Wednesday, December 13, 2017

Why condos are more expensive than houses in the Greater Toronto Area

Ryerson’s City Building Institute published an interesting paper this month that concluded that builders are not building enough family-sized condo units to keep up with the future needs of GTA home buyers.

The report highlighted what they called an affordability gap between the average sale prices of detached homes and condominiums.

But when we control for the size difference between low-rise homes (detached, semi, row houses) vs condos we find a very interesting paradox in the GTA’s real estate market – it’s actually less expensive to buy a home compared to a condo.

To illustrate this point I’ll compare house and condo prices in two different neighbourhoods.

Condos vs Houses in Maple

Maple is a neighbourhood in Vaughan that has both low-rise houses and condominiums.

A young family can buy a 1,385 square foot rowhouse in Maple for approximately $685,000 (all numbers are based on an average of recent sales).

Maple does not have many recent sales of 3 bedroom condos that are similar in size but when we look at the larger two bedroom units in the area we find that they are selling for roughly $684 per square foot. This means that a 1,385 sqft condo would cost approximately $947,000 at the current market rate (1,385 sq ft at $684 psf.)

This theoretical family-sized 1,385 sq ft condo in Maple would cost buyers an additional $261,000 when compared to buying a rowhouse that is the same size. It’s also worth noting that this difference in price ignores the fact that the rowhouse has an additional 650 sq ft of living space in the finished basement (basements are usually not included in square footage calculations for houses) along with a yard and an extra parking spot.

Condos vs Houses in Leslieville

Leslieville is a neighbourhood in central Toronto that also has a mix of houses and condominiums.

A typical three-bedroom starter home in Leslieville costs approx. $1,150,000 for roughly 1,355 square feet of living space.

While there are not many condos in Leslieville that are similar in size, the average price per square foot for larger condos in Leslieville is $851 which means that a 1,355 sq ft condo at this market price per square foot would cost approximately $1,150,000 – exactly the same price as a house.

But even in Leslieville where we appear to have price parity – houses still offer more value for families. As I mentioned earlier, this price parity ignores the fact that the finished basements in houses makes the total living space in them 50% larger than condos and it ignores the access to a private back yard. Both tend to be very important features for young families.

If we factored this additional living space into our calculations – houses would be significantly less expensive on a price per square foot basis than condos in Leslieville.

Why are condos more expensive than houses?

The majority of new condominium construction is driven by investor demand – not demand from families – and investors are willing to pay much more (on a ppsf basis) than end users are. Investors also prefer smaller units because they are less expensive and typically have a better return on investment than larger units.  Because of this, the price that developers are paying for land is based on what investors are willing to pay for condos which explains why its hard for them to build affordable family-sized condos.

In the case where the demand is from end users, condos fill a price gap in the market. If we refer back to my Leslieville example – many of the larger two-bedroom condos in Leslieville are approximately 1,000 square feet and sell for roughly $850,000. If your budget is $800,000-$900,000 and you want to live in the heart of Leslieville – a condo is your only option.

The same of course applies to buyers who have a budget under $400,000 in the GTA. They don’t care that they’re paying more per square foot to live in a condo vs a house because buying a low-rise home on a $400K budget isn't possible.

But young families with a budget of $700,000 on the other hand do have options. They can choose to buy a 2 bedroom 1,000 sq ft condo in Maple for that price, or a 3 bedroom 1,385 sq ft row house with a finished basement and a back yard. For most, it’s a pretty simple choice.

Monday, December 11, 2017

New mortgage rules could disqualify 10% of buyers with big down payments: BoC

New rules coming in January could disqualify up to 10 per cent of prospective home buyers who have down payments of 20 per cent or more, the Bank of Canada says.

The new rules will likely cause those buyers to settle for smaller homes, put more money down or delay buying. Some may also take out riskier loans from alternative lenders that are not federally regulated, including credit unions and private mortgage lenders, the central bank said on Tuesday in its twice-yearly review of the financial system.

The change will require those applicants to prove they could still afford their mortgage payments if interest rates were raised two percentage points, a procedure called a stress test.

