The GTA condo market is in a state of economic lockdown, according to a new report released Thursday by Urbanation with CIBC Economics. The report suggests that prices are too high for investors to buy relative to resale prices, rents and interest rates, while developers can’t lower condo prices due to high development costs.
“As a result, new condo sales — the primary driver of new home construction in Canada’s largest market — have dove off a cliff to their lowest level since the late 1990s,” the report, authored by Urbanisation’s Shaun Hildebrand and CIBC deputy chief economist Benjamin Tal, states.
For example, the percentage of pre-construction condos that are pre-sold is at a more than 20-year low (of less than 50 per cent). Without at least 70 per cent presales, projects can’t begin construction, which is dramatically slowing down the supply pipeline.
“This reality will result in a sharp pullback in completions and a stagnating housing stock in the coming years, which is sure to make the affordability situation even worse,” the report stated.
The report also notes that projects can’t qualify for construction loans, which has important economic implications. If each construction crane represents about 500 jobs, then, already, the number of condo projects under construction in the GTA has been reduced by no less than 75 since 2022, impacting nearly 40,000 jobs.
“As of June of this year, overall construction employment in Ontario fell by no less than 7.5% on a year-over-year basis. With the exception of the COVID recession, this is the weakest showing since the 2008 recession,” the authors said.
The report also looks at population growth. At the center of the efforts by the federal government to limit population growth is the newly introduced cap on international students, with a targeted decrease in the number of temporary residents to 5 per cent of the population over the next three years.
“While we doubt that that policy will do much to reduce population growth in 2024, it’s reasonable that population growth will be notably slower in 2025 and 2026. When combined with higher condo completions in the next two years, this will somewhat ease the pressure on the rental market, but it also potentially creates further headwinds for condo investment demand,” the report suggests.
For now, the report’s authors doubt that this (as well as other factors, such as lower construction costs and a possible easing of the key interest rate by the end of 2025) will enable developers to lower prices to a level that will attract investors back into the market.
Still, elevated interest rates and municipal development charges mean new condo prices will remain sticky.
“New condo prices have dipped by only 5% from their high, while resale condo prices have corrected by 12% and are at risk of further decline given the recent surge in listings,” the report states, noting that buyer incentives offered by developers and rent growth of 30 per cent from COVID lows are helping to bridge some of the gap for investors — but it’s not enough. “Quite simply, new condo investment doesn’t work at the current market average price of close to $1,400 psf.”
Condo investments are also losing their appeal, the report suggests, mainly due to price appreciation, rental cash flow and market confidence (the key ingredients for condo investments). The authors state that for condo investment to regain its appeal, resale prices and rents will have to rise faster, and interest rates have to decline more significantly.
“The current price gap between new and resale condo prices remains near a record high at roughly 60% and a full 20 percentage points above its long-run average,” the report states. Meanwhile, rental yields are only slightly up from their record lows during COVID-19, and effectively below the risk-free rate offered by government bonds.
The share of newly completed condos used as rentals reached a recent high of 34 per cent in 2023. But, the impact of higher mortgage rates began to change things in the first half of 2024 as the share dropped to 25 per cent, according to MLS listings.
“We also saw a huge decline in investment activity within the resale market, where the share of units bought and then rented declined to a three-year low of 10% in 2023 before dropping to only 2% in the first half of this year,” the report states.
Most condos are cash flow negative
Looking at the investment situations of these newly completed condo rentals, nearly a quarter of all newly completed condos in 2023 that were used as rentals did not have a mortgage (consistent with data from previous years). Using the entire pool of condo rentals completed last year, 58 per cent had a mortgage and were cash flow negative (that means that rents didn’t cover ownership costs, including mortgage, condo fees, and property taxes). Only 18 per cent had a mortgage and were cash flow positive.
“Focusing solely on leveraged investors for this analysis, we see that 77% were cash flow negative in 2023, representing a large increase from 2022, which marked the first time that the majority of investment units turned cash flow negative with a 52% share,” the report states. “First half results for 2024 show the situation worsening still, with 81% of leveraged investors in a cash flow negative position.”
The analysis also found that, on average, condo investors who closed on their newly completed units last year experienced negative cash flow of about $597 each month, which was more than 2.5 times greater than the negative cash flow that investors who closed in 2022 experienced (-$223), and a “far cry” from the positive cash flow investors experience in 2020-2021.
The report, which can be read in full here, states that the more difficult economic environment for condo investors appears to be causing more people to put their units up for sale, which can be seen through the record-high number of condos listings currently on the market and “correlated to the approximately 60 per cent share of the stock built in recent years that is owned by investors.”
“This is a troubling sign for the outlook for rental supply in the region and raises an alarm bell over the necessity to increase purpose-built rental supply,” the report concludes.
