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Photo: James Bombales

When buyers bite the bullet and finally decide to purchase a home in the pricey Toronto market, one worry is often on their minds — where are prices headed, and where is the best area to buy?

While it can be difficult to predict which neighbourhoods will see the biggest prices gains and drops, there is one way to tell which areas are most vulnerable to drops in prices, according to John Pasalis, president of online brokerage Realosophy.

“While we can’t predict the precise moment when the market will begin to cool down, we are able to make some quick inferences once the market has started to apply the brakes,” he writes, in his latest note. “Did the market gently hit the brakes resulting in a gradual cool down or did it slam on the brakes resulting in a rapid deceleration in the market?”

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Once that question is answered, Pasalis says that buyers have to ask themselves which neighbourhoods and home types would be most vulnerable if prices were to fall.

For instance, while many buyers might assume that if the average home price in the GTA were to fall by 10 percent, every home in the city would see its value drop by that amount. In reality, some homes could experience a relatively small drop in prices, while others could see a drop of up to 30 percent.

“Figuring out which neighbourhood is vulnerable to a big correction vs which one is less vulnerable is not a matter of chance – the answer is typically hidden in the underlying trends for each neighbourhood,” he explains.

One way to tell which neighbourhoods are vulnerable to a price correction is to track their level of investor activity leading up to the last peak in home prices. According to Pasalis, GTA neighbourhoods with the highest level of investor activity in March 2017 saw the biggest drop in prices that May, when the market experienced a steep drop in prices.

In the above chart, Pasalis used Realosophy data to show how home price growth dropped across the GTA in line with a fall in investors. He argues that tracking such data is the key to understanding where the market might be headed, and which property types are worth investing in. For instance, over the past two years, low-rise homes have seen a steep drop off in prices, while the condo market has fared relatively well.

“While we can’t predict the exact timing of a house price decline, we are able to use data and statistics to measure the risk that house prices might fall in one neighbourhood vs another,” he writes. “In a volatile market, this can be the different between making a safe real estate purchase vs seeing the value of your home fall by over $200,000 in a matter of months.”

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