The towering cranes in downtown Toronto that have come to symbolize the city’s booming condo market may also be the sector’s Achilles heel. According to a new report from Bank of America Merrill Lynch, the pending “wall of inventory” that’s about to hit the Toronto condo market will lead to a correction of up to 15 percent.
“Completions of Toronto apartment units [condos] are now at the highest level in almost four decades,” Ryan Bohren, an economist at Bank of America Merrill Lynch, said in the report. “Additionally, the number of units under construction is at record levels; implying completions are unlikely to trend lower anytime soon.”
Bohren says residential construction continues to outstrip the natural housing formation rate. New housing starts came in at a stronger-than-expected 206,000 in September and were revised higher by 7,000 in the previous month -- far surpassing the natural formation rate of 150,000 to 175,000 households per year recorded in the last two censuses.
Yet, the housing construction boom is not a new phenomenon -- it’s been over a decade in making. From 2002 to 2008 Canadian housing starts have consistently trended above the 200,000 unit level, according to Canada Mortgage and Housing Corporation. While housing starts briefly fell in the wake of the financial crisis, they have since moved back over the 200,000-threshold.
And within the construction boom, condos have come to play an increasingly prominent role.
“Multi-unit dwelling construction has surged back to near the all-time peak in activity, while single-family construction has landed softly below the long-run average,” Bohren says.
“Certainly demographics are starting to favour a trend to condos (an aging population and new immigrants as main source of population growth), however this level of building activity in the multi-family sector is hard to justify under current demographics.”
Bohren estimates there is as much as 4.8 years worth of condo inventory in the greater Toronto area (GTA). Currently, there are 18,000 condo completions and another 37,000 in the pipeline.
“Even if we assume 50 percent of Toronto’s household formation is now destined for condo purchase or rental that is still over 3 years of inventories,” he says. “As these units are completed the market will likely have an increasingly hard time absorbing them, leading to higher vacancies and downward pressure on prices.”
David Madani at Capital Economics, who has called for a 25-percent correction for Canada’s housing market, also believes a strong supply of condos is a sign the market is overheating.
“This trend cannot be sustained,” Madani says in a recent note. “We suspect that this elevated level of housing activity is being driven by investors, motivated by extremely low borrowing costs and expectations of capital gains.”