How condo developers are bracing for a choppier market ahead

Builders can see trouble on the horizon. Their solution? Lots of perks and upgrades, and a big bet on renters

Condos with a fence and graffiti reading "Ka-ching!"

Canada’s housing market is a bit like an old china teacup right now—it’s pretty from a distance, but there are cracks if you look close enough. While the national picture remains relatively steady, some analysts are worried about overheated markets in Ontario and British Columbia. Looking particularly precarious is the condominium sector in Toronto and Vancouver, forcing developers to shift their strategies to compensate.

The Toronto market is still exhibiting plenty of “boom behaviour,” says David Madani of Capital Economics, thanks to purchases made several years ago during the heady days of the market. “We’ll continue to see those inventories get to really high—if not dangerous—levels,” says Madani.

But there are indications of a slowdown, and developers are starting to extend ever-more lavish incentives as the number of unsold newly completed units rises. The bonuses can be worth tens of thousands of dollars in some cases, including deals on parking or storage, the waiving of maintenance fees and upgrades to better units.

While developers will continue to offer perks, Madani says that won’t be enough to bolster buyer confidence if long-term market conditions look uncertain.“If investors get cold feet because of concerns of overbuilding and inventories…they may just move off to the sidelines,” says Madani. “A lot of investors, up until recently, have been buying on the expectation that valuations canjust keep going up.”

Demographics are partly to blame for increasing softness in the market, says George Athanassakos, a finance professor at Western University’s Richard Ivey School of Business. When a high proportion of people are in their working years (between the ages of 20 and 64), it tends to boost housing markets. When the proportion declines, markets soften. That process is underway now, he says.

Toronto’s condominium market is particularly vulnerable, Athanassakos says, as a huge oversupply of units is hitting the market. The city saw a 42% jump in the number of newly registered condos during the first quarter of 2015, according to research firm Urbanation. The Canada Mortgage and Housing Corporation warned late last year that large cities risked overbuilding if developers continued to churn out condo units before they were sold. This is happening while the prime demographic driving demand—25- to 35-year-olds—declines. Expect Toronto condo prices to drop by 25% or more, says Athanassakos, leaving developers struggling, cutting back construction or going out of business. “Over the last 10 years, it was all positive. There were tailwinds,” he says. “Now, there may be headwinds.”

Other analysts are less gloomy. Scotiabank senior economist Adrienne Warren says condo supply also feeds demand for rental properties, a hot commodity in both Toronto and Vancouver, where vacancy rates are low. “I don’t think there’s a lot of risk over the medium-term that the condos we’re building in Toronto won’t be absorbed,” says Warren.

Sal Guatieri, senior economist at BMO Capital Markets, argues that millennials are only one segment of the population driving demand in both cities. International migrants are another factor, and condos remain the only affordable option for first-time buyers in those cities. He says the supply of condos becoming available this year in Toronto may dampen or even drop prices, but overall, the market remains vibrant. Developers are shifting toward building rental-purpose units to fill the demand from that market, and new construction will likely slow down this year, says Guatieri.

“As long as we’re in this very low interest rate environment, I just don’t see a major problem,” says Guatieri. “Whenever interest rates go up, most likely we see some softening of prices, but we don’t think it will be bad enough to hurt the economy in a meaningful way.”

How worrisome the housing picture is overall is itself open to debate. Markets across much of the country have softened, particularly in the energy-reliant Prairie provinces of Alberta and Saskatchewan, where low oil prices are wreaking havoc on regional economies. The Canadian Real Estate Association reports the average price for a Canadian home in March 2015 was $439,144, up 9.4% over the same month last year. But if Toronto and Vancouver—where house prices remain strong, despite condo concerns—are removed from the calculation, that average drops to $332,711, an increase of just 2.4%, even with current rock-bottom mortgage rates.

Recently, The Economist released a survey of housing costs around the world that suggested Canadian properties are overvalued by 35% when compared with income. The magazine’s warnings echoed those issued days earlier by the Bank of Canada in its April 2015 monetary policy report. The central bank maintained its long-standing prediction that regions experiencing elevated house price growth, such as British Columbia and Ontario, will face localized risks, but the most likely scenario remains a “soft landing” and stabilization of debt-to-income ratios.

“Nevertheless, elevated house prices and debt levels relative to income continue to leave households vulnerable,” the report noted. “The adverse impact of the oil price shock in Alberta and continued robust price growth in Toronto and Vancouver suggest a risk of correction in these markets.”

Corrections typically don’t flow beyond regional markets, the report noted. But, it added, “if corrections in several important local markets materialized simultaneously, the spillover effects to the rest of the economy could be significant.”

Athanassakos argues Canada’s housing market is headed for a fall. “If you go back in time, there’s not really another period where the housing market [has been] so out of whack,” he says. “Eventually, bubbles burst.”