Friday, June 13, 2014

Condos Aren’t to Blame for "High Rents"

A recent OECD report on Canada (reported in a Globe and Mail article) suggested that the condominium market has played a big role in creating a shortage of affordable rental housing.
It argues that because developers favour building condos over rentals (for a number of reasons), the growth of condos has  crowded out new rental construction. And, because investors are buying new condos and renting them out, their units are raising rents to levels beyond the reach of average renters.
But is the condo market really to blame?
They certainly have become the dominant form of new rental supply in the GTA. As the table below shows, condos have accounted for 99% of the net change in the total rental apartment stock over the past five years. Over one quarter of all condos are now used as rental. But while the supply of condo rentals has seen remarkable growth of 80% since 2008, they represent 25% of all apartment rentals – meaning traditional rentals still represent three quarters of the market. This share is consistent for the City of Toronto.
As shown in the chart below, the average rent for purpose-built rental units in Toronto is considerably less than condo rental apartments ($1,035 vs. $1,576 for one bedrooms and $1,225 vs. $1,835 for two bedrooms). A couple key factors are that the stock of purpose-built rentals is mostly outdated, and most are subject to rent control – rents for sitting tenants can only rise by provincial guideline amounts (2.5% in 2013 and 0.8% for 2014).
But notice that rents in purpose-built units constructed since 1990 (rent control doesn’t apply to buildings built after 1991) are very close to condo rentals — a difference of $111 for one bedrooms and $144 for two bedrooms. In fact, there are many examples of new purpose-built rentals charging above nearby condo rentals.
Ultimately, when including condos in the measurement of average rents for all apartments in Toronto, the level rises by just $97 (see chart below). In other words, when excluding condos from the equation, average rents for apartments in Toronto are 8% lower.
So it can be said that condos have played some role in raising overall rent levels in the market, but certainly can’t be blamed for creating a shortage of what is defined as ‘affordable’ rental housing. Why? Because it can’t be said that rents would necessarily be lower if the growth in condo development was replaced by purpose-built rental construction.  Investor-owned condos, which have been declining in size, are actually attributed to slowing growth in rents — average condo rents were down 1.7% year-over-year in Q1 according to our latest UrbanRental Report (although still up year-over-year on a rent per square foot basis).
If a housing segment is to blame for crowding out purpose-built rental construction, then look towards the low-rise market. Population density, provincial growth policy and land availability in the GTA have dramatically shifted development away from low-rise homes, leading all development to gravitate towards high rise and creating greater competition for multi-residential land. High-rise is now the dominant form of construction, representing over half of all housing starts in each of the past four years compared to a 30% share 10 years ago.
The lack of low-rise supply has played a major role in pushing up housing prices in the GTA and impacting ownership affordability. As shown in the chart below, when excluding condos, average resale prices have grown by 84% over the past 10 years. By comparison, condo values have appreciated by 63%. As a result, the gap between the average price of condos and their alternatives has grown to a record $233,000, which is more than twice the gap from 10 years ago.
It can be argued that if it weren’t for the growth we’ve seen for condos, we would be facing a much bigger housing affordability issue. Not only would rents be likely close to or just as high as they are now, prices for entry-level homeownership would be out of reach for first-time buyers, spiralling towards even lower rental vacancy rates and an even greater shortage of ‘affordable’ rental units.


Wednesday, March 19, 2014

How Many Condo Completions Should We Expect?

There has been speculation reported through the media recently that upwards of 70,000 condo units will come to completion by the end of 2015. This, it is suggested, will cause too much supply for prices to remain stable.
As Urbanation has the data to refute such projections, we felt compelled to weigh in with some hard facts.
Fact #1: There isn’t even 70,000 units currently under construction.

