Is Toronto the new Manhattan?

If you are not already a homeowner in Toronto, maybe now is the time

The mortgage industry in Canada has experienced some big changes in the last few months. Add the recently increased interest rates to that mix, and you have a good recipe for a conspiracy theory.

The first question that comes to mind is this: does the U.S. election have anything to do with these changes? Especially for people from our part of the world who are experts in conspiracy theories, right?

And while we wait and see how Trump’s administration will affect the American economy, and indirectly the Canadian one, let us analyze the situation north of the border… The history of the last 10 or so years, the reason for the changes, circumstances, consequences, and so on.

One of the biggest “problems” in the Canadian real estate market of the last few years (let’s say decade) was the so-called uncontrolled real estate value increase. That growth most affected Toronto and Vancouver. Both cities proved themselves to be good destinations for foreign investors because of some of their natural advantages (more details to follow), and also because of the relative stability of an economy that withstood (still questionable) the financial crisis much better than the rest of the world.

One of the biggest reasons why the Canadian economy fared better than our American neighbours or many other countries in the western hemisphere is because of its monetary economics, at least the part that directly affects interest rates.

The Bank of Canada has always been very conservative, particularly after a big crisis in the 1980s when interest rates reached a record 18%. Around ten years ago, while our southern friends were approving mortgages for people who were not able to afford them, while people without any real job security were multiple property owners, the approval conditions were much stricter in Canada. In other words, if someone was not able to afford credit, they would not get it. Because of this, when the 2008 subprime housing crisis hit America, the owners of these properties began returning their keys to the bank; the number of properties increased, and the prices dropped. In Canada, this was not the case. Only a very small amount of people was not able to pay off their credit, since it was originally given to them on the basis of realistic qualifications.

In the last few years, the Bank of Canada, along with the Ministry of Finance, has striven to stay conservative and to enact regulations and restrictions that would not allow the price of real estate to go up, nor for people who pay their mortgages to lose their homes because they can no longer afford them. We have seen various changes. The amortization period has dropped from 40 years to 25 years for certain mortgages; the qualifying rate for some mortgages has nearly doubled; the mortgage approval program not based on income, regardless of the percentage of down payment, has practically vanished, etc.

We saw that these changes had a big effect on the purchasing power of many applicants; we saw the speculators decrease their purchases of investment properties; we saw some other results. However, what we did not see was the decrease of real estate prices, at least in Vancouver and Toronto.  

Let’s go back to these two cities.

Vancouver is a city surrounded by mountains and ocean and that physically cannot grow, except in height. Therefore, the value of land is understandably high. Add to that the fact that a large percentage of its population is of Asian descent and you will conclude that it is an exceptional investment destination for rich Asians, be they from Hong Kong or Mainland China.  

For that reason, foreign investors greatly influenced the value of real estate in Vancouver. When the demand is great, the prices rise. And when the Canadian dollar dropped a few years back, it looked as if Canadian real estate came with a 20% discount compared to the United States. Of course, an increase in demand comes with an increase in price.

The changes implemented by the Bank of Canada in the past few years did not have a big effect on controlling the value of real estate in Vancouver, since it was not average applicants who were raising the prices. It was mainly rich investors who were buying these properties in cash—properties that were mainly empty throughout the year.

At that point, all three levels of government (municipal, provincial, and federal) agreed that Vancouver’s problems would have to be solved with solutions specific to that region, more specifically by taxing foreign investors. The change was felt overnight. Purchases drastically decreased, and the investors shifted their interests to cities like Toronto, Portland, and Seattle.  

Why did the prices in Toronto continue to increase, and what did the Bank do to stop it?

First of all, I am sure that you have seen that every single square foot of downtown (and not-so-downtown) Toronto is being used to its maximum potential. Parts of town that until recently were considered bad have turned overnight into neighbourhoods first settled by hipsters, then millenials, and then families with children. A Starbucks sprouts on every corner, and if not them, then other smaller cafés that serve—in my opinion—much better coffee.

Buildings sprout on every corner. People who live downtown have less and less desire to travel, and can run more and more errands close to their homes. They go grocery shopping close to where they live, and in the evenings they go out to local spots. Recently, I was speaking to the person who rents our apartment and for whom I am getting a mortgage for a property she intends to buy. When I asked her in what part of town she wishes to buy, she said she was looking at a townhouse in the Trinity Bellwoods area. That did not surprise me. What did surprise me was when I suggested that they look at, for example, Long Branch (Etobicoke) and for a little bit more money buy a house, she answered, “Where is that?” 

