Speculators versus Investors: Who's Fuelling Toronto Home Prices?
Author: Tracy Ruddell
Part one of our two-part series on Speculation in Toronto Real Estate
Scan the Business, Personal Finance or Real Estate section of any major daily and you’re sure to find at least one article on out-of-control Toronto home prices. The flavour du jour for what’s fueling the housing affordability crisis? Foreign buyers. But are foreign buyers really the driving force behind the ever-increasing cost of Toronto homes for sale?
As we talked about in our February Toronto Real Estate Market Review, the truth is, there’s no clear answer on that due to the lack of foreign buyer data captured in this country. What we do know for sure is that, regardless of the true levels of foreign ownership in Toronto, it’s just one part of larger, multi-faceted problem. Part of the analysis of that problem requires differentiating between speculators and investors as addressing each requires different solutions. It’s really the speculation category that has economists concerned, a market segment that includes both local and foreign buyers.
Let’s take a look at the differences between a Real Estate investor and speculator and what the Government has had to say about it at the release of this year's Federal budget plan.
There is a big difference between these two types of investment strategies. Traditional Real Estate investment looks at growing personal wealth over a longer-term horizon. The focus is usually on income properties that leave investors in a cash-positive position each month while continuing to grow in equity over the mid- to long-term. A landlord purchaser fits the typical investor profile. That's really what most people are referring to when they talk about investors; people who buy income properties.
You could argue, however, that everyone buying Real Estate is looking at it as an investment (or they should be). We always coach our clients to buy with re-sale in mind and not just the comfort of the here and now. Whether you’re buying an income property or a Principal Residence with the idea of growing your personal wealth over time, what makes traditional Real Estate investment so attractive is that, not only are you earning incredible returns on your money, you’re earning money off of the bank. Toronto homeowners are earning about 25-30% on average right now in annual appreciation while paying less than a tenth of that in mortgage interest. In this sense, traditional Real Estate investment is a relatively safe bet. That's another major difference between investors and speculators: risk assumption.
Speculators aren’t looking at Real Estate investment in the same way as traditional investors. Speculators have one mantra: buy low, sell high. To accomplish that, they've tended to focus on either the pre-construction market or renovation flips (although we feel this is now changing in Toronto). These investments tend to have shorter time horizons than traditional Real Estate investment, <3 years typically and often as short as 6 months.
You could simplify it even further by saying that investors focus on long-term investment in a relatively safe market and on generating a positive cash flow whereas speculators look at short-term transactions in a questionnable market (or questionnable time-frame) and roll the dice on big wins come re-sale.
Speculators are taking much greater risks than traditional investors in the hopes of greater reward. To accomplish this, they're often willing to pay substantially more than other buyers in a multiple bid situation, knowing that they’re paying over market-value (whatever market value means, these days) because they're gambling that those 25%+ annual returns we’ve been seeing are going to continue. Paying 5%, 10% even 20% or more over what the next bidder in line is willing to pay doesn’t phase a high-risk speculator because they believe they’ll make that back within 6 months.
So far, they’ve been right. Is it sustainable, though? That's the question. And why does it matter to the rest of us?
Speculation is already having numerous, negative effects on the market, namely:
#1 Speculators, in some neighbourhoods and condo buildings, are blocking end-user buyers from purchasing a home by buying out entire floors / substantial portions of projects,
#2 They may be artificially inflating the overall market by paying well over market value for properties.
Why does it matter? You may think: so what if they lose their shirt on re-sale down the road? It matters because if there is a correction in our future, it could mean bad news for all home owners and not just speculators. If you have pockets of neighbourhoods or condo buildings that have 60% or 70% speculation ownership (foreign or local) and they all start selling at once, values will likely spiral as supply explodes. This can have a knock-on effect to surrounding areas, even those areas where speculation activity has been mild.
So, if it's happening at a large enough scale, unchecked speculation in Toronto Real Estate could inflate housing prices to the point where we’re all living in a house of cards. The fear is that there won't be a soft-landing for the average homeowner who may end up owing more than they own.
This only carries weight, of course, if Toronto’s levels of speculative buying are as high as some people fear. We’d be remiss if we didn’t share with you that many in the industry disagree that the issue is rampant. Great Gulf President Christopher Wein recently told BNN news that the speculation issue has been overblown. He says supply is still the big issue and that demand is coming mainly from new immigration and not speculation. He does add however that builders can help alleviate concerns by restricting the number of units or homes that any one person can buy. You can watch the full interview here.
In our opinion, speculation is a serious (and growing) problem in Toronto Real Estate but it's not the only problem by any stretch nor will addressing it in isolation of other issues be enough to cool the market. There's much to be done both to bolster supply and temper demand; finding the balance between the two being the key, of course. Regardless of the exact levels, however, speculation is something that needs to be addressed when you have hard-working Torontonians not able to get a foot on the property ladder, not due to lack of income or savings, rather due to supply issues and fierce bidding wars
The question of the month is: whose problem is this? Besides the everyday Torontonian priced out of their own home market, that is.
Prime Minister Justin Trudeau spoke earlier this week about the issues in both Vancouver and Toronto and made it clear that he feels Provincial solutions are most prudent. As reported by Global News, Trudeau touched on the fundamental issue of Federal control measures; specifically, that nation-wide solutions are not necessarily appropriate when what we really have is a tale of two cities.
“We recognize the tools of the federal level are necessarily pan-Canadian, and there are tremendous differences and variances between the housing markets in Vancouver and Toronto and housing markets in other cities.
So we’re working very closely with provinces and municipal authorities to ensure that the impacts that we need to have in certain areas of the country don’t result in unwanted impositions or negative impacts on other parts of the country.”
At the same time, we have Ontario Finance Minister Charles Sousa urging Federal Finance Minister Bill Morneau to address speculation through Federal capital gains tax. Specifically, as he wrote in his letter dated March 17th, he urged the Minister to consider boosting the taxable amount above 50%, thereby reducing the incentive for people to flip. Morneau released Budget 2017 last week with no changes to the current capital gains structure. Gossip is rampant on Bay Street that changes to capital gains tax may still come but Morneau himself addressed this issue with the press last week, calling it out as “idle speculation”.
Clearly, there’s still dissension in the ranks on what appropriate cooling solutions should look like and which level of Government is responsible.
Join us again for Part Two of our special series on Real Estate Speculation when we’ll take you through some of the options for cooling the speculation market.
Image credit: House of cards image by Sean Nel from Shutterstock.