According to Urbanation, a total of 58,659 condo apartment units were under construction as of the end of 2013 in the Toronto CMA. This is consistent with statistics reported by CMHC (53,545 units) — who record starts a bit later in the process once the foundation is poured.
While there have been previous instances of completions over a two year span exceeding the number of units under construction at the beginning of the period, it has never been by a wide margin and is not expected to happen over the next two years.
Firstly, projects are getting larger and staying under construction for a longer period time — the average is more than two years. Secondly, the 24,130 units in pre-construction at the end of 2013 were collectively 60% sold — below the five year average and typical minimums required by lenders to advance construction loans — meaning starts are being delayed.
Fact #2: Scheduled occupancy dates have become an unreliable measure.
Developers have the best intentions of delivering completed units according to schedule. But, as the chart below shows, many can’t. Over the past few years there has been a growing disparity between scheduled and actual completions as development timelines have become stretched. Many factors are at play, including increasing project scale, resource constraints, building complexities and weather. Based on recent patterns and the progress made to date for projects scheduled to complete this year, Urbanation expects approximately 19,000 completions in 2014.

Fact #3: Higher completions don’t necessarily mean weaker market conditions.
Urbanation's more realistic expectations for completions this year and next (totaling roughly 40,000 units) won't, on their own, cause prices to decline. If you expect demand to remain stable, you should also expect market conditions to remain balanced and supportive of current prices levels.

Also consider the market's starting point. As shown the chart below, the sales-to-listings ratio ended the year in the upper end of the boundary characterized by balanced market conditions, which led prices to grow by over 5% year-over-year. Note that this occurred despite a record level of completions for the market in 2013. In order for the sales-to-listings ratio to fall into a 'buyer's market', listings would need to grow by more than 30% — twice the growth in expected completions.
Also note that when the sales-to-listings ratio declined in late 2012/early 2013 to the lower boundary of a balanced market and prices experienced marginal declines, it was caused by slower sales as a result of the introduction of tighter mortgage policy — not rising listings. In fact, listings followed the demand trend and helped keep the market stable.
We certainly aren't dismissing the fact the completions will be higher in the years ahead. We recognize that it creates certain vulnerabilities for the market should demand unexpectedly fall. However, we also don't believe it should be used as the main basis for projecting a decline in condo prices.  


Friday, November 29, 2013

Urbanation Response Part 2: Do Condo Rents Look Poised to Fall?

This is the second part of a Blogpost that responds to research findings reported through a recent Globe and Mail article that states condo rents are declining.
This post will address the validity of the claim made that “the Toronto rental market may no longer absorb supply as it comes on-stream, resulting in lower rents and increasing cash outflows for landlords…”
The first part to this blog post addressed the more glaring issues related to the quality of the research conducted that found condo rents are declining.

Condo rents are not falling
As mentioned in Part 1 of the blog post on this topic, Urbanation tracks condo rental activity through the MLS system, which we estimate covers at least two-thirds of the market.  We marry transaction data with our own proprietary database of square footage measurements for condo units, first taken from developer plans and then verified post-registration from surveys submitted to the land registry.

Our data shows that on a per square foot basis, average rents in the third quarter grew by 4.2% from last year. While a rising inflow of newly completed units with above average rents per sq ft are helping to push this level higher, our same-sample analysis (using only buildings common to Q3-2012) still shows rents are growing, albeit at a slightly slower pace of 3.5% year-over-year. This reflects a market that is starting to balance out following three years of exceptional growth in rents. But note that the rentals-to-listings ratio remains elevated at above 70%, which still supports further growth in rents.

Demand will be able to absorb new supply

We expect that the emerging trend towards more balance in the rental market will gradually continue over the next couple years. As more units come to completion, more investor-held units will be listed for rent. But it’s important to recognize that rental demand is currently running at a 20-year high, driven by such factors as reduced ownership affordability for first-time buyers, strong growth in the population aged 25 to 34 and migration into the core. This, combined with the lack of growth in conventional rental supply, is why vacancy rates remain near historic lows despite the growing supply of condos — which made up 85% of the growth in rentals over the past 10 years.

