Is Toronto’s Real Estate Market Really That Overvalued?

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Living in Toronto, it really does seem like I’m living in a real estate bubble. A single family home currently averages $1.3m with even condos now averaging $800K. Even the government is getting more involved with more policies in hopes of reducing speculative investing and improve affordability.

In this article, I will try to answer the following questions:

  • What did historical growth look like for Toronto and does the growth rate make sense?
  • How affordable is Toronto when taking account the average income growth vs. real estate price growth?
  • How affordable is Toronto when comparing Toronto to other major hubs around the world?
  • What’s driving the price increases in the past decade?
  • With all things considered, is Toronto overvalued?

Toronto Historical Price Growth Since 2005

$1.3 million on average for a home seems extreme when the average median household income in Ontario for 2019 is only $91K. But from a family that immigrated from Hong Kong, that’s still cheap considering the price per sqft on average in Hong Kong in 2018 was $6,000.

Below shows the price increased throughout the different property types since 2005. As a note, all prices in this article will be quoted in Canadian dollars.

Price is relative and I know currently, the topic of real estate prices in Toronto is extremely controversial. I know it’s not fair to compare Toronto to a city that is currently sitting at the top of the overvalued list, but what I wanted to understand does it mean to be over or under valued? With stocks, you can analyze the fundamentals so if we took a more scientific approach, is Toronto really that overvalued?

Real estate prices in Toronto have been growing on average 6% annually (if we remove the spikes in 2017 and 2022). It’s not surprising that investors make up more than 25% of Ontario homebuyers because it’s been such a safe and consistent investment. On an annual look, the only time Toronto has posted a negative return was 09′.

Another note is that real estate produces leveraged returns. A house only requires a 20% deposit, the other 80% is often financed through a mortgage from a bank. So most homebuyers are at a 4:1 leverage.

So that 6% annual return is really about 24% with simple math. If you take account of an average mortgage rate of 3%, the returns drop to about 12%.

There’s other variables such as rent that could further increase your returns but without getting into the weeds, the message is clear; as an investment, real estate has been a no brainer investment for the past 20 years.

Ontario Median Income Growth

Looking at Ontario’s median income, it has consistently increased by about 2.5% a year. This is less than half of the rate of real estate price growth. In 2020, the median household income in Ontario is $98,000.

When we compare income to the average single family home benchmark, that’s when we see the craziness. The gap between income and real estate price continues to widen at a consistent rate between 2005 to 2015.

Past that point, the gap grew exponentially and an average home is almost 9.5X the median income in 2020. This continued to worsen through 2020 and the average home price to median income ratio is over 13X.

To put this simply, in April 21′, the average home is now at $1.3m. In order to afford the average single family home, the home owner has to put at least 20% down which is $260K.

This means in order to qualify for the $1m mortgage, the household must be making at least $250K annually. Assuming a 3% interest rate and a 30 year term, that’s $4.2K monthly just in mortgage payments. On top of this, there’s the $8K annual property tax. So on an affordability standpoint, yes, Toronto is extremely unaffordable.

Toronto vs. Major Cities Around the World

I’ll split this up into multiple comparisons to reduce clutter in the charts. I first compared Toronto with the other major Canadian cities. What was surprising is that Toronto has briefly taking the #1 spot when it comes to unaffordability in 2021 but went back to 2nd in 2022.

The rule of thumb is that no more than 30% to 32% of your gross annual income should go to mortgage expenses. Toronto currently average 67% and Vancouver at 74%.

When we compare Toronto with the major cities in US, to my surprise, Toronto tops that list next to New York. I think New York is a more comparative measure since San Francisco’s low mortgage to income ratio is mostly due to an high median income of $104K USD vs. $65K USD in New York.

When comparing Toronto to the Rest of the world, Toronto’s fairly close to Tokyo and Sydney. Singapore and Hong Kong is on a whole different level of unaffordability.

Toronto Real Estate Supply

The law of supply and demand is eco 101. If there’s less supply with demand remaining constant, prices will rise. What I wanted to understand is how has the distribution of supply changed (i.e. new builds of detached, semi-detached, towns, and apartments) throughout history.

Semi-detached as remained fairly consistent throughout history, sitting around 3%. Townhouses have been on a slight rise since the 1980s and remained consistent from the 90s till now around 15%.

The huge shifts are coming from detached and apartments. Land in Toronto is becoming more scarce. As a developer, it’s more profitable to make towns and stack 3 floors to maximize sqft than to build detached homes. Condos are being built higher and smaller to still make them “affordable” thus increasing supply.

If you also remember the price index in the first chart of this article, buyers are being pushed out of detached and single family homes. Based on the median income, towns and apartments are still within reach so we see buyers being pushed into this market thus increasing demand.

Toronto Real Estate Demand

Demand is broken up into the natural rate of increase of Toronto’s population + immigration + demand from multi-home investors. To keep it short, I won’t explain too much of the math behind it, but below is a chart of my estimated supply surplus or deficit. If the blue line is below the orange line, we’re at a supply deficit and vice versa.

Toronto has been in a supply deficit since 2016 which explains the significant price growth in the last few years. What makes this even worse is that Canada is looking to increase the immigration number to 400K, which is double the historical immigration trend since the 2000s. Half of those immigrants come to Toronto which is already in short of supply.

So is Toronto Overvalued?

Currently, I don’t think Toronto is overvalued, but I do think Toronto is unaffordable. As long the banks continue to allow buyers to borrow beyond their means, the feds continuing to keep the rates low, immigration is at it’s all time high and supply continues to be at a deficit, I think the prices are fairly valued.

But with interest rates on the rise and a rush of developers pushing out new high rises condos every week, my prediction is that prices will either stabilize or decline a bit over the next few years.

The reason I think the prices won’t significantly drop is because if the economy is on the downturn, there’s no rush for a home owner or investor to sell. Home owners who have bought at the highs or thinking of selling can delay until the economy stabilizes.

For investors, they can continue to rent out their properties as rent is still continuing to catch up to the increase in property prices and HELOCs can be used as a bridge for short-term cash flow needs.

The bubble will only burst when interest rates hit a certain X% where homeowners sitting on variables rates suddenly realize they can no longer afford their home. Unfortunately, I don’t have those numbers to make an educated guess, but I feel like that will be the start of the bubble bursting.

This analysis is a little different than my usual S&P 500 analysis. If you liked what you read, let me know in the comments and I might continue to update this outlook in the future.


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