How Canada’s real estate market lost its mind

Not many events can compel people to shell out more than $150 to spend an entire Saturday perched on metal folding chairs inside a chilly, cavernous auditorium. But in Toronto, the prospect of getting rich in real estate will do the trick. Last month, a spectacle billed as the Real Estate Wealth Expo stormed into town, drawing upwards of 15,000 people to see an eclectic mix of speakers, from motivational speaker Tony Robbins to musician and gyration enthusiast Pitbull.

At 8:30 in the morning, a quartet of real estate industry professionals takes the stage to whoops from the crowd for a panel on Toronto’s housing market. Local realtor Daryl King (the “king of real estate!” according to the moderator) tells the crowd the key for first-time buyers is just to get a foot in the door. “We haven’t seen the end of it,” he says of the region’s double-digit surge in home prices. “So buy today, before it’s too late.”

One of the biggest challenges for first-time buyers and investors, the panel agrees, is shutting out negativity and overcoming the fear of failure. “The worst thing you can do is listen to somebody that’s never done anything,” King says to applause. “Say that again!” the moderator crows. “That is profound.” King adopts a mocking tone, “ ‘Oh, prices are too high. They’re gonna come down. The market’s gonna crash.’ Yes, it may adjust at one time. But if you never get in the market, you’ll never have a chance.”

The Wealth Expo is the physical manifestation of Toronto’s housing lust, with exhibitors promoting flipping and investing seminars, and lawyers touting “mobile signing” services to close deals anytime, anywhere. But signs of real estate mania are everywhere in the city. Open houses can attract lineups, even in sub-zero temperatures. On a -10° C day in March, Stephanie Fusco queued up with her husband and around 15 other interested buyers to view a house listed at $1.2 million. “They had us waiting outside like it was a nightclub,” she says. The 1,200-sq.-foot property couldn’t accommodate all the people who turned out, and the listing agent kept the crowd moving swiftly through the house.

Pre-construction developments can be even more popular. The sale event for a block of 28 townhomes in an upscale part of Toronto recently drew more than 750 real estate agents; some were so eager to buy they offered more than the list price, neglecting the fact the units would be parcelled out through a lottery system.

List prices these days are largely meaningless and properties routinely sell for over asking—which agents happily promote by affixing a “Sold for over asking!” plaque to the sold sign on the front lawn. Take a recent semi-detached listed in the city’s west end for $699,000. To step inside was to travel back in time to the 1970s. The house was festooned with brown rugs, brown linoleum floor tiles and, in the basement, wall-to-wall wood panelling. After just five days on the market, it sold for $1.03 million in March—$331,000 more than the list price. Under-listing is a well-worn strategy to stoke bidding wars, which have become the norm.

Lenders, despite tightened mortgage eligibility criteria, are still furiously scouting deals. AM radio in the city is cluttered with ads for quick and easy loans. RMG Mortgages, a division of national independent lender MCAP Corp., recently sent an email to brokers in Ontario encouraging them to close deals with clients with low credit scores. Each approved loan earned the broker an entry into a draw for an NBA March Madness prize pack.

Homeowners are finding their mailboxes stuffed with flyers and letters from real estate agents designed to entice them into selling, with assurances that their houses are worth more than they think. Homeowners are responding. “I’ve been bombarded with calls from existing homeowners looking to tap into their home equity,” says Adam Farber, assistant director of investor relations at a private lender called Corwin Mortgage Capital in Toronto. And they’re using the cash to purchase investment properties. “Everyone is doing this on the speculation that prices will only go up in value.”

In this frenzied market, a shrewd speculator barely has to work to see a return. Scott Ingram, a Toronto real estate agent, took note when a house in his neighbourhood sold recently for $1.04 million—a $102,000 increase from the last time it was sold, which was only nine months prior. Zero renovations had been done in the meantime.

The hypercompetitive market is exhausting for those hunting for a home, but even some real estate agents are feeling the strain. “It’s not fun to operate this way,” Ingram says. “If clients are constantly priced out and losing bidding wars, it’s easy to get discouraged. I share in some of that grief.”

The rental market, meanwhile, isn’t any more forgiving. The rising cost of homeownership is pushing more people to rent, and the vacancy rate in Toronto has tightened over the past few years to 1.3 per cent, according to CMHC. Some landlords are exploiting the situation. Tenants in a condo building known as The Bridge received letters in March informing them rent would double in some cases—from $1,400 to $2,800, a resident of a one-bedroom unit told Maclean’s.

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Just how did Toronto end up in this situation? Most industry reps point to housing supply constraints. Economists, however, say that’s only part of the picture. Foreign investment, speculative activity and buyer psychology are also driving the market.