Assuming a flat profile for household formation and ownership rates, the number of net new renter households will average around 10,000 per year out to 2016. Over the same period, condo completions are expected to average 20,000 units per year. Assuming 60% of these units are owned by investors and 3/4 will list their units for rent, we will see an average of roughly 9,000 condo listings per year from new completions. While supply can also be added from older condos (as owners hold onto their units after moving out) and some new purpose-built units, the point is that demand and supply should remain at similar levels.  

This isn’t to suggest that the market won’t change — we firmly believe that more balance is on its way. Realistically, there are likely to be short-term periods of weakness experienced in selected areas of the market over the next few years. But on the whole, the market should not experience a pervasive decline in rents. However, this may not be enough to keep some investors from looking to sell their units. It’s no secret that cash flow margins on rental units have become squeezed, and they will remain that way as higher priced units enter the market and rent growth slows. But with vacancy rates expected to remain low, the equity accumulation inherent in having a steady stream of rental income go towards mortgage costs and principal repayment will continue to encourage most investors to hold.

Condo investors recognize the advantages that leveraging a low-cost mortgage brings, as well as the sense of security in owning a piece of property, which is particularly shared among new immigrants who tend to be big purchasers in the market. So it’s difficult to assume that because unlevered cap rates are below financial market dividends that investors will begin to suddenly change course.

History has taught us that supply tends to direct itself towards where demand is strongest. The exceptions being when owners are forced to sell because they can’t close on their homes or can no longer afford their mortgages — neither scenario should have enough prevalence to impact the market. Should the economy remain stable and interest rates remain low, mortgage arrears will remain near historic lows (0.31% in Ontario as of August 2013). As a greater volume of units come to completion, there will naturally be more reports of buyers struggling to close on their units, but they will continue to represent a very small minority. The vast majority of units set to complete have deposits paid of at least 15% (equal to around $60,000 on a $400,000 unit) — buyers will do whatever they can not to lose their investment. They have also been pre-qualified to close – something banks require before advancing construction loans (despite reports of the contrary).  

The market will be challenged by resisting forces for price and rent growth over the next few years, but should remain stable in the absence of any strong deterioration in confidence. The media can help to prevent this by, at minimum, offering readers a more balanced selection of informed opinions on the market. 

Part 1 - Do Condo Rents Look Poised to Fall?:

Urbanation Response Part 1: Do Condo Rents Look Poised to Fall?

This is the first part of a Blogpost that responds to research findings reported through a recent Globe and Mail article that states condo rents are declining.

A recent report by an equity research firm came to the conclusion that condo rents are on the decline, which, in turn, could trigger a sell-off of investor units that would cause condo prices to “drop dramatically.” They found that on a per square foot basis, rents declined by 1.6% from last year. The basis of their analysis came from researching ‘for rent’ postings on Craigslist in 47 projects, and comparing them to the results from last year’s exercise. They added that mortgage pre-approvals are not needed to buy new condos and buyers may have trouble closing, which could lead to “significant losses” for developers and lenders.

Urbanation does not have access to the actual report, so we are basing our response on the information published in the Globe and Mail.

The first part to this Blogpost will address the more glaring issues related to the quality of this research. The second to follow will address claims of impending rent and price declines and closing risk.

Using Craigslist as the basis for determining changes in market rents poses at least a few major problems.
Craigslist doesn’t report transacted rents
It’s important to recognize that Craigslist is a listings website – it shows how much owners are asking for their rentals, not what they are getting. While it may be true that listing values can generally be used as a close approximation for transaction values, it is less likely to be the case on Craigslist. These listings can often be posted by individuals with very little knowledge of the market, and are more likely to under- or over-price their units, relative to units on the MLS system, which are posted by realtors who work in the market every day. If there is a difference in the degree of over- or under-pricing units between two periods, the change in average rents calculated becomes unreliable.

