The following is a re-post from Fortress Real Developments’ blog, authored by the company’s SVP Market Research and Analytics, Ben Myers. Fortress Real Developments is a Canadian real estate development company that seeks out opportunities in major markets. The company has over $2 billion of built out value currently under development and construction, according to its Twitter bio.
Below you will find the latest blog post in our “Other Side of the Story” series where we comment on real estate articles in the news and tell you what it means for Fortress, our clients and investors in the Fortress Real Capital product.
Our intent is not to demean the journalist or the publication, but to simply provide a further perspective on the results. As such, I continue to get bombarded with requests to comment on articles in the newspaper and online about the Toronto condominium market. With so many media outlets, Canadian real estate as such a hot topic, and so many data sources, there is seemingly content for these articles every day.
The two articles I want to focus on in this blog post are:
I will focus on the NY Times article first. I’m sure you’ve read similar articles to this one, and in relation to some of the others, this article is relatively tame. One thing that is amusing is that the article is viewed by many as being credible because it appears in the NY Times and it is an unbiased outside look at Toronto. Outside look? The author actually lives in Ottawa. Is it credible, does the author know, understand and cover real estate on a regular basis? He has recently written articles on Canada’s Worst Driver, Taser Deaths, Arctic Camels, Maple Syrup Robbery, Prank Calling and Brothels, and according to his New York Times page, has not written or contributed to an article that included the word condo since 2005! Now I’m not writing this article to slag the journalist or the New York Times, I met Ian earlier this year and he is a very nice guy and I do not doubt he did extensive research for the article, I just wanted to point out he is not a New Yorker that bangs out pieces every day on the real estate market. But, I wanted to bring attention to ‘the other side’ on a few things he brought up.
The article references the recent Bank of Canada report, which I discussed in my last blog post and the fact that May resale condominium sales in the ‘416’ area of Toronto were down 6.4% versus May 2012. The article conveniently excludes the fact that prices were up 1.6% year-over-year, but suggests the decline in sales would lead to a decline in prices in the future. Did resale condo prices decline in the ‘416’ in June? Nope, they went up.
The article mentions “Buyers who do get cold feet and abandon their purchases lose their 20 percent deposits, a significant amount in a city where the average condo sales price was $372,768 in May”. Including this in the article suggests that this is actually happening to any extent, which it is not. The average price of a new condominium is actually close to $400,000, so a purchaser would (on average) be walking away from a $60,000 to $80,000 deposit. I don’t know how many people would leave that type of money on the table while also taking the risk of being sued by the developer for breach of contract.
I will present a quick example, a project occupying in 2013 likely started pre-construction sales in 2010 (or earlier) when the average price of a new condominium was $353,000 (source: Urbanation Q1-2010); so let’s assume that a person put down $70,600 (20%) on that $353,000 suite. That unit is now hypothetically worth $400,000 given the price growth since 2010. How many people do you think are walking away from $117,000, the combined down payment and unit appreciation? Prices would have to drop over 30% for a purchaser to even consider it, and the biggest doomsdayers in this market have not called for that!
Moving on to the Globe article by Sheryl King, the head Economist of Bank of America Merill Lynch. Not sure why she is writing “Special to the Globe” articles, but I have not heard much from her since she gained much publicity in 2011 when she called for the imminent decline of the Toronto condominium market. She proclaimed the “wall of condo inventory” would dampen activity and prices would fall 5% to 10% in 2012 – there were 18,000 new condo sales in 2012 in the Toronto CMA and new condo pricing is up 4.6% since her 2011 comments (per Urbanation).
Her article runs through some typical investor math, average this divided by average that and the investment yield is small initially. What I would suggest is real world examples, compare apples to apples, what did the investor pay for the suite and what is his return on investment after all costs, taxes fees and paint jobs are included. Sheryl is correct in that the results will show that initially there is limited return on 20% down, but the typical investor is not investing for the short term, as she is also correct is her assessment that there are very few ‘flippers’ in the condo market anymore. Many investors plant money in Canada for capital preservation, other investors look to buy units to eventually give to their children, or use for their retirement, or as a second home when they plan move out of the city. Many investors never plan to sell their suites, they plan to leave them to relatives. As many of our clients understand, it is not easy to make money in the stock market or with their mutual funds, they understand and like hard assets, realizing that the value of the unit will never go to zero.
My favourite line from the article is her assertion that the split between single-family and apartment household formation has not changed in 10 years? Huh? According to CMHC completions data for the Toronto CMA, the ground-oriented (single-detached, semi-detached and row) and apartment (condominium and rental) was 27,698 units to 10,946 units or a split of 72% to 28% in 2003. In 2005 the shares dropped to 67% to 33%, in 2008 it was 57% to 43%, falling further to 44% to 56% in 2011, and from January to April in 2013 it was 42% to 58%. To suggest that the household formation split in the CMA has not changed in 10 years is ridiculous.
Sheryl suggest that the maximum number of apartment units that could be absorbed into the resale market is 17,000 per year and there are 50,000 condominium apartments under construction, a three year supply. What she doesn’t mention is that it takes the average project about 2.5 to 2.75 years to complete construction, so if I project that 50,000 units out three years, we are looking at the potential for 55,000 condo completions over that time. If we can only absorb 17,000 a year (51,000 in three years), we will be ‘oversupplied’ by 4,000 condominium units or 1,333 a year, or 111 per month. I know I’m throwing a lot of math at you here, but assuming every one of those 111 units per month is listing in the resale market (not rented, not unlisted, etc) that would increase resale supply by a just 1.5% each month (~7,000 active condominium apartment resale listings per month).
A 1.5% increase in listings a month is not going to be the straw that breaks the camel’s back for the Toronto condominium market. However, I have a just as plausible explanation of what might happen. On average since 2001, the Toronto CMA apartment market has been absorbing 730 units more per year. Therefore if 17,000 units could be absorbed in 2012, then 2013 might be able to absorb 17,730 units, 2014 would absorb 18,460 suites and 2015 would absorb 19,190 units. The three year total? 55,380 – the exact total we expect to complete over the next three years!
Isn’t math fun? Remember that there is always another side of the story.