Overview
The business media seems to feel that it is its mission to promulgate doom and gloom. We are in a “recession” - gold is trading in “bubble territory” - “European sovereign debt issues” are the new Lehman, and so on, and so on...
Of course at some point in the financial continuum every pundit, whether positive or negative, will be right. So what about those pundits calling the Toronto real estate market and particularly the condominium market a “bubble” about to burst.
Let’s begin by looking at the definition of a bubble. Generally a financial bubble seems to exist where “transactions occur in high volumes at prices that are considerably at variance with underlying values”.
The condominium market is certainly experiencing a period of “transactions occurring in high volumes”. Are prices at “variance with underlying values”?
First, let’s look at the volume. It is common belief that the high volume is being driven by four factors:
• Large immigration into the City ( estimated by some as up to 100,000/year) • Offshore investors who find Toronto to be both a safe haven and undervalued as compared to other major cities in the world. • Lack of suburban land for single family homes • A low interest rate environment
What is the underlying intrinsic value? As compared to other large “world class” cities, real estate values in Toronto are at the lower end of any scale. However, offsetting this is the fact that rental rates are very low compared to other world class cities and are not keeping pace with prices as there is a very healthy inventory on the market. Also, the investor market is not looking at absolute numbers but will buy based on the spread of rental income in and debt service and expenses out. So long as mortgage rates are low (historically, extremely low) the equation works. However, when interest rates rise (and I do not know when!), there will be an impact as well. What else can impact this market? I’m not sure that immigration can hold up. Where are the newcomers working? Southern Ontario as a result of the recession is still minus 300,000 jobs and the local economy is driven by out of Province factors. Rising energy costs will have an impact on carrying expenses. Currently, through government initiatives, energy costs may be below their true cost and when catch-up occurs there may be an impact. In my mind the greatest risk to the intrinsic value is the bubble that I will call the “City of Toronto”. The current funding deficit is approximately $750,000,000.00. The local government led by the Ford brothers is playing nickel and dime games in trying to stem the outflows. The real issue is the inflows. As compares to other “world – class” cities our residential property taxes are low. They are at levels that are not sustainable and at some point a politician will have to do the very unpopular act of raising taxes quite significantly. You cannot balance a budget by solely cutting costs and not raising revenues! The realty tax issue is also being compounded by the fact that condominiums are now rising on land that was traditionally considered office/commercial sites. I would suggest that you compare the realty taxes paid on one square foot of commercial/office space versus the taxes that are paid on one square foot of residential space in comparable locations. You will see that there is a rather significant difference. So the City of Toronto’s revenue problem is self perpetuating. So is there a bubble in the real estate market? Based on the definition and the current underlying specific factors probably not. However, there is another bubble that is about to burst – the City of Toronto revenue base. A SIGNIFICANT INCREASE IN REALTY TAXES IS INEVITABLE and this will have a significant impact on the real estate market generally and the condominium investor market specifically.