The sample size is too small
The listings vs. transaction value issue may not be that problematic if one were using a large enough sample that could mask differences in the degree of over or under pricing units between two periods. But 47 buildings isn’t enough. It represents only 3% of the total number of condo buildings in the Toronto CMA.  It’s also unclear if the same buildings were monitored at both points in time. Given that they report, 553 postings in October of this year versus 148 last year – this isn’t likely the case. Rents can be very project-specific, and even slight changes in the sample can impact results.

Inconsistent reporting of unit sizes
It was stated in the article that the research ‘controlled for unit sizes where possible’ to measure changes in rents per square foot. When measuring changes on a per square foot basis in a small sample, precision is paramount – you can’t look at rents per square foot for some units and not for others. And the unit sizes must be accurate, or at least consistently reported across sample periods. Is it a stretch to think that some people posting on Craigslist may exaggerate? Again, this may not be that big of a problem if everyone exaggerated by the same degree. But if one person posts a 650 square foot unit for $1,600 in 2012 and the same unit gets posted in 2013 for the same rent but it’s now advertised as 675 feet  – it reduces the rent per square foot by almost 4%. Similar issues may arise using unit size information taking from MLS listings, which is why Urbanation goes through the arduous process of maintaining a complete database on unit sizes taken from survey measurements on record at the land registry.

Who's research should be taken with a “grain of salt”?
We recognize that transactions through the MLS system don’t represent all activity in the condo rental market, but we do believe it represents the strong majority.  Rentals through MLS will reach 20,000 units this year, which equals an annual turnover rate of roughly 8% of the entire stock. Adding in units sold yields a total annual turnover rate of about 15%. The ‘true’ annual turnover rate of all condos is likely closer to 20%, which means total rental transactions through other means such as Craigslist probably add about 1/3 to the total.

This means Urbanation captures about 2/3 of the entire condo rental market. The activity within the 47 buildings monitored through Craigslist would capture no more than 5%. Nonetheless, the authors of this research cautioned that claims such as Urbanation’s that rents per square foot are rising by 4% year over year should be taken “with a grain of salt”. We wonder, what would be appropriate to take with their claims?

