Stress Test Relief!

There’s a very big real estate story that isn’t getting much widespread coverage in the community. When federal regulators announced the unveiling of tighter rules on uninsured mortgages and mortgages with down payments of less than 20 percent, the market sputtered.

The move was designed to clamp down on risky mortgages, tighten confidence in the housing sector, and to cool a market that was literally on fire. The tests required that borrowers needed to prove they would be able to manage the costs of their mortgage if rates were to rise. Experts believed the move single handedly knocked out 10% of prospective buyers from having a shot at sealing the deal on a home purchase. We’re talking about tens of thousands of people, at the least. The stress tests were praised by experts, economists, and some bankers but were lambasted by the real estate lobby and politicians. 

After almost a year of criticism and calls for reform we finally have some relief. The rate at which a mortgage holder has to qualify being able to pay for has now gone down from 5.43% to 5.19%. While not a significant change, it will have an impact on those prospective buyers on the margin. Some experts believe that the continuation of a lessening trajectory could have a significant impact on the market, with as little as a further 0.50% reduction lifting thousands into home ownership. Tim Hudak, CEO of the Ontario Real Estate Association asked for federal regulators to restore 30 year insured mortgages, to further ease stress test rules for new homebuyers, and to scrap the requirement that those who change their lender on an existing mortgage have to also pass stress tests. With an election rapidly approaching, don’t be surprised if further loosening of these rules continues, real estate has been repeatedly polled as one of the biggest concerns on peoples’ minds.

 

Finally, when Canadians were asked to pick which city they would own real estate in, the result, quite strongly, was Toronto! That’s right, our city is seen by most average Canadians as the best place in the country in which to own a home. Despite Vancouver’s beautiful natural environs, great weather, and lack of winter blues, and Montreal’s thriving cultural scene, affordable prices, and great food choices, Toronto still won out. Unfortunately for those polled, rents and home prices continue to rise in the city, with one metric showing that the price for two bedroom and one bedroom units is effectively the same. The demand for ANY space is so great that it doesn’t matter how many bedrooms it has. This summer continues to deliver positive news on the real estate file. 

On The End of the Era of Central Bank Independence

It’s all over folks. We’re going down a new road. After intense pressure from President Trump and other members of his Administration to lower rates and boost stimulus, Federal Reserve Chairman Jerome Powell folded.

In his latest Committee Hearing with the House of Representatives in Washington, Powell outlined his view that the U.S. economy was showing signs of weakness and that the Fed would intervene more actively to stimulate it. Tembo watched the Hearing carefully and noted a stark shift in tone for Powell to a much more accommodating rhythm with a more humble persona than his usual confident, lawyer-investment banker stern self. Powell was in full listening mode. The transformation from Hawk to Dove is complete for Powell. This shift marks what is in many ways the end of Central Bank independence. Never again will the Fed be able to march on with its policies undeterred when a political figure with as volatile a record as Trump threatens the Chair with termination.

What was interesting about the hearing was the fact that Powell said that the Fed’s current huge balance sheet (now in the many trillions of dollars) was not an issue in again buying stocks and bonds ‘if it decided to do so.’ In other words, Powell was saying that even though we’ve become such an interventionist, buying bank to the tune of trillions of dollars, we’re happy to buy more if we need to. The Fed’s shift in tone was so strong that gold prices surged to multi-year highs. Markets enjoyed the capitulation of the Fed and showed solid gains. The Fed’s shift is a big win for Trump, as the political benefits from the likely economic gains from stimulus will help the President as he gears up for the 2020 election. Not since President Lyndon Johnson’s era in the late 1960s has a Fed Chair been under so much pressure from a President. But unlike the privately intimidating Johnson, Trump has been arms length, open, and very public about his disdain for the Fed’s unease of more stimulus and lower rates.

