Five Forces Driving Ontario Home Prices
Last Updated December 18, 2024.
House prices are influenced by supply and demand, which operate at the highest level; other factors influence supply or demand. Mortgage Sandbox uses a five-factor framework to collect information and conduct our market analysis. The key factors are core demand, non-core demand, government policy, supply, and popular sentiment.
In the long run, economic forces fundamentally drive the market, but in the short run, sentiment can push prices above or below economic fundamentals.
Summary
Core and non-core demand are much lower than in the past.
Currently, the prime drivers of the market are high rates and mildly negative consumer sentiment, both of which put downward pressure on home values.
1. Core Demand
Core demand is a function of:
Population Growth: The pace at which people are moving to an area. An average of roughly 2.5 people live in one household.
Home Price Growth: Changes in the market value of the desired home.
Savings-Equity: How much disposable after-tax income you’ve been able to squirrel away plus any equity you have in your existing home.
Financing: Your maximum mortgage is calculated using income, monthly expenses, and interest rates.
Population Growth
Ontario’s population is almost always growing, but the growth rate is important for our analysis.
If population growth is the same or lower than in the past, then there is less upward pressure on prices.
After a pause in 2020, Ontario's population growth is back on track and has made up for lost ground during the pandemic. While population growth in the past two years looks alarming, the average population growth over the past years is modest.
Canada has set record-breaking immigration targets, and it would appear they have met 2022 immigration objectives. Curiously, full-time employment has not been growing at the same pace as population growth.
As recession fears grow, we might expect Canadians to be less open to such high immigration targets in a weak jobs market.
Home Price Changes
Price growth reduces affordability and reduces the pool of qualified potential buyers. In an ironic twist, rising prices create downward pressure on prices. This is a factor for first-time homebuyers trying to buy an entry-level apartment.
As a rule of thumb, homeownership costs are considered unaffordable when they exceed 40% of household income.
According to RBC Royal Bank, homeownership costs in the GTA stood at 68% of the median household income, whereas in Ottawa, ownership costs were 39%. In other words, the GTA was beyond economic fundamentals, while Ottawa’s home prices reached the economic limit.
Savings-Equity
Equity
Existing homeowners benefited from price appreciation, so they have more home equity to use when buying another home.
A recent softening in the market has eroded some of this equity, but not enough to have a significant impact.
Condo-to-House Price Gap
A large gap means more savings and mortgage financing are needed for condo owners to upsize to a house.
House values rose more quickly during the pandemic than condo values. In the past few months, the gap between house and condo prices has narrowed.
A narrowing price gap helps to make upsizing more accessible for condo owners.
Savings
The savings cushion that Canadians accumulated during the pandemic has been spent, according to Statistics Canada. "On average, regardless of a household's demographic or economic characteristic, gains in household wealth acquired over the previous year have been erased," Statistics Canada reported on Monday, October 3rd.
With inflation rising faster than incomes, everyday items are becoming more expensive while paychecks are unchanged. If this trend continues, Canadians will run out of savings (including nest eggs for buying a home) and begin taking on debt to cover everyday expenses.
Financing
Mortgage Interest Rates
Since 2020, mortgage rates have been rising. They are in the mid-range compared to the past 30 years but are the highest since before the 2007 financial crisis.
So long as mortgage rates remain elevated at current levels, home buying budgets will remain depressed.
Employment and Incomes
While the employment picture has improved significantly, you must hold a job for 3 to 6 months before applying for a mortgage. Also, full-time employment in Ontario appears to have softened since the summer of 2022.
Job growth is critical because high population growth will not put upward pressure on home values if those new arrivals don't have meaningful work.
Recently, full-time employment has trended downward. If full-time employment continues to trend downward, we can expect less demand in 2024, regardless of population growth.
Homeownership Costs
The cost of utilities (heating oil, natural gas, and power) has risen. In many cases, heating costs alone have increased by $100 per month. Add the rising cost of groceries and gasoline to the equation, and it is clear that homebuyers have less disposable income to put toward mortgage payments.
Overall Core Demand
While Ontario's population has been growing at higher rates, full-time employment has not kept pace.
The biggest driver on the core demand side is rising interest rates. A household that would have qualified for a $600,000 mortgage in 2021 will now only qualify for $450,000. This and record home prices show why home purchases have dwindled.