The restrictions would affect about $15-billion a year in new borrowing, particularly in Toronto and Vancouver – markets that have had the steepest run-up in prices in recent years. The tighter rules could disqualify as many as 12 per cent of borrowers in the two cities, which account for half the value of homes sold in Canada.

Stress tests are already mandatory for mortgages in which the down payment is less than 20 per cent. The federal Office of the Superintendent of Financial Institutions announced in October that it will extend the tests to mortgages that have down payments of 20 per cent or more of the purchase price – known as low-ratio mortgages – to make sure the borrowers can cope with higher interest rates.

The Bank of Canada expects the impact to be less severe than changes made in 2016 that raised the cost of high-ratio insured mortgages, for which borrowers put down less than 20 per cent. The bank's 10-per-cent figure represents the share of low-ratio mortgages issued in the 12 months ending in June, 2017, that would not have qualified under the stress test. The impact is higher in Toronto and Vancouver because such mortgages make up a larger share of those markets and prices are higher.

"The new rule will have some impact, but it is unlikely to derail the housing market on its own," Bank of Montreal economist Benjamin Reitzes said. "We'll need higher rates for that."

The stress test could eat into the buying power of the most-stretched borrowers by up to 15 per cent, Mr. Reitzes said in a research note.

Tim Hudak, CEO of the Ontario Real Estate Association, said the OSFI rule change and other recent housing-policy measures will be hard on buyers.

"The cumulative amount of government intervention in the housing market means that many people will no longer be able to buy their first home or upsize when the kids come along," Mr. Hudak said. "The piling on of federal, provincial and local government interference risks not only hurting aspiring homeowners, but damaging the broader economy when fewer homes are purchased, furnished and renovated."

Over all, the Bank of Canada said in its review that the main threats – rising household debt and overheated house prices – remain elevated. The threat level has been about the same since 2013.

But for the first time in a while, the bank sees "preliminary signs of improvement" in the quality of new lending triggered by the improving economy, higher interest rates and tighter mortgage rules announced in 2016.

"Our financial system continues to be resilient, and is being bolstered by stronger growth and job creation, but we need to continue to watch vulnerabilities closely," Governor Stephen Poloz said in a statement accompanying the bank's Financial System Review.

The Bank of Canada's cautiously optimistic tone comes amid evidence that higher rates and tighter lending standards are helping to cool the housing market and stem riskier borrowing. For example, fewer Canadians with extremely high debt levels are taking out mortgages with little money down.

The report suggests most borrowers could handle a "moderate increase" in mortgage rates, especially if their incomes also rise. Nearly half of outstanding mortgages in Canada face an interest rate reset within the next 12 months.

"The Bank of Canada sees things moving in the right direction," Toronto-Dominion Bank economist Brian DePratto said in a research note.

The rate of the increase in house prices across the country slowed to 10 per cent a year in October after a significant slowdown in Toronto. Prices are heating up again in Vancouver, particularly in the condominium market, the bank said.

The housing markets in both cities took a hit from the introduction of taxes on foreign buyers. Vancouver's started to recover early this year, with the average price of a detached house last month at about $3-million, virtually identical to the record high in April, 2016. In the Greater Toronto Area, detached houses sold for an average of about $1-million in October, down 16 per cent from April.

Mr. Poloz acknowledged that the threat from high household-debt levels and the run-up in home prices will take "a long time" to work off.

Part of the problem is that buyers find ways to deal with tighter mortgage rules. When Ottawa clamped down on high-ratio mortgages in 2016, some borrowers shifted to low-ratio mortgages, which now account for three quarters of new mortgages, up from two-thirds in 2014. Many are also using home-equity lines of credit, which do not require regular interest and principal payments.

The bank said it is closely monitoring developments in the private lending market, worth as much as $15-billion a year.

Many economists and real estate industry officials anticipated the OSFI rule change could curb home sales next year. The Canadian Home Builders' Association has forecast the rule changes combined with other recent housing-sector policy reforms could reduce total house transactions by 10 per cent to 15 per cent.

In a submission to the federal government in August, the association said that would translate into a decline in resale-home transactions of 50,000 to 75,000 units a year, while housing starts could drop by 20,000 to 30,000 units.

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