What this all means is simple. The Fed is now almost guaranteed to lower rates. It will also be much more open to reigniting the quantitative easing it pursued in the immediate aftermath of the last recession (buying assets in the open market). It is a huge political win for Trump, as his unadulterated, raw strategy of open criticism has now yielded results. When Trump started criticizing Powell he was widely mocked and attacked from across the spectrum. Nobody was used to this, and in previous political eras it would have been inconceivable for a mainstream, run of the mill politician at any level to attack the Federal Reserve or its Chair. For Canada, the Fed’s surrender will result in huge pressures on the BOC to cut rates as the game to lower the value of the dollar and lower the cost of money overall now begins in earnest.

The Return of Surging Detached Home Sales

Toronto had its best June for real estate in over 2 years. With over 8,800 units sold, we beat our 2018 and 2017 figures. Only in 2016 was the number of sales around this time of year higher. Also recall that 2017 was a blockbuster year for demand, price growth, market activity, and general enthusiasm. The slight drop in sales compared to last month also matches historical averages – we usually see a surge in Spring and April/May that dips slightly as we head into the summer. New listings declined slightly, to 15.8K, and all in all, we saw a price increase of 3.6% from a year ago, with $798.5K now representing the average. A 3.6% boost is solid, well above inflation, and nothing to sneeze at. Stats show price gains in semi-detached, condos, and townhouses. But the really big news from last month was that sales of detached homes surged 19%, a very handsome rise indeed.

The average detached home price is now $832K, with average sale prices now at early 2017 levels. If trends continue we could see a return to the plateau of just over $900K that was attained in the last bull run for prices in the 1st quarter of 2017. The cause of the positive sales numbers was the fact that supply didn’t change, and demand didn’t relent in its chase for housing. Condo sales were down, mostly in the core, but rose generally throughout the rest of the city and across the region, likely as a result of higher prices downtown and lower inventory. Stats also show that people are leasing condos at much higher rates as opposed to outright ownership (15% in the 2nd quarter). Listings are generally rising across the GTA. Rents keep going up, and past inflation, but at a lower pace than what was the trend in the last year or so. The average one bedroom condo in Toronto will cost dwellers just under $2,200. 

Despite this positive news key stakeholders and real estate bodies continue their calls for more accommodation, relaxed regulations, and a winding down of the stress tests that have locked out an estimated 100K people from getting into the market. Interest rates are holding steady, and as we’ve repeated, momentum seems to be shifting to more monetary accommodation around the world as opposed to a gradual rising of rates. In Japan, Europe, and China, central banks are maintaining, and in some cases boosting money supply in their regions, lowering rates, and buying more stocks and bonds to ‘stimulate’ the economy. This trend is going to come to North America, and sooner rather than later. Overall, given where we were not long ago, when pessimism and disappointment were building, the underlying fundamentals are getting better! 

Toronto’s Biggest Real Estate Project

Oxford Properties, the real estate arm of OMERS, the pension plan for Ontario’s municipal workers, has signaled its intention to build a $3.5 billion mixed use project just north of the Rogers Centre and CN Tower. The proposed development would see two office towers of 58 and 48 stories respectively, 800 rental apartments in two buildings, and 200,000 square feet of retail space built; just over 20% the size of the Eaton Centre. The project is innovative for several reasons and is receiving a buzz of largely positive attention.

For one, the designers involved are internationally renowned: Pelli Clarke Pelli Architects. Responsible for the International Finance Centre in Hong Kong, the well known Petronas twin towers in Kuala Lumpur, and other major landmarks. The building designs appear sleek, curvy, and modern while avoiding the usual uniformity of Toronto high-rises. Second, the towers will be largely re ntals with an integrated day-care on site. The units will also feature 2 and 3 bedroom units which Oxford claims are sorely lacking in Toronto’s downtown core. The office blocks are designed to cater to large scale tech. and financial employers undergoing rapid growth with young work forces who prefer downtown living to their older counterparts. A fair amount of retail space and a connection to the PATH will provide convenience and more employment opportunities to locals as well.