For those sitting on the sidelines, the gnawing fear of getting permanently shut out grows more intense as prices climb, and some take the plunge no matter the cost. At this pace, waiting just a month or two can be the difference between owning a home and resigning oneself to renting. The average selling price for all homes in the Greater Toronto Area, including houses and condos, surged to $916,567 in March, a 33 per cent rise from the year before, according to the Toronto Real Estate Board. Since January alone, prices are up 19 per cent. A lowly semi-detached house in the city is now worth more than $1 million.

Prices are growing even faster in the surrounding suburbs. More first-time homebuyers and investors are looking to Barrie, Ont., a city about 100 km north of Toronto, where the average selling price jumped 33 per cent compared to the year before. Even real estate agents are surprised. Chris Messecar, a local realtor, listed a semi-detached home in March with an interior that hadn’t been updated in about three decades. On one night during the bidding period, a woman was murdered about a kilometre away from the home. The incident did nothing to dissuade potential homeowners. “Only one agent reached out about it and said they were somewhat concerned,” Messecar says. He received 11 bids, and the property sold for $104,000 over asking.

Canada is a country deeply reliant on real estate. The industry accounts for roughly 12 per cent of its gross domestic product. In British Columbia, real estate and related fields such as construction and finance make up an astounding 40 per cent of GDP. Vancouver is seeing prices rise again after numerous efforts to cool the market. And in Alberta, not even a recession and a nine per cent unemployment rate did much damage to house prices in Calgary and Edmonton. “It’s surprising how well it has held up, given the severity of two years of contraction,” says Todd Hirsch, chief economist at ATB Financial.

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But in a country obsessed with real estate, the Toronto market is now the biggest problem—surpassing Vancouver as the epicentre of housing insanity­—and a troubling example of what happens when homes are no longer seen as just places to live, but as a path to riches. Even skeptics who once deployed euphemisms such as “robust” to describe Toronto real estate can no longer ignore the troubling forces at work. Douglas Porter, chief economist at BMO Financial Group, used to be in that camp. Now he says “bubble” is the only way to describe Toronto. “We’re trying to send a message to both policymakers and potential buyers that we are on the verge of getting into a dangerous place,” he says. Equally troubling is that economists don’t see anything on the near horizon that will reverse these trends. The housing market might just get even crazier.

Stephanie Fusco, 28, and her husband started their house search in Toronto in December 2013, when the average selling price for all properties was just $520,000. They’re still looking. They lived with their parents and saved diligently for a down payment before they were married. Within weeks of starting their search, they had to adjust their expectations. “We were seeing decrepit homes listed for $850,000. There were houses we had to walk out of because of the stench,” she says. They broadened their search to semi-detached and townhomes, but they had a hard time justifying the prices. Whenever the couple did place an offer, they were outbid. They searched as far afield as Vaughan, about 40 km north of Toronto, to make an offer on a house but found themselves in a bidding war with 12 others.

Fusco has a folder on her computer called “RIP Homes” consisting of past listings. Looking back, she says her desire to find a home to live in for the long term was the wrong approach. “In today’s market, it’s actually detrimental for a buyer to have that mentality,” she says. Had the couple just bought whatever they could get at first and sold after a couple of years to upsize, they might be homeowners today. “At this point, I joke we’re looking for four walls, a roof and a parking spot,” Fusco says.

There are a number of reasons why first-time buyers like Fusco are frustrated. Interest rates have been falling since the early 1990s, lowering mortgage carrying costs and opening up homeownership to a greater swath of Canadians. Two decades of steadily rising prices have convinced people that owning a home is a good, stable investment. And then there’s social pressure. Our culture values homeownership (and all levels of government provide incentives to support it) and it’s seen as a stepping stone to adulthood. In Toronto specifically, population and wage growth have ensured demand for housing.

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Still, the recent price increases defy logic—and the argument put forward by developers that there’s a lack of supply in Toronto doesn’t fully explain the situation either. Condo prices are growing at a rate of 19 per cent year-over-year too, even though a record number of units are under construction relative to the population, according to TD Economics.

“Tight supply starts to become a justification for all outcomes,” says Beata Caranci, chief economist at TD Bank Group. If buyers are convinced supply is low, then the big price increases will seem logical, exacerbating their fear of missing out and pushing them to act irrationally. Toronto’s price surge did indeed coincide with a significant drop in listings, but that could be a result of psychology on the seller’s part. Some homeowners could be holding on to their properties in anticipation of prices rising even further. Families that would otherwise sell their homes to upsize could also be staying put simply because prices are so high, and competition is so fierce, that the hassle isn’t worth it.

