Aspiring Canadian homeowners and investors attempting to assess the hot condo market aren’t the only ones monitoring prices in that space. The Bank of Canada (BoC), too, has an eye on condo trends.

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In its latest financial review, the central bank says the domestic financial system remains vulnerable to the housing market as well as to consumer debt. Even though tighter lending rules have helped cool the market, condos remain hot, particularly in Toronto and Vancouver, with evidence of potential speculative activity by rental investors, says the BoC.

Understanding housing market activity in the two cities is a must, says CIBC deputy chief economist Benjamin Tal. “And, if you want to understand Vancouver and Toronto, you must understand the condo market”—especially that of the Greater Toronto Area (GTA), he adds.

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Based on his analysis, rental investors account for about 48% of new condo sales in Toronto. “Those are not foreign investors,” he says. “Those are domestic investors.”

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Many are likely pleased with their investments, given those who bought their condos five years ago have experienced capital appreciation of 40% to 50%, says Tal. However, about 45% of those who have a mortgage and took possession in 2017 have negative cash flow, meaning that rental income falls short of mortgage payments and condo maintenance fees, according to an April CIBC report.

“They lose money on a monthly basis, at times a large amount of money—more than $1,000 a month,” says Tal. Rising rates could multiply this shortfall, which in turn could cause condo rental investors to alter their behaviour and, in effect, the market.

“The big question mark is to what extent those investors will continue to buy, or even maybe they will start selling,” says Tal. The answer is important, he adds, noting rental investors accounted for a record-high 80% of new GTA home sales last year.

Tal’s forecast calls for relatively little market impact. From his analysis, which includes responses from focus groups, he says these investors are in it for the long haul and they expect condo prices to continue to rise.

The market will likely soften slightly as investors at the margin make an exit and as condo supply increases. That said, “the overall story is not of a derailing market,” says Tal, “but rather a market that is going back to normal equilibrium.”

Canada’s overall housing market is cooling effectively, he adds: “There is no question […] that polices are able to impact the psyche of consumers and homebuyers.”

How cool is cool?

The housing market cooling is more a result of OSFI regulations, specifically mortgage stress testing, than interest rates hikes, says Tal.

In fact, a “significant” 12% of the market is now unable to qualify for a mortgage, he says. Subsequently, “demand is slowing and therefore we see some softness in sales.”

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So far, low-rise, detached homes—a more expensive housing segment than condos—have been hardest hit, representing 80% to 90% of market softness. Over the next six to 12 months, Tal expects the condo market in the GTA and Vancouver to make a larger contribution to market slowdown.

The condo space will be housing’s “next shoe to fall”, he says, for two reasons. The first is excess supply. “We have a lot of supply in the pipelines coming from condo developers over the next year,” he says. The second is the market’s reduction in demand. “Investors will start selling, or at least they will not be buying as rapidly as before, reducing demand,” he says.

Other regions such as Eastern Canada and Calgary are also contributing to a softer housing market. “The OSFI regulations were aimed at Toronto [and] Vancouver, not St. John’s, Newfoundland,” says Tal. Regardless, such regions are cooling, too, as they face the same restrictions on qualifications. “That’s something that is slowing down the market as a whole,” says Tal.

He expects Canada’s housing market to continue to slow over the next few months, but reiterates that “it’s not a freefall.” Says Tal: “It’s not something that will derail the market; it’s something that will bring the market back to a normal equilibrium.”

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