The real unique aspect of the project is that a large park will be built over the rail lands the project is adjacent to. The rail deck park complements recent proposals to build a $1-2 billion park above the rail corridor to provide the downtown core with much needed green space. To put the scale of this project in context, in total Union Park represents over 4.3 million square feet of retail, office, and residential space, more than twice the size of the square footage of the Toronto Eaton Centre complex and 25% bigger than the West Edmonton Mall, once the largest mall in the world. The project is a gamble. It is a expensive proposition and depends on a large number of tenants occupying its retail and office spaces in particular. Bold and ambitious, Union Park highlights the scale of Toronto’s ongoing construction boom and signals to the world that we’re just getting started!

Higher Inflation in Canada

Canada is an expensive place to live in. With a generally high quality of life comes high taxes, prices, and fees. Canadians pay some of the highest airfare, phone bills, and property taxes in the world. They also pay huge sums for modest real estate, as well all know all too well. Last month, inflation in Canada hit 2.4%, driven by a surge in food prices. Fresh vegetables and meat along with new car prices rose significantly. The only commodity that saw prices fall was gasoline, which recorded a 3.7% decline. Without the fall in energy prices, the inflation rate would have been 2.7%.

There are different definitions of inflation in the economics community. Some economists hold the view that inflation is solely an increase in prices. Others believe that inflation is almost always a direct result of an increase in the money supply driving up prices, more money in circulation means higher prices. In Canada, inflation monitoring, data collection, and targeting is sophisticated and well regarded internationally. The BOC has an inflation target rate of 2%, and is zealous is maintaining this rate. 

What last month’s figures mean is more difficulty for the central bank. On the one hand, economic growth is very modest and pressure to reduce rates to spur demand and lower housing costs is strong. On the other hand, the BOC is mindful of high debt, the need for a normalized rate environment, and now a growing trend of incrementally rising inflation. An interest rate rise now to blunt the modest increases in inflation we are seeing and would honour the BOC’s commitments to 2% inflation, but it would dampen the economy and irritate a number of sectors in need of debt. An election year makes the BOC’s task harder still.

Tembo’s read on all of this is that inflation rising will lower the possibility of a market favoured rate cut. If it continues to build up past 3% expect a rate hike unless the Fed gives in to growing pressures to reduce rates. 

Growing Pressure to Cut Rates

Senior economists from CIBC are making bold predictions on where interest rates will be going. They predict that the BOC will cut rates by 25 basis points next year, in lockstep with the Fed. This would see rates fall from 1.75% to 1.50%, if current rates hold. The rationale for the expectation of a cut follows weakening economic data, slowing growth, and a significant trade and account deficit. Banks have also reported financial data which shows Canadian contributions to their bottom lines seeing little to no growth, with the bulk of profit growth coming from U.S. assets.

In addition, pressure over mortgage stress tests has many believing that lower rates are necessary to give hope to the tens of thousands of prospective home buyers who have now been squeezed out of the market permanently. But the real overhang on this file has been the growing chorus of voices across the border which are demanding that the U.S. Federal Reserve cut rates, pump up the economy with more quantitative easing, and more efforts to stimulate a stagnant U.S. economy. The originator of much of this pressure has been Donald Trump himself. Trump’s language of criticism against the U.S. Fed and Fed Chair Jerome Powell has been consistently scathing for some time now.

Several days ago, the President tweeted that the U.S. stock market and economy would reach even higher levels if the Fed ‘did what China is doing’ by lowering rates and making the U.S. dollar cheaper in relation to competitors to boost exports. He also claimed that the Fed has ‘consistently been raising rates’ on his watch, seeing it as discriminatory. He also has stated the view that the stock market would reach record highs if the Fed lowered rates. At first, many called Trump’s language unprecedented and authoritarian, but now economists, market watchers, and business leaders are echoing his criticism of the Fed and are urging it to supercharge the U.S. economy so it can better compete with China. Lower interest rates are on their way. 

