Interest rates expected to increase in late 2016 or early 2017

Recently, industry analyst Ben Myers of Fortress Real Developments, released his fourth Market Manuscript, giving us an extensive yet concise look at Canada’s housing market, in relation to affordability, interest rates, and many other factors. After reviewing the Market Manuscript, we had the opportunity to ask Myers a few questions, allowing him to go further into depth on some housing market issues.

Ben Myers

Newinhomes.com (NIH): Are interest rates going up or down? What will happen either way?

Ben Myers (BM): Based on the research I did for the Fall 2015 Market Manuscript, most analysts expect a rate increase in late 2016 or early 2017. I expect the increases to be gradual and spread out to allow homebuyers with tight budgets and variable rates to adjust their spending habits. There have been enough warnings about interest rates increasing that no one should be surprised by a rate hike, so hopefully people are prepared to cut their spending elsewhere should their cost of borrowing go up.

NIH: Multiples starts are on the rise, same with sales. Is this a good sign for the Toronto CMA's condo market?

BM: The increase in multiple starts and sales is good for the Toronto CMA condo market to a certain level. I have long argued that 17,000 to 20,000 new condominium apartment completions is a healthy level of new supply for the metro area on an annual basis. The CMA has far exceeded that pace over the past year but the market has not experienced any measurable decline in resale or rental transactions, or any price or rent correction, which is a very good sign for buyers, lenders and developers.

It appears that the Toronto area can absorb more condo units than I have previously forecasted, due to a sharp decline in new ground-oriented housing supply. Young couples and families looking to move-up from an entry-level condo will have to be satisfied with a stacked townhouse or small row unit instead of a single-detached house.

This reality may not be good for buyers individually that are looking for more space, but the increased demand for more affordable product is good for the long-term health of the condo market.

NIH: What's your opinion on developers travelling overseas to court foreign investors in person?

BM: As long as it is done in moderation (less than 10% of total sales in a project), than I’m all for it. I’m not sure why it matters what the nationality of a condo investor is? The GTA clearly needs more high-quality rental supply and if foreign investors can help domestic developers get their projects built faster, and add more ‘affordable’ rental housing, it is a win-win situation.

If these investors are well capitalized and long-term investors that want to hold their units for several years, this is exactly what we want. The more capital flowing into Canada is good, but we don’t want short-term flippers that will take their profits out of our economy.

Some people worry about foreign buyers that purchase single-detached properties and don’t use them, effectively reducing supply, which is not occurring in Toronto. In reality, foreign condo investors are actually creating supply.

NIH: Low inventories in the low-rise market are causing prices to surge. What will happen if single detached homes in the 416 continue to average over $1 million.

BM: New singles in the GTA overall averaged above $1 million in June, new ground-oriented housing is close to $800,000. If people want to buy a new home they are going to have to be willing to sacrifice on product type, unit size, or location. Ten years ago there were over 17,000 unsold new low-rise housing units on the market, today it is closer to 4,500, with much of that product in the outer suburbs of Milton, Brampton, Caledon, East Gwillimbury and the far-east GTA.

With a potential expansion of the Greenbelt, land vendors with unrealistic pricing expectations, and NIMBY pressure on municipalities, land supply will be further constrained and prices will continue to rise.

Look for increased tear-down activity of existing housing supply, more renovation gut jobs and second-storey additions, and a further explosion of the stacked townhouse built form in the outer 416 and inner suburbs.

NIH: Are Canada's and Toronto's markets really at risk of overvaluation and overbuilding? Why or why not?

BM: There is a huge misunderstanding of the seasonally adjusted annual rate of housing starts in Canada that are released monthly – I discuss it in detail in the Market Manuscript. One month starts are low so that’s bad for our economy and a reflection of low demand, the next we’re overbuilding and a sign that this excess supply will eventually cause prices to decline. In actuality, we are on pace for 182,000 housing starts in Canada in 2015, based on the average of nine forecasts I pulled together. The 50-year average is 189,000 and 5-year average is 195,000, so we’re clearly not overbuilding.

In Toronto, experts believe we need about 35,000 to 38,000 new housing units annually to satisfy demand, we started about 33,000 units in 2013 and 29,000 in 2014. In 2015, the consensus forecast is for 35,000 starts, so despite very high housing completions this year, we will be considerably underbuilding moving forward.

Without a thorough and adequate analysis of supply, the current measures many analysts use to determine housing valuation nationally and in Toronto are useless and a waste of time. The Bank of Canada admitted that measures like price-to-rent and price-to-income are easy to understand and compare across countries, but were misleading in a number of ways.

NIH: Why isn't rising household debt a threat to the housing market?

BM: It might be, but we don’t have enough accurate data to fully assess it. Canada’s ratio of debt-to-disposable income is similar to a number of other countries in Europe with very healthy housing markets, so it is difficult to say how much of a vulnerability it truly is to our housing market and our economy. Based on my survey of builders and developers, they were not concerned at all with the debt situation.

I would prefer to see how the average debt level has changed in comparison to net worth, which has increased substantially for many people in recent years.

NIH: At which phase in development do condo developers drop their prices? Is pre-construction still the best time to purchase?

BM: Most developers are very reluctant to drop prices, as it eliminates the sense of urgency to purchase. This is why it is essential to get the prices right at the start of a project, and why I did so many market studies for my previous employers. Based on my survey, only 31% of developers would lower prices after occupancy has occurred, and 37% of those developers would wait six months or longer before resorting to that sales tactic.

Developers need buyers the most during the pre-construction period, so that is when they offer the best prices, and often offer the best incentives as well. Always advisable to get in early when looking to buy pre construction.

NIH: How come only 12% of developers in Toronto aim to sell out the condo by the time of completion? Is more room for profitability the only reason?

BM: Some high-rise developers are willing to hold off on selling all of their units because they anticipate the market will continue to appreciate during the pre-construction and construction phases of development, and even if it doesn’t, buyers will typically pay a premium for the ability to walk through a completed unit and get a ‘feel’ for it and see the views and common building amenities.

Obviously, not all of a developer’s hard (construction) and soft (all other) costs are fixed, so they like to have a buffer available with unsold supply. Developers will try to pass on cost increases to buyers by raising the prices on their unsold supply if the market will support the increase.

NIH: Is there any correlation between the 12% of developers who aim to sell out and the 12% who will never lower their prices?

BM: Nope, no overlap at all.  Developers that will never lower their prices tend to be the ones that are willing to take on greater risk, and that entails not selling their project out prior to completion, banking on future price inflation.

NIH: Predictions for the final quarter of the year: Average low-rise price and average high-rise price in Toronto CMA

BM: Average new low-rise house will average about $820,000 for 2,500 square feet in 2015. The average new high-rise condominium will average approximately $460,000 for 800 square feet. Look for new low-rise house prices to increase by 8% to 12% per year and condominium apartment prices to go up by 3% to 4% annually.

A big thanks goes out to Ben Myers for taking part in our quick interview. For more details on Canada’s housing market, download the whole Market Manuscript here.