Monthly Newsletter: June 2005

It’s June and the warmer weather is finally upon us.   How about starting your summer fun by joining us this Thursday, June 2nd at 7:30 p.m. for our party at the RPM Café?  We will be hosting a networking evening for our clients, suppliers, contractors and friends.  It will be fun for all featuring live comedy, music, and Texas Hold’em Poker.  We’ll also be serving light snacks, refreshments and cigars.  I hope to see as many of you as possible.  If you’ve never been to our offices before, the RPM Café is part of the Plex building located at 6 Brentcliffe in Leaside.

I’d like to start this month by welcoming Leila Bannister-Brown to the Plex family.  Leila will be responsible for marketing, website maintenance and promotions as well as administering the largest database of known income properties in the GTA which we have been developing since Plex was formed.  We are thrilled having Leila around the office and look forward to having her contribute to our team.
This month I will focus on the one issue that seems to be on everyone’s mind.  The question I get asked most often is: Are we in a real estate bubble and will these higher prices in Toronto ever come down?  I have touched upon this in past newsletters but this month I’d like to explore this topic in more detail and present a few opinions that are in line with my thoughts on the matter.

There have been plenty of stories coming out of the US lately about how certain real estate markets are over-inflated.  Stories abound on CNN about how the real estate market in some cities is too hot and how consumers are borrowing too heavily, overpaying for what they get. Many experts agree that certain states are experiencing unnatural and unsustainable pricing.  Some writers have used words like “insanity” and “irrational” to describe certain housing markets.  Fed Chairman Alan Greenspan said last week the booming U.S. housing sector shows signs of some “froth” but that the central bank actually does not see a national housing bubble.  “We don’t perceive that there is a national bubble but it’s hard not to see … that there are a lot of local bubbles,” Greenspan told the Economic Club of New York. The central bank chief also said the inability to reduce home prices, which have climbed by double-digit percentages over the past few years, was not a serious macroeconomic problem. Prices, he said, were supported by relatively slow productivity growth in home building. Eventually, home prices will decline because the underlying pattern is unsustainable, Greenspan said.  “Without calling the overall national issue a bubble, it’s pretty clear that it’s an unsustainable underlying pattern. What we see are a number of forces, which are, as far as I can judge, not infinitely projectable,” he said.  Reading between the lines here it seems like this is a prediction for some sort of day of reckoning.

In economics, a bubble is defined as a price level that is much higher than warranted by the fundamentals. Bubbles occur when prices continue to rise simply because enough investors believe investments bought at the current price can subsequently be sold at even higher prices. They can occur in virtually any commodity including stocks, real estate, and even tulips.  I think that in Toronto real estate prices are going to, by and large, remain stable.  My feeling is that if we are on the verge of a collapse or even a slow-down, much of the fever-pitched activity that I have observed over the past several months will have to subside – if not stop entirely.  So long as we are seeing demand outpacing supply and urban areas close to the downtown core fetching record prices through multiple offers, I think that current prices will remain at current levels.
Linda Leatherdale in the Toronto Sun cites that Toronto’s real estate market is actually calm and cool when compared to some of the hot spots south of the border.  From 2002 to 2004, some hot markets like San Bernardino and Las Vegas saw house prices skyrocket by 65%-plus, as investors flip homes faster than pancakes in hot hubs like California, Nevada and Florida.  Toronto’s home price gains are small in comparison – with average prices up 14.7% over the same period.  She surmises that “it’s still not the speculator-infested market of the late 1980s – which is unlike the U.S., where 23% of all homes bought in 2004 were for investment”.

Since we deal with many builders, speculators and investors I can concur that the investment quotient in Toronto is markedly lower.  First time buyers have definitely forced acceptable cap rates down but savvy investors are still mindful of maintaining strong returns.  A new report entitled “Bursting Aspects of the Housing Bubble” echoes this same sentiment that one of the key tenets of a housing bubble is speculative buying and that’s just not happening in most markets in the country.

A report from TD Economics also says that risks in the housing market are exaggerated, and that concerns about a housing bubble, overly leveraged homeowners and a crash in the condo market are overblown.  The report says one misconception is that recent homeowners, who entered the market when rates were low, will be deeply hurt when rates rise.  “Despite the growing popularity of variable-rate mortgages, longer term fixed-rate mortgages remain the most frequently used financing option for most homeowners in Canada”, says the TD Economics news release.  “As such, most homeowners are already insured to some extent against the risk of rising rates since their mortgage payments would remain fixed over the term of their mortgage.”  The generally held belief is that when interest rates start to creep up, they will do so slowly and not cause a sudden, unanticipated shock to the economic system.

Doug Porter, senior economist at BMO Nesbitt Burns, states the Toronto housing market will remain strong. “There are no obvious land mines ahead for the housing market. The jobs market is still healthy and consumer confidence is still relatively high,” said Porter.
Another popular housing myth seems to be that condos have been overbuilt in Toronto.  Given the higher prices of single family homes, condos keep home ownership accessible to younger people and recently arrived immigrants who are drawn to a larger urban centre like Toronto.  Many developers pre-sell their units prior to construction, so I don’t think the oversupply will be as great as many folks think.  Since condo sales represent 40% of the overall real estate market in Toronto, I don’t think the sector would continue to thrive if a down-turn was around the corner.

I believe that if prices in the hottest areas of the city are not going to crash and only slip marginally (if at all), then housing in Toronto will remain a sound investment.   Naturally, I’m in the business of selling investment realty, so you might think that my thoughts are self-serving.  Honestly, I think that since we haven’t seen the same speculative investment push of some of these ultra-high markets, the investment marketplace in Toronto only has room to improve.

Next month we will focus on why a good income property is a great hedge against any positive market corrections and why building an investment property portfolio is a smart retirement plan.  I hope to see you at the Plex party and look forward to chatting with you soon.

P.A.

paul@plex.ca

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