On Money Laundering and International Property Ownership Laws

On Thursday, May 30th, the federal government revealed it had found over $1 billion in new tax revenue. Where did the Feds get the money? From real estate. Four years of drawn-out, complicated CRA audits saw almost 42,000 files reviewed in the key housing markets of B.C. and Ontario. The results netted over $100 million just in penalties based on flimsy tax compliance done in real estate transactions. The Feds are doing what they can to shake this ‘money tree,’ and have allocated some $50 million in additional spending to further these audits and to root out more non-compliance. This is on top of hundreds of million of already announced investments in the CRA which started four years ago, all aimed at rooting out tax dodging and generating more revenue for Ottawa to spend without raising taxes. 

 

Canada has established itself as a one of the real estate money laundering hotspots of the world. Some $50 billion was laundered across the country in 2018, with just over $7 billion laundered just in B.C. This is a very rough estimate, as it is impossible to put an exact figure on all of the washed monies. This represents a drop of the many trillions of dollars of ‘dirty money’ floating around international markets. Canada offers anonymity to real, or ‘beneficial’ real estate owners, just like notorious tax havens like the British Virgin Islands, the Isle of Man, or the Seychelles. We are recognized for some of the weakest money-laundering laws in the world. And the truth is, our economic stability and quality of life depend on washing dirty money. Without it, the real estate lobby, the big banks, and governments across the country would be starved of business, capital, and revenues to spend. We’re all complicit. 

 

Canada is one of the few countries in the world where there are virtually no restrictions on foreigners buying real estate here. The system depends upon an openness to foreign capital and as many high value transactions occurring as possible. In rapidly growing Thailand, for example, it is almost impossible for a foreigner to own a controlling stake in land or housing. There are very few ways to get around Thai property rules, so Canadians who’d like a beach house in Thailand have to jump through many, many hoops to pull off a buy. In New Zealand, previously lax rules for foreign ownership are being tightened and New Zealand government was elected in 2017 on a campaign of restricting foreign ownership. Prime land in our country is open for their world to buy. 

A Recovery That’s Gaining Steam

The latest stats are out and they’re very good for Toronto real estate. Sales last month rose by 19% from May 2018 figures. The number of transactions almost hit 9,900 and are approaching more robust historical averages. Home prices also went up by 3.5%, higher than inflation, and condo prices shot up 5%. The average home price in Toronto is now $838.5K, and the average condo price is $590K. Detached housing prices increased by only 1% to $1.042 million, but were marked by a much lower inventory and number of transactions, thus dampening dynamism.

Prices for condo townhouses are growing at the fastest pace, with a 6% increase recorded last month. Their combination of being relatively affordable and slightly more spacious than traditional condos has afforded them a great deal of attention with prospective homebuyers. Overall, new listings barely grew, and real estate experts claim that there is little capacity for this figure to expand, so further increases in prices and demand are anticipated – especially is sales continue to recover. If we have more positive months like May, expect price growth to rapidly rise once agai
n. To put this very positive month in perspective, the market has now returned to the levels it was at shortly before the introduction of stress tests. This shows how strong the underlying fundamentals of GTA real estate are. 

While we have a long way to go before we see prices and demand for detached houses reach the dizzying levels of March and April 2017, semi-detached and condo townhouse figures are almost at their Spring 17′ peaks. Condo apartment prices almost never fall in Toronto, so positive trends for a quarter or two should get numbers to meet Spring 17′ peaks as well. The $1.2 million average detached home price levels which marked Spring 17′ are a long ways away but not impossible to revive. GTA monthly unit sales reached a high of almost 13,000 in mid 2016, and at the beginning of 2019 were barely at 4,000. If trends continue we should see a few more months of rising sales. Keep in mind that there are growing rumours of an incoming BOC rate cut, in addition, Canada’s big banks will likely work to revive growth in domestic credit and mortgage operations, so incentives and lower rates may be well on their way!