An influx of deep-pocketed foreign investors could also be taking properties off the market, especially since Vancouver implemented a 15 per cent tax last year for foreign nationals. “I do believe that at least some investors went directly from Vancouver to Toronto,” Porter says. “That has played a role in launching Toronto, and some surrounding cities, into the stratosphere.” The same is true of domestic investors and speculators. According to TD, roughly 17 per cent of homes in the region were resold within two years as of March 2016, up from nine per cent a year earlier. Excess speculation restricts supply and jacks up prices, too—which further cements the belief in the minds of buyers that they have to act fast, and that the recent pace of the market is sustainable.

Buyers are driving farther and farther outside Toronto until they can find a home they can afford. (That’s what helped made Guelph, Ont., the most desirable place to invest in real estate, according to the latest annual rankings from MoneySense.) Stephanie Small and her husband, Graham Ross, have rented an apartment in Toronto for the past nine years with their two daughters, but their landlord would like them out in order to renovate. Other rentals in the city were smaller than their current place, not to mention way more expensive. Priced out from buying a home in Toronto, they settled on Ajax, a bedroom community east of the city. In September, they placed their first bid on a home listed for $460,000. It sold for more than $600,000. “We kept being told by our real estate agent that it was an anomaly,” Small says. “But we’ve put bids on six houses since then, and we’ve been outbid absolutely every time.”

Small and Ross then considered older properties in town they could renovate. “Those were the ones that heated up the fastest,” Ross says. “Our guess was it was flippers.” Ross could spot this crowd at open houses: older guys with serious expressions taking measurements. To get a leg up, Small penned a letter targeted at homeowners who might be thinking about selling, promising a hassle-free experience. She wrote about her connection to Ajax (“I would love to raise my two little girls in the same safe, family friendly neighbourhood where I grew up,” she wrote), and included an illustration of her family. Then the couple left copies in dozens of mailboxes. They received one reply, but the homeowner wanted more than they could afford. While canvassing the town, Small and Ross noticed an unusual number of homes that seemed to be unoccupied. “There was a shocking amount of them that were empty,” Ross says. They later checked to see if these homes were available for rent, and couldn’t find any listings. “It was clear whoever bought them had no intention of putting anyone in,” Ross says.

They received financial help from both sets of parents a few months into their search, but prices kept escalating out of reach. They took a step back in March when townhomes starting selling for more than $700,000 (“They’re not worth it,” Small says) and stopped packing the whole family into the car every weekend to tour open houses. In April, they called off the search entirely. They still need to find a place soon, however, especially with their youngest daughter starting kindergarten in September. “It’s disheartening,” Small says. “We make a decent living. We should be able to afford some sort of roof over our head.”

So how are first-time buyers getting into the market? Canadians have shown a willingness to plunge themselves deeper into debt, of course. Nationwide, the household debt-to-income ratio stands at 167.3 per cent, a record high. In Ontario, mortgage payments account for roughly 60 per cent of income, according to BMO; if the trend continues another 24 months, that figure will hit 1989 levels—the same year the market crashed.

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Even six rounds of macroprudential rule tightening to restrict access to credit and prevent Canadians from becoming overleveraged has done little to temper the housing market. Last October, Ottawa increased stress-testing provisions for insured mortgages, but the change may not have had the intended effect. “What we’ve seen in Toronto is the new measures have prompted people to avoid mortgage insurance at all costs,” says Porter at BMO. That means cobbling together a 20 per cent down payment by any means necessary—whether it be relying on parents for assistance or taking out a loan.

Private lenders can help those who are turned away from traditional financial institutions, too. Since October, Farber, at Corwin Mortgage Capital, has been fielding more calls from first-time buyers. He’s not cheap—the interest rate for a first mortgage starts at 6.99 per cent—but he’s flexible. “The bank wants to see what your income is in black and white, whereas a private lender like myself will take everything into account,” he says. Farber is most concerned with the amount of equity in the property and how quickly he can move it again if a borrower is unable to make payments.

Some of his clients are millennials, whose parents are not only supplying a down payment but will be helping with payments, too. A bank would steer clear of that situation, but Farber will meet with the parents to hear them out first-hand. “That’s a story I want to hear,” he says. “For a bank manager, that story doesn’t fly. But to me, I have more sympathy and compassion for these younger first-time homebuyers.”

