Speculators act as catalyst for increasing the supply of condos
Urbanation recently reported that in condo projects, domestic investors can make up 50% of the buyers of the end units. However, in certain projects, share of domestic investors can be as high as 90% of the project. This number caused quite a sensation in the press as well as on this blog as well. Many of us look down upon such rampant speculation, yet Finance 101 taught us that speculation serves an important function. It provides liquidity in the market, supports prices and greases the wheels of commerce.
Financial institutions require certain percentage of pre-sales to for extending construction financing to developers. This is where speculators (nee investors) come in. By acquiring these condos as investments they help the developer achieve the pre-sales milestone, get construction financing from financial institutions, break ground and complete the project.
It is because of these investors that large number of condo projects are under construction in GTA
Focusing on the high rise, above graph clearly shows that despite high active condominium projects, the high rise remaining inventory is at the lowest level when compared to the recent past. Moreover, in terms of vacancies, CMHC is reporting all time low of sub 2% as vacancy rate which means that there is just enough rental unit supply in the market as there is demand.
Speculation ensured availability of sufficient inventory for the families to rent. If the speculators weren’t there, GTA might actually be facing a shortage of housing and not just shortage of affordable housing. So pat on the backs to speculators for enabling Torontonians to have shelter over their head. And above numbers / graph back this argument.
Playing devil’s advocate, I come up with the following. Below is mainly based on hypothetical and anecdotal situations and should be treated as such.
- Despite low inventory of condos, the prices in resale market aren’t increasing as fast as investors would like. This is anecdotal. A few of the condo investors I talked to said that detached housing is a better investment as its price increases quickly enabling them to flip the property. This has not been the case in condos so most of the owners are forced to put the property on rent. Significant portion of that rental income goes toward paying the maintenance expenses.
- Media keeps telling us that Millenials like the “live, work, play” aspect of condos such as rooftop terraces, sauna and swimming pool in the building, and they also look very appealing in the condo brochures. However, when the Millenial’s family starts to grow with the arrival of kids, these amenities are used less and less. Yet the service charges keep on coming. Unlike gym membership which you can chose to not renew, you are stuck with the maintenance charges of these amenities. So Millenials start contemplating a move to detached housing in a good school district. Thus demands for condo living is transitory as compared to demand for low rise single family housing.
- First major maintenance cycle will be around the corner for the new condos that millennials moved in to so they will be finding out shortly if the maintenance reserve that the condo board maintained is sufficient or will it result in sudden increase in maintenance expenses right around the time when millennials’ expenses are increasing due to the growing family size. Any upward shocks in maintenance charges may disillusion millennials from condo living.
- Dark windows: It received lot of press in Vancouver press and cited as evidence of foreign speculation. It hasn’t been mentioned in Toronto but what if we have the same problem. This would mean there is lot of inventory which is not coming to the market and neither available on the rental market. In the absence of hard numbers, driving down Gardiner or QEW and counting the large number of black windows isn’t a very logical way to reach any conclusion. But it is food for thought.
- The problem with speculation is that the apartments get constructed as per the needs of investors and not owner / occupiers. According to CEO of BILD, the price of condos is increasing because the size of condos is increasing. But is there a need for larger condos? We don’t know because it is not the end user who is buying.
- CMHC reports a vacancy rate of 1.8% for Toronto and TREB also quotes CMHC. Even ignoring the empty condos/dark windows theory are we sure that CMHC is really surveying the correct units. Below is from the TREB quarterly rental report
Number of apartments listed for rental was 12,093 out of which only 9,164 were leased. That puts a vacancy rate rate of around 24%. It would be a good exercise to see where is the disconnect between CMHC and TREB numbers what will be the impact once it is reported that there is a 25% vacancy in apartments/condos instead of the 1.8% that is reported.
Speculation has brought stability in the market by not allowing the prices to rise as rapidly. However, based on the factors outlined above, I would forecast increased volatility in the condo sector.