For someone who works for the provincial government, I doubt that it was a question of not knowing the geography of the city, but simply the fact that she wants to live in the city, to bike to work, to buy organic groceries in the local supermarket. For them, everything west of High Park is not the city anymore, but rather the suburbs. For her—and many other millenials who live in Toronto—it is much more important to stay in the city even if it means living in a smaller place that has its limitations. Maybe their opinions will change once the kids grow up and they no longer have space for all the bikes and hockey equipment. But in the meantime, it is exactly these kinds of buyers who are pushing up the demand, which is pushing up the prices of real estate in Toronto’s downtown core.

Lately, it is becoming more and more common to hear the phrase “the Manhattanization of Toronto”—the idea that downtown Toronto is slowly turning into Manhattan.  There is less and less land available, the population is growing, families are not moving out of the circus but rather staying in it. All of this influences the strong demand for apartments in downtown Toronto, which in turn influences the price of real estate. And why would it not? When you look at it, in what other city in the world can you get an apartment for $300,000 and then walk to the financial district as influential as that of Toronto? Where the crime rate is the lowest in the world for this kind of metropolis, and where there is a job for everyone who wants to work?

Maybe the increase in real estate prices in Toronto does not have so much to do with earlier lax mortgage approval conditions. Maybe it is a restructuration of the city.  Maybe, now that the value of houses has gone up, future buyers will look for the next best alternative, but still in Toronto. Is it a townhouse downtown? Is it a two-bedroom apartment?

Either way, the new rules are in place. Let us examine the two most important segments.  

Firstly, there is a new rule that all mortgages where the down payment is less than 20% must be qualified using the Bank of Canada posted rate, no matter the product. Until recently, anyone who applied for a 5-year closed fixed mortgage had the opportunity to use that interest rate as the qualifying interest rate. Under today’s circumstances, suppose that the rate is 2.69%. The new rule requires that 4.74% be used as the qualifying rate, which practically lowers the purchasing power by 25-30%. In other words, someone who would have qualified for a mortgage of $650,000 can now borrow around $500,000.

The second change is related to whether or not the mortgage transaction is insured by CMHC, Genworth, or Canada Guaranty. What most Canadians do not know is that many Canadian institutions insure all their mortgages, even if it means paying the insurance premiums out of pocket. The new rules control which kinds of mortgages can or cannot be insured, and this is where the situation becomes complicated. Every mortgage becomes unique depending on whether it is a purchase or a refinancing, the purchase price, the property purpose, the amount of down payment, and so on, and as such comes with a price. In other words, if you see a promotional interest rate of 2.79% in a bank, that interest rate can be accessible to people buying property valued at less than $1 million, for example, but not to someone who wishes to refinance an existing mortgage.

Do I personally think that these changes will lead to a price decrease in Toronto? Absolutely not! I think that it will definitely be much harder for our children, the so-called millenials, to buy freehold houses in Toronto one day. I think real estate will continue to rise, since Toronto remains a top and secure destination for foreign investors.

In this age of globalization as we are experiencing it, I think that Toronto will reach the level of London, San Francisco, Moscow, or Paris, where the price of real estate vastly exceeds the purchasing power of its residents.  

Which leads us back to Donald Trump…

First of all, I doubt that the increase in interest rates is a direct consequence of Trump’s victory. In fact, it is, but not in the long run.

As is well known, the market can react well or badly to unexpected news. For example, if the profits of a company end up being lower than expected, its shares can fall, since they were originally based on the expected (higher) profit. Or, if someone unexpectedly wins the presidential election, there are signs of insecurity; of what happens next, and how. This is what happened when Trump won: the market practically went crazy, but quickly stabilized.  

The interest rates for mortgages are not based on the same principle. They are based on the economic situation of the country, the (un)employment rate, inflation, the predictions of all these factors, and so on.

We witnessed that interest rates in Canada went up quickly after the election. Many connect that to the presidential election, but I do not think it is the case. It is not news that the economic situation before elections can be fairly stable. Maybe it was the last try of the previous administration to leave a positive effect on voters. In our part of the world, it would sometimes happen overnight before an election—the paving of some parts of towns or villages that were waiting on infrastructure for years. That is why many people say over coffee, “Let’s wait for this election to pass and see what is really going on.” That was the case with interest rates as well. I think they were bound to go up in the U.S., but some important indicators were ignored until the curtain finally went down. In the words of Djordje Balašević, “The circus is leaving our small town…”

Let us put aside, for a moment, the support that many people from the homeland have for Trump, for obvious reasons…  

Although only time will show the true intentions of his administration, the fact remains that Trump’s protectionist climate precisely makes Toronto an even more attractive destination for foreign, non-white investors.