Toronto is the new Vancouver, but this housing market will also cool

Diana Petramala is an economist at Toronto-Dominion Bank.

Toronto has taken the mantle from Vancouver as Canada’s hottest major urban housing market.

Vancouver has begun to embark on what we expect to be a modest 10-per-cent home price correction, reinforced by the implementation of the new land-transfer tax on non-resident buyers on Aug. 2.

In contrast, the Toronto market has picked up steam. According to the Toronto Real Estate Board, existing home sales hit a record in August and the average home price was up 18 per cent (roughly $100,000) from last year. Toronto’s appreciation in average home prices since early 2015 has now exceeded Vancouver’s.

On Wednesday, the Bank of Canada signalled a continued stable and extraordinarily low interest-rate path in the months ahead, so there is little to brake the Toronto market’s near-term momentum.

Economic fundamentals continue to favour robust home demand: Employment growth so far this year is running at about 3 per cent year-over-year, more than triple the national pace. And the population between 30 and 40 (those in the first-time buying stage) has been growing rapidly over the past two years, contributing to a large pool of pent-up housing demand.

We also can’t ignore the city’s attractiveness to foreign purchasers. A quest for yield around the world will remain supportive to real-estate investment.

Despite its rapid valuation growth, Toronto real estate continues to be relatively affordable when stacked up against Vancouver and other global cities. At roughly 3.5 to 5 per cent, cap rates on rental apartment investments in Toronto are more than a percentage point higher than those recorded in Vancouver. The additional land-transfer tax on non-residents in Vancouver will also likely prompt more foreign buyers with an interest in Canada to set their sights toward Toronto.

The combination of strong domestic and foreign demand, coupled with tight supply conditions, is likely to continue to keep Toronto home prices rising at a double-digit pace through the rest of the year and into early 2017. But next year is likely to be a different story.

Even as the Bank of Canada remains on hold for the foreseeable future, most forecasters expect longer-term bond yields in Canada to follow U.S. yields higher by mid-year.

The Toronto market has become even more sensitive to higher interest rates than in the past. So even small movements in mortgage rates next year will help to take the steam out of housing activity.

The market still has a record number of new units under construction, which, once completed, should help alleviate some of the price pressures stemming from too little housing supply. All in all, we expect average price growth to drop from an average of 15 per cent this year to about one-third that pace in 2017.

Forecasters have been calling for higher interest rates since the recession ended in 2009, yet bond yields keep testing new lows each year. What if these predictions of higher yields fail to materialize again in 2017? Another year of price growth at or near double digits cannot be ruled out.

However, history shows that the longer home price growth remains unchecked, the greater the risk of a severe landing. In the event that housing activity in the country’s largest housing market fails to cool, there would be more pressure on policy makers to act, either through a real-estate tax or more mortgage regulation.

Attention has also shifted to supply-side policy initiatives in recent months. Policies targeting housing supply are not a short-term solution to what has largely been demand-driven strength. But governments do need to chip away at a number of structural barriers that are limiting the flexibility of supply to respond to demand and to help promote a more diverse and affordable housing stock.

The Toronto market will eventually cool. The question mark is whether the trigger will be higher interest rates or policy action.

Special to The Globe and Mail
Published Wednesday, Sep. 07