Tuesday, June 18, 2013

Urbanation Comments on the Bank of Canada Financial System Review

In its recently released Financial System Review, the Bank of Canada once again flagged the Toronto condominium market as a key risk.
Given the high level of attention this has received in the media, Urbanation felt it necessary to provide responses to their messages:
 “Construction activity remains strong in [the Toronto condominium market] despite the slowdown in overall housing demand over the past year and the total number of housing units under construction remains significantly above its historical average relative to the population.”
Of course it does. Construction in the Toronto condo market adjusts to changes in demand with a 12-18 month lag because the majority of units that start construction are sold well in advance during pre-construction sales campaigns. That means the slowdown in sales activity over the past year will work down construction volumes in the year ahead. But don’t expect a dramatic slowdown as roughly 30,000 units were in pre-construction at the end of Q1-2013 and were collectively 60% sold.
The total number of units under construction will continue to remain above its long-term average because there has been a dramatic shift towards high-rise at the expense of low-rise development in recent years. Since high-rise projects stay under construction for a lot longer than low-rise homes, the total housing supply under construction is ultimately boosted relative to historical averages or the population.
“The number of unsold high-rise units in the pre-construction and under-construction stages has remained near the high levels observed since early 2012. If the upcoming supply of units is not absorbed by demand as they are completed over the next 12 to 30 months, … [it increases] the risk of an abrupt correction in prices…”
Unsold condo inventory numbers are the most misunderstood statistics about the market. It’s very important to understand that the majority of unsold units are in projects that are still in the pre-construction stage. If these projects haven’t sold enough units to meet their conditions for construction financing (typically 70% or more), they won’t begin construction until they do, or will perhaps be cancelled. So, most of the unsold inventory reported today will either never materialize or have several years to be absorbed prior to completion.
The projects that are under construction remain 89% sold —a figure that hasn’t changed over the past year. While the number of unsold units has risen with more projects under construction, this represents little risk to the market. The construction process is lengthy and by the time the average project arrives at the completion stage, it is 95% sold. Even if sales stall at the 85-90% mark, the developer will generally turn a profit by this point and can be more aggressive with its incentives or opt to hold onto the units after completion and rent them out. As of Q1-2013, there were about 600 unsold units at recently completed projects – a level that is virtually zero in comparison to the size of the market and one that can withstand increases without threatening prices.
“If the investor component of demand has boosted construction in the condominium market beyond demographic requirements, this market may be more susceptible to shifts in buyer sentiment.”
Tough to argue with that.  Investors have likely purchased about 60% of units that are under construction today. If they all came to completion in a short span, the majority decided to sell and demographic requirements declined, prices would no doubt fall. It’s possible, but not likely.
In the absence of an economic shock, household formation in the Toronto CMA is likely to continue averaging approximately 35,000 households per year (as it has over the past three census periods). With low-rise housing seemingly capped at 15,000 units per year going forward, a 20,000 unit gap is left for high-rise to fill. Based on historical trends, capacity constraints and construction progress to-date, it appears unlikely that many more than 20,000 condos per year will be completed over the next few years.
Furthermore, most investor-held units are likely to continue flowing into the rental market, where demand is currently running at a 20-year high, vacancy rates remain close to 1% and very few purpose-built rental apartments are being constructed. There is little reason to believe there will be a major shift towards investor flipping – if short-term speculators were the majority of buyers, there would have been a much stronger run-up in prices than 7% per year over the past five years (In the previous cycle, condo prices increased by 170% from 1985 to 1989).
It’s true higher investor involvement in the market raises risks to prices because they are more prone to shifts in sentiment, and there is no way of being certain that the economy and demographic demand will remain stable. While it’s important to continue closely monitoring the market, these risks appear to be well contained at this point. Actually, without higher investor involvement, the market today may have been facing a different – and perhaps more difficult – set of problems. Supply would be much more restrictive, causing prices (and perceived overvaluation) to be even higher and a severe shortage of rental properties.

Tuesday, May 14, 2013

Toronto Condo Market Strengthens per Urbanation's Q1-2013 UrbanRental Report




growth in leases and rents pick up speed in
the first quarter

TORONTO – May 14, 2013:  Urbanation Inc., the leading source of information and analysis on the Toronto condominium market since 1981, released its Q1-2013 rental market results today.

A total of 3,919 condominium apartments were leased in Q1-2013 on the MLS system, up by 31% from a year ago. Growth in rental transactions continued to outpace growth in rental listings, pushing average index rents higher by 4.4% from last year to a record $1,856 per month or $2.33 per square foot.

Over the past two years, rents have risen by more than 10%, equal to an additional $170 per month or 23 cents per square foot on average.

 “Demand for renting condos has heated up with less first-time buyers. Rental transactions have exceeded resale volumes in the condo market since mid-2012, when the latest round of mortgage rule changes came into effect” said Shaun Hildebrand, Urbanation’s Senior Vice President.”

Units listed for rent on the MLS system in the first quarter grew by 19% from last year. Out of the 4,859 units that registered in Q1-2013 (the second highest quarterly total of the past four years), 13% were rented out in the quarter, compared to less than 2% that were resold.
“Investors are increasingly choosing to hold their units rather than flip them for sale. For the first time in a while, rents are rising faster than prices,” added Hildebrand.


Urbanation is Canada’s leading condominium market research company. Since 1981, Urbanation has analyzed the Toronto condominium market, publishing the “industry bible” – Urbanation’s Condominium Market Survey. This quarterly report tracks new, resale and future condominium projects. The newest report from Urbanation is UrbanRental, which tracks activity in the condominium rental market. Urbanation also provides the development community with essential consulting services, which include site and topic specific market studies and surveys.


Media Contact:           Pauline Lierman
416 922 2200