a trickle and then in a thunderous herd. In this scenario, condo prices would drop dramatically, given relatively small unit sizes that do not attract a wide segment of potential buyers and the already weak underlying fundamentals. ”

And that, the report states, would also have a negative effect on the banks.

“Banks with large relative exposures could endure higher loan losses,” it states. “Bank of Nova Scotia, for instance, and CIBC have slightly larger uninsured condo balances relative to common equity. Concurrently, or independently, buyers of unfinished condos may have trouble closing, for a variety of reasons. Depending on market conditions, private developers may absorb significant losses, and banks that lend at high loan-to-values can be expected to share in those losses.”

Added into that is the fact that in order to buy a condo, a pre-approval was not necessary, and so many buyers who have purchased units that haven’t yet been built will still be able to back out of the deal when they find that market conditions just are not what they were when they first set out to buy the condo.

But not all economists and experts think that these extremes are going to become reality for the Toronto market. Benjamin Tal, economist at COBC, says that all factors need to be taken into consideration – and in this case, that means looking at the overall housing market, and the fact that people are going to put off buying altogether, but they will be renting, and that’s good news for investors.

“I agree that the rental market will not be as strong in 2014, 2015,” says Tal. “This is a market that hasn’t been tested yet. And the test will be when we get extra supply in the next year or two, that’s when you will test the willingness of investors to be in this market given that rents probably won’t be rising at today’s pace.”

He expects that when that time  comes, the market will remain steady, if not robust.

“Young people now cannot afford to buy a house,” he says. “Even young married couples. They will be renting more than buying. I think Canada’s home ownership rate of 70 per cent has peaked.”

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