Why rents are softening and what’s in store for Toronto’s condo market

Urbanation Inc., which researches Toronto’s condo market, released its latest rental findings last week. The number of condos rented over the Multiple Listing Service in the Toronto area hit an all-time high of 6,708 during the second quarter, up 26 per cent from a year earlier. But the number of new listings rose by an even greater degree, and so – when measured per square foot - annual rents ticked up by just 0.7 per cent from a year earlier, to an average of $2.37 per square foot.
It marked the second quarter in a row that rents grew by less than 1 per cent on a year-over-year basis, after an average growth rate of 4 per cent during 2013. And the average monthly rent, which can be impacted by the size of condos that renters are moving into, actually fell by 3.2 per cent from a year earlier, to $1,787, as the average size of units being rented shrunk again, by 3.8 per cent, to 755 square feet.
I asked Urbanation senior vice-president Shaun Hildebrand for more details about what he thinks is taking place in the condo rental market in Canada’s most populous city. It’s a pocket of the country’s real estate market that economists are watching closely as they try to determine whether too many condos are being built. Mr. Hildebrand, who used to be a senior market analyst at Canada Mortgage and Housing Corp., talks here about deficiencies in the data, and why he doesn’t think condo rents in Toronto will drop materially.
Q. Both rentals and rental listings are up by more than 25 per cent from a year ago. Do you think that’s in line with demographics, or are we seeing a bit of a shift away from ownership toward renting? Where is the rental demand coming from?
A. Growth rates for condo rentals and listings are far stronger than overall growth in condos and population growth. But it’s important to recognize that we can only monitor condo rentals through what occurs on the MLS system, and this is a mechanism that has grown itself in popularity in recent years. So some of the growth being reported is due to a better capture of the data.
But still, the upward trend in rental demand is clearly visible, otherwise all the newly completed units listed for rent wouldn’t be absorbed. To some extent it reflects a shift away from owning, as resale volumes have remained below previous highs following the latest round of mortgage tightening in mid-2012.
I think a lot of the demand is demographic driven as a wave of baby boomer children are finishing school and moving out on their own. This has been helped by improving job opportunities, which were scarce for younger adults for several years following the recession. The census data also reveals a general movement of people towards higher density locations, which could reflect a lot of factors, including commuting times and costs. We also can’t forget the lack of purpose-built rental construction (apartments) driving renters to the condo market.
Q. Rents have grown by less than 1 per cent for two quarters in a row. Do you think this is the start of a trend?
A. I do. Even though demand is strong, it isn’t quite able to keep up with supply growth. With completions expected to remain high through to 2016, I would say supply continues to have more upside than demand. That said, I don’t think we’ll see conditions so unbalanced that rents noticeably fall. Some of the units in the current stock will be sold to first-time buyers – not all investors have long-term intentions. A new building typically has a much higher share of units used as rental at occupancy than it does a few years down the road.
Q. If rental growth continues to be lower than it has been historically, would you expect to see some investor-owners sell their condos?
A. I think we’ll begin to see more investors sell than in recent years, but still not a lot. For units that came to completion so far in 2014, there was no cash flow based on a 25 per cent down payment [that’s on average: some have a few hundred dollars each month, others are negative] – but cash flow has been thin for some time now. I can’t imagine a huge shift in investor behaviour so long as interest rates remain low.
With prices growing slowly for some time, I don’t think investors have distorted expectations. The resale market is now in a better position to absorb more listings than it has been over the past few years, so any repercussions for price would be limited. The problem with trying to predict how many will sell versus hold is that we don’t have any information on investors that purchased units currently under construction. CMHC recently released a survey of investors that showed that almost two-thirds have down payments of more than 20 per cent and almost 60 per cent planned to hold for more than five years – but the sample largely missed those that bought pre-construction units in recent years that have yet to complete.
Q. We hear a lot about the Toronto condo market these days. In your opinion, are there any mistaken impressions or myths you think need to be corrected?
A. A lot of talk surrounds the foreign component. However, I do not have anything other than informal survey results to add to the discussion. We polled the [condo] industry late last year and asked what percentage of new condo buyers they believe are foreign (results were anonymous), and the highest number of votes was for between 5 per cent and 9 per cent, a close second was between 10 per cent and 19 per cent. Few believed it was 20 per cent or more.
I also think there is a fear that all of the units currently under construction will be finished at once, flooding the market. We monitor construction starts, construction progress and completion timelines very closely. Completions can be expected to average about 20,000 a year over the next three years, which are record levels but aren’t high enough to alone create an over-supply of units. We’ve completed over 19,000 over the past 12 months, and other than slower rent growth, the market has been unaffected so far.

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