Despite more business coming his way, Farber is turning down more deals because he’s worried prices have overshot. “How do you lend against a house that should in theory be $1 million, but someone overpaid in a bidding war at $1.4 million, and they want a loan for 75 per cent of the value?” he says. “That’s a scary property to lend on. If the market takes a dip, we’re all f–ked.” Farber recently had what he calls his “Big Short moment,” referring to the movie about the U.S. housing crash. In one scene, a character goes to a strip club to learn what’s actually happening in the housing market, and a dancer lets slip she owns five houses and a condo. For Farber, it was a Toronto cab driver who revealed he owned a handful of pre-construction homes and planned to flip them. “It sounds like a bubble is going on,” he says.

Toronto’s wild housing market has finally attracted the attention of the provincial government and Ottawa. This month, Canada’s federal Finance Minister Bill Morneau requested a meeting with his Ontario counterpart, Charles Sousa, and Toronto Mayor John Tory to discuss the “dramatic house price increases.” With the Ontario budget expected soon, Sousa has vowed to implement measures to cool the market and help first-time homebuyers. Both a foreign buyer tax and a speculation tax have been floated.

Vancouver’s experience shows that a foreign buyer tax might do some good. Since implementing that 15 per cent charge last summer, the raw number of home sales have fallen about 40 per cent, primarily in the upper end of the market, and the steep price gains have levelled off. The market didn’t crash, as some had feared, and the drop in sales shows the tax was successful at “squeezing out some of the excess demand,” says Caranci at TD.

But the impact might only be temporary. The Teranet-National Bank House Price Index shows Vancouver is up 1.7 per cent so far this year, and the index is just shy of the peak reached last September. Caranci says further tinkering could be required; the Australian state of Victoria saw no impact when it imposed a three per cent foreign buyer tax in 2015, and recently raised it to seven per cent. Hong Kong had to double its levy to 30 per cent.

The tax hasn’t helped first-time buyers much, either. Vancouver is still a massively unaffordable city. It takes 46 per cent of the median income to cover the cost of owning a condo, according to RBC’s housing affordability index. (A detached home requires 121 per cent.) Recent buyers Matthew Castillo and Genesis Rigor were largely priced out of Vancouver, even with the assistance of the province’s new Homeowner Mortgage and Equity partnership, which matches down payments of up to $37,500, interest-free for five years. Instead, the young couple looked in Richmond, B.C.

The market was more competitive than they expected, and they lost bidding wars on six properties. But they were not dissuaded; Castillo and Rigor are getting married later this year and wanted to secure a place before their wedding date. “We also decided to buy now because we saw how fast the market is rising and the later we wait, the higher the prices would be,” Rigor says. They made an offer for a condo at the top of their budget—with no conditions. “That was the way to go,” Rigor says.

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Of course, the foreign buyer tax was never meant to be a cure-all, and Toronto shouldn’t expect it to be. But economists argue it’s a decent first step. If there’s a negligible impact on housing activity, Caranci at TD says, then domestic speculation could be the larger issue that needs addressing. Scotiabank chief economist Jean-François Perrault suggests such a measure is in order. “Given there is evidence of speculation driving Toronto home prices to unreasonable, unjustifiable levels, you might want to make speculation a little bit more costly,” he says. One way to do that is through a progressive tax on the sale of secondary properties. The shorter the duration of ownership, the higher the tax. This would likely have a bigger impact on the market, as it would apply to both domestic and foreign speculators, Perrault says.

Absent policy intervention, though, economists don’t foresee anything that will cause prices to adjust significantly. Interest rates are likely to stay low, Toronto’s population is growing and wages are improving, ensuring a baseline level of demand. TD forecasts home prices will soar between 20 per cent and 25 per cent overall this year, and tick up as much as five per cent next year.

There are at least two risks to that forecast, though. A recession would cause home prices to fall substantially, Caranci says. The level of indebtedness among Canadian households would hold back an economic recovery, too. “This is a market that is primed to have an extended downturn,” she says. The longer the boom continues, the greater the risk of a contraction.

The other is a change in sentiment—if buyers can no longer justify the prices, or if sellers list their properties because they believe the market is about to turn, or if speculators and foreign investors find better opportunities. A drop in prices could have a snowball effect, especially if flippers and investors panic and dump their properties.

But at the Real Estate Wealth Expo, where attendees line up to have their photos taken with realtor Daryl King and local condo developer Brad Lamb, it is hard to foresee sentiment changing any time soon. The mood is best captured by Pitbull, who swaggers on stage later in the day in a tight black shirt and dark sunglasses, a spectacle that brings the housing-mad crowd to their feet as a pounding drum beat kicks in. “Que no pare la fiesta,” Pitbull growls, while a throng of lithe dancers paw at his aggressively bald pate. “Don’t stop the party.”

This article first appeared on Maclean’s