Have You Ever Heard of Section 37?

Planning law and regulation in Toronto and the province is complicated, cumbersome, and difficult to understand. It is overwhelmingly written by Queen’s Park, given the Constitutional arrangements in Canada which afford provinces so much legislative punch and power, especially in comparison to regional and municipal governments. Planning law reviews do occur on a routine basis and everyone has their own opinions and views on the state of the overall system and on what should be reformed. One interesting component of planning in the region is Section 37 – which refers to a section of the Ontario Planning Act. 

Section 37 is a clause which gives municipalities, through local Councillors (elected politicians), the power to negotiate changes to planning and zoning in exchange for monetary commitments to certain arbitrary projects. For example, let’s say you’re a developer with a fair bit of cash and you want to build a 30 storey condo in an area where zoning says 20 is the max. You’ve got access to a deal to buy a plot of land for a decent price, now want to make some profit, but calculate that a 20 storey building won’t net you the kind of proceeds you want. So, what do you do? Well, you activate S. 37 and ring up your local City Councillor.

Negotiations start. The Councillor hears you out and thinks what you want is not too unreasonable – it’s only a few extra storeys. What’s wrong with making money? Now in exchange for the immediate zoning change for your extra 10 storeys, the Councillor wants you to scratch his back. You see, he wants to get re-elected, and there’s a neighbourhood where he didn’t get as many votes in the last election that he could use in the next. He wants you to promise $250,000 to upgrade a park in his tricky neighbourhood. You say sure, why not, and the deal is done. Under Section 37, the commitments to projects in exchange for zoning changes are designed to be used to help the community add resources in needs in exchange for the heavy duty development changes. If a developer builds a 60 storey condo instead of a 20 storey condo, the impact on roads, sewers and local schools will be massive.

Councillors have huge power to negotiate these deals for their own political ends and the Section 37 system has come under serious scrutiny in recent years, especially under now deceased former Mayor Rob Ford. With the planning system undergoing massive reforms by now Premier Doug Ford, expect Section 37 to be changed thoroughly.  

Thaws, Rebounds and Real Estate Leaders

In our last blog, Tembo expressed optimism and positivity over the latest real estate stats in Toronto. Sales did well in April, and the amount of listings of new homes rose sharply.

 

Analysts were particularly optimistic over the rise in prices, which went up for two consecutive months. This combination of successively positive data suggest a healthy underlying market and the potential for growth and opportunities over the summer. Toronto’s market continues to dominate Canada’s housing sector, with almost as many homes sold in our city as Montreal, Calgary, and Ottawa combined. Positive expectations for increased demand, sales, and higher prices over the next few months are not without merit.

From May 20-23, Toronto will host Collision, one of the pre-eminent technology and AI Conferences in the world. One of the highlights of this Conference has been the focus on the growth and dynamism of tech. job growth in the city. Over the last 5 years Toronto has created more jobs in the tech space than any other urban area in North America, including mighty Silicon Valley. All of these young tech. professionals will need quality housing in the city and the amount of FDI (foreign direct investment) going to tech is expected to grow ever more rapidly in the next few months and years. This will be a big boon to housing. Economic growth in the city is projected to continue growing in real terms (above inflation), and immigration is growing, not slowing. These two macro trends suggest overall demand will continue rising.

On a final note, Toronto’s leadership in the real estate space continues to be cemented internationally. The biggest real estate company in the world is Brookfield Asset Management. It leads all of its peers in sales, amount of assets, and is extremely competitive in terms of the profits it generates. Separately, the volume of condo projects being built in Toronto and the GTA continues to build up. Chinese developers are building major condo towers in Scarborough, Newmarket is seeing its first major condo development in over 30 years, and Peel Region continues to see the ambitious condo projects underway.