Thursday, 26 November 2015

Supply and Demand, Toronto Style

Back in the day, some of us may have taken an Economics 101 course that first brought to our attention the theory of supply and demand. The rules are pretty simple. If supply goes up too much, demand falls and prices fall. Flip that around and you have the same theory in reverse. When supply is low, demand increases and so do prices.  This relationship between supply and demand could be applied to the fur trade three hundred years ago or to blueberries in the supermarket right now (more expensive out of season when supply is down).

When people are looking at real estate, they like to look at factors like interest rates and the Canadian economy. And these are very important macro factors to consider. Still, I really think you need to look at the local economy to see what is happening. It's the smaller local supply and demand factors that often sway real estate prices. This is why prices are still going up in Toronto and Vancouver and not in the rest of Canada. This is why New York, Oregon and Texas didn't suffer the recession like Florida, Nevada and California. Local factors of supply and demand make a difference.

As far as Toronto is concerned, supply and demand can explain a lot about prices and where they will go.  The most obvious example of supply and demand in Toronto has to do with houses. As I've mentioned in many blogs before, houses are rarely built any longer. It is not cost effective for a builder to construct a house when that builder could build a condo and make a better return on his or her money. Plus, as Toronto matures, there are fewer locations to build a house. Houses would need to be built in the outer suburbs which would be a far drive away and a very different lifestyle than the city offers. Even the inner suburbs don't have the space for many more houses, and we see much more condos under construction. So, houses go up in price because the city is growing and demand is growing, but supply is limited.

Of course, in Toronto, houses are not the only thing in short supply. Low rise condos also are in limited supply and therefore perform better than their bigger high rise condo cousins. Conversion lofts are another great example. These are now in shorter supply than they were before, but this is a recent phenomenon. Not too long ago, there were a lot of conversion lofts hitting the market. Nowadays, there are not many old factories, warehouses and churches that have not already been converted. So, I'm seeing a greater demand on these kinds of condos as new supply stops coming to market and the demand increases.

Now, all this talk make seem to suggest that large condos are a lousy investment because they are in greater supply. And to a certain extent, this is true. Since there is more of a large condo supply, prices are kept reasonable because there are less competition for those units and more options added to the supply all the time. This is where most of Toronto's construction takes place - in the high rise condo sector. They may not appreciate in value the same way as houses or conversion lofts or even low rise condos in Toronto, but they are more affordable.  For some, big condos are a great starting point. I would not discourage someone from buying in a big condo, but I would say you need to pick the right big condo with a healthy reserve fund, a good location and a little character.

Supply and demand is a funny thing. From the buyer side, it is easier to buy a larger condo because there is so much supply. It is more affordable and there is less competition. Easy Peasy for a buyer. When it comes time to sell, you may not have the price appreciation you would see elsewhere in Toronto. In many neighbourhoods, conversion lofts, lowrise condos and houses are tougher to buy sometimes but as an investment, your chances of appreciation are greater. You'll have a harder time buying, but a easier time selling.

Thursday, 19 November 2015

Why Are There So Many Rental Apartments Under Construction?

It was not too long ago that Toronto could not build their condos fast enough. For several years in a row, Toronto had the rare distinction of building more condo units than any other city in North America, even cities four to five times larger like New York and Mexico City.  Torontonians didn't know whether to be proud or afraid. For some, this explosive growth of condos revealed a worrying trend toward an oversupply of condo units. This oversupply, it was believed, would lead to a larger number of units than buyers, and subsequently a market correction.

The thing is, we are no longer number one. Though the Toronto condo market still has many new units coming up, plans for new buildings have subsided some, and many developers who had once built condos have now put their focus on something quite different. Rental properties.

In fact, one Toronto developer in particular, switched mid-construction from condo building to rental building, even after some of the units had been pre-sold. Earlier this year, Urbancorp cancelled its Kingsclub condo complex for plans to build three rental towers instead. Some buyers who bought pre-construction were a little miffed that they were not going to have the condo unit they bought come to fruition. And who could blame them? After months or even years of waiting for their dream condo, all those who had invested in Kingsclub condo received were their deposits back. Not exactly worth the wait...

This swich from condo to rental apartments is a small portion of the rental construction boom under way. There are rentals also under construction all over the city. The number of new rental apartments under construction across the the GTA is at a 25 year high. We have not seen any rental construction since the early 1990s. So, why all this focus on rentals? Is there a fear from developers that building condos are not a good investment at the moment? Are they worried about a coming condo crash?

In some ways, developers are concerned over condo oversupply. Because of the explosion of condo construction in the past, it is not surprising that we would need to slow down. And at the moment, the condo supply seems to be healthy because the developers have pulled back a little plus the demand for them stays strong. Still, I think the real reason developers are going into rentals has more to do with their bottom line: Money. Simply put, rentals, these days, are profitable. They are catching on to what a lot of condo investors have been doing for many years now. They are cashing in on Toronto's impressive rental market.

It seems there has been a lot of water cooler conversations about the rise in condo prices, but rents have also been on the rise along with condo prices. As a renter, you are paying much more for rent in Toronto that you would have five years ago. Currently, the average 743 square foot unit rents for $1870/ month.

So, why would developers not get in the game? I'm sure they can see an opportunity when they see one. Instead of receiving a one time payout from a condo purchaser who buys a unit once, the developer just rents out the unit and had continuous cash flow paid out each month. It's the same thing condo investors have been doing for decades.

The rental market is very appealing. The vacancy rate is still relatively low in this city. Despite all the new condo owners who rent out their units, the vacancy rate in the downtown core still come in just below 2%. For the developers who focus on apartment buildings that are just for renting, the vacancy rate for these comes in at around 0.6%. Those are pretty good numbers for a developer.

But  why are these rentals being gobbled up? It appears there are more renters these days because more people spend a longer time in the rental phase. They need to build up more equity to buy, or maybe they find purchasing too much of a drain on their finances. The desire to live downtown burns strong for many and house prices rise keep home ownership out of reach for some.

 But renters are not just priced out or preparing homebuyers. There is a motherland of renters coming in the years ahead. The baby boomers will want to rent and live off the equity of their sold homes they lived in for decades.

The rental market may have had little appeal for a long time, but it's back in a big way. Developers are finally understanding what many small time condo investors have known for a while: Rents are strong and consistent in Toronto and renting has a big future ahead of it for Toronto.