Many people in Ontario want to own their first home or upsize. However, fewer households have the financial capacity to make their desired purchase compared to six months ago.
Find out how much you can afford to buy!
2. Non-core Demand
This represents both short-term and short-term investments, and recreational demand (i.e., homes not occupied full-time by the owner). Here is where foreign capital, real estate flippers, and dark money come into play. It also includes short-term rentals, long-term rentals, and recreational property purchases.
Since non-core demand is ‘optional’ (i.e., not used to shelter your family), it is more volatile than core demand.
Foreign Capital
Beginning January 2023, Canada has banned some foreigners from buying Canadian homes until 2025. The foreign-buyer ban won’t apply to some students, foreign workers, or foreign citizens who are permanent residents of Canada; however, the additional hurdles will reduce the flow of capital to Canadian real estate compared to previous years.
Long-term Rental Investors
Rental investments are a significant driver of home prices. Nearly 40 per cent of Toronto’s condos are not owner-occupied, so rental investments are an important driver of home prices. Similar trends are reflected across Ontario.
There are new risks in the rental market due to planned reductions in study permits, rising mortgage costs, and rising property taxes.
The Minister of Immigration, Refugees and Citizenship announced that the Government of Canada will set a study permit intake cap for two years. For 2024, the cap is expected to result in approximately 360,000 approved study permits, a decrease of 35% from 2023. It is unclear what impact this will have on rent rates.
As well, borrowing costs have more than doubled. For many owners, condo maintenance fees have also been driven up by insurance and energy costs.
Finally, property taxes are rising across Canada. It is now more difficult for tenant incomes/rents to cover mortgage costs, maintenance fees, taxes, and wear and tear.
Short-term Rentals
Airbnbs were huge in Ontario before the pandemic.
International travel has begun to recover. Perhaps aspiring Airbnb entrepreneurs will pour back into the market.
In October 2022, according to Airdna.co, short-term rentals were:
Toronto: 10,000 rentals with 78% occupancy.
Ottawa: 1,600 rentals with 73% occupancy.
An occupancy rate between 70% and 95% is typically considered a supportive investment environment.
Tourism is finally on track to match or exceed pre-pandemic levels! This bodes well for short-term rentals.
House Flippers
When house prices were rising, it was a more straightforward business for hours flippers.
The market has softened everywhere except in Alberta, and house flipping is beginning to look risky.
Note: The flaw with the chart below is that most flippers will "live in the property" for at least 1 year before selling so they can claim it as their principal residence and avoid capital gains tax on the sale. The regulators don’t count flips that occur within 18 months.
Share of homes purchased and then flipped within 12 months (%)
Dark Money
Dark money is the crime proceeds or money transferred to Canada illegally. This includes money earned legitimately and illegally transferred from countries with capital controls (e.g., China) and legitimate earnings moved from nations subject to international sanctions (e.g., Iran, Russia, and North Korea).
It is laundered in the real estate market to hide the illegal nature of the funds. Sometimes, the property's true owner is hidden by using a Straw Buyer, and other times, a shell company owns the property.
Sometimes a real estate agent or lawyer will accept the illegal cash to help the nefarious individuals hide its true origins. In 2015, a B.C. realtor was caught with hundreds of thousands of dollars in her closet at home.
We see no evidence of a diminished role for dark money in Ontario real estate. A recent report suggests mortgage fraud actually increased during the pandemic.
Overall Non-core Demand
Given the foreign buyer restrictions and volatility in the rental market, we assess that capital inflows toward residential real estate for non-core uses will soften in 2023. This adds some downward pressure on Ontario home prices.
3. Government Policy
Foreign Buyer Restrictions
The Federal Government, using its housing agency, has banned home purchases by non-Canadians between January 1, 2023, and 2025. There are some exceptions for those with temporary work permits, refugee claimants, and international students.
The two-year ban was implemented to allow the government to study whether it reduces the property market's levels of speculation and commoditization.
Overall Government Influence
Overall, the government unwound many programs supporting home values through the pandemic and subsequently implemented restrictions on foreign investment. Compared to a year ago, there is significantly less support from the government to maintain home values.
4. Supply
Supply comes from two sources.
Existing sales: Existing home sales are sales of ‘used homes.’ They are homes owned by individuals who sell them to