Given the tremendous development activity taking place in the Toronto area (Toronto Census Metropolitan Area) over the last 10 to 15 years, it is not surprising that many have pointed to a potential housing crash.
But is it true?
The following commentary investigates the major indicators of a housing crash and demonstrates why it is unlikely to materialize in the Toronto area by addressing three questions:
1. Are we building too much housing (i.e., overbuilding)?
2. Are these homes being absorbed (i.e., purchased)?
3. Are Canada’s lending and underwriting standards protecting us from a crash?
1. Are We Building Too Much Housing?
Benjamin Tal and Nick Exarhos from CIBC noted in a CIBC Economic Insights report from November 2014 that the likelihood of overbuilding in Canada and its major cities is low and it is largely due to immigration. The authors specifically state that the level of housing construction activity is keeping at pace with demand for homes, which is primarily driven by immigration, a key source of Canada’s population growth.
As can be seen in Figure 1, Canada has grown from 28 million to 35.5 million residents between 1991 and 2014, demonstrating an average growth of approximately 326,000 new residents per year. Immigration has accounted for over 70% of total population growth since 1991, with Canada welcoming about 240,000 immigrants per year. As well, the country’s yearly growth, which is also shown in Figure 1, has been increasing since the late 90s.
More than a quarter of Canada’s total growth since 1991 took place in Toronto and its surrounding municipalities. As shown in Figure 2, the Toronto area grew by almost 2 million residents to reach a total population of just over 6 million in 2014, averaging about 87,000 new residents per year. Since 2001 however, the city and its surrounding municipalities grew by over 90,000 people per year, representing higher growth in recent years. Furthermore, annual growth to 2041 is expected to increase to about 94,000 per year.
All this population growth translates into demand for housing, meaning that a certain number of homes must be built per year to accommodate the 90,000 new residents the Toronto area has and will likely continue to face every year.
Ben Myers from Fortress Real Developments published his Market Manuscript report on the Canadian housing market in fall of 2014 in which he concluded that there was no evidence of overbuilding in the country as the housing market is largely supported by favourable employment and stable immigration levels. One of his analyses in the report explored the impact of population and employment growth on the amount of homes built in Canada’s major cities. Using data between 2003 and 2013, Ben applied a ratio between yearly population growth and the number of housing starts (i.e., when construction for a housing unit begins) to establish that every 100 new residents translated into a demand for roughly 41 homes in the Toronto area since 2003.
Ben’s analysis is replicated in this commentary, but the period was extended to analyze data between 1991 and 2014. As can be seen in Figure 3, data from the Canada Mortgage Housing Corporation (CMHC) was used to determine that the development community has averaged slightly fewer than 32,000 home starts per year between 1991 and 2014. Applying the same ratio calculation as Ben Myers did, it was discovered in this analysis that every 100 new residents created demand for roughly 37 homes.
The results from Ben’s analysis and the one in this commentary are very similar. However, the slightly lower demand of 37 homes per 100 residents is largely because the period analyzed in this commentary captures the recession of the early 90s, which was relatively pronounced in Ontario and the Toronto area, and is reflected in both Figure 2 and Figure 3 via the lower annual population growth and lower housing starts.
The ratio of 37 homes translates to 2.72 persons per housing unit, which simply means that a housing unit is expected to accommodate on average, roughly 2.7 people. This is almost identical to the persons per unit figure (2.77) from the Canadian Census for the Toronto area when the total population is divided by the total existing housing stock in 2011. Moreover, of the approximately 2.08 million homes in the Toronto area at the time of the 2011 Census, about 90,000 were unoccupied or vacant. This means that more than 95% of homes in the Toronto area were occupied in 2011. And that rate has been increasing over the years.
Why the increase in housing starts in recent years?
A variety of reasons are responsible for this including broader demographic forces, relatively stable and improving economic conditions (with the exception of the most recent recession), declining interest rates and pent-up demand due to under-building in the 90s.
In essence, over the last 24 years, the development community has been building homes to accommodate on average 2.7 people, which is in line with the average number of people per household in the Toronto area. Furthermore, high occupancy of housing (at 95 %+) shows that home builders have responded well to the demand generated by population growth in the Toronto area since 1991. Benamin Tal, Nick Exharos and Ben Myers were right: there is evidently no indication of overbuilding in the Toronto area as the housing market is largely supported by immigration, which is a key source of Canada’s population growth and generates tremendous demand for homes.
2. Are these homes being absorbed?
Based on the findings in the previous section, it is evident that homes are being absorbed on a broader scale. But in order to get a historical view of housing absorption, the total number of completed homes and the number of unabsorbed (i.e., not purchased) homes since 1991 is examined for the Toronto area using CMHC data. Figure 4 shows the total number of completed homes per year in red bars, relative to the number of unabsorbed units in blue bars, and the rate of unabsorbed units as a share of completions represented by the green line with its axis on the right. The data demonstrates that in fact the housing market in the Toronto area has never performed better than in recent years. The level of unabsorbed units has remained at around 3 to 4% over the last 17 to 18 years, which reflects very healthy supply-demand levels.
Simply put, this data and chart show that on average more than 95% of homes completed every year since 1991 are purchased.
3. Are Canada’s lending and underwriting standards protecting us from a housing bubble or crash?
Mortgage rates, accessibility to mortgages and lending standards are other major factors impacting supply of and demand for housing.
Low and declining mortgage rates make it very appealing for consumers to get into the home ownership market, increasing demand for homes. Subsequently, an adequate supply of homes must be available to meet this demand, otherwise prices can escalate and it is possible for a housing shortage to ensue.
Figure 5 has been adopted from the RBC-Pembina, Location Matters report from November 2013, and it shows the relationship between mortgage rates and average housing prices in Canada and Toronto since 1980.
Current mortgage rates in Canada are at historic lows. Between 2001 and 2008, mortgage lending rules were loosened, which led to a growing access to mortgage credit, increasing demand for housing and consequently causing a significant rise in prices. In particular, introduction of the Canada Mortgage Bond (CMB) program in 2001 and availability of interest-only loans in 2006 were some of the key factors driving the population to home ownership. Following the most recent recession however, the federal government made mortgage lending rules much stricter, increasing the minimum down payment required to 5%, enforcing mandatory insurance for any down payment less than 20% and reducing the amortization rate to 25 years.
Even though many have anticipated interest rates to rise into the future, it does not seem to be the case for now. The drop in oil prices in late 2014 urged the Bank of Canada to lower prime-interest below 3%, which suggests that many people will likely continue to strive for home ownership in the near future. Declining interest rates, coupled with population growth, which is largely driven by immigration, generate extraordinary demand for housing in the Toronto area. Despite this, the relatively tight mortgage lending rules for homebuyers in Canada serve as a strong safeguard against a housing crash.
With regards to financing real estate projects, lending and underwriting standards in Canada are fairly rigorous. It was common practice before the 1990’s for developers to build their projects on speculation, which means that sales of housing units or leasing of space took place generally after construction of a project was completed. This ultimately led to overbuilding (i.e., oversupply) and in part contributed to the recession experienced in Ontario and the Toronto area during the early 90s. Nowadays however, substantial pre-sales of housing units are required in order for a bank or lender to finance construction, which is often the bulk of a developer’s costs. In particular, it is the norm for banks and lenders today to request a pre-sale of about 75-80% of units in a housing project before providing a loan. In essence, lenders are very reluctant to finance real estate projects unless they are virtually guaranteed a return. Moreover, following the recent recession, many lenders increased the upfront equity requirements for real estate projects, meaning that home builders must now finance a greater amount of their project with their own money.
These types of strict and regulated underwriting standards for real estate projects in Canada are one of the factors why the housing market in the country continues to perform well.
Based strictly on observation of development activity in the Toronto area, it is not surprising that it appears like a housing crash is imminent. But when population growth is taken into account, and its impact on the housing market is investigated, a different picture emerges. Immigrants, who are drawn by the stable economic environment and high quality of life features in Canada and specifically the Toronto area, are an important source of overall population growth and are largely driving demand for homes. This demand is further supported by declining interest rates over the years, which are currently at historic lows. Despite the insatiable demand for housing and tremendous development activity in the Toronto area, lending and underwriting standards are very well regulated, prohibiting the likelihood of overbuilding and protecting the country from a housing crash.
CIBC Economic Insights Report, November 2014- http://research.cibcwm.com/economic_public/download/einov14.pdf
Ben Myers, Market Manuscript, Fall 2014- http://fortressrealdevelopments.com/news/the-market-manuscript-by-ben-myers-fall-2014/
RBC-Pembina, Priced Out: Understanding the factors affecting home prices in the GTA, November 2013- https://www.pembina.org/reports/priced-out.pdf
Canada and Ontario Population Growth- http://www.statcan.gc.ca/tables-tableaux/sum-som/l01/cst01/demo02a-eng.htm#
Canada Immigration Levels- http://www.cic.gc.ca/english/resources/statistics/facts2013/permanent/index.asp#figure1
Toronto Population Growth- http://www.statcan.gc.ca/tables-tableaux/sum-som/l01/cst01/demo05a-eng.htm
CMHC Housing data- https://www03.cmhc-schl.gc.ca/hmiportal/en/#TableMapChart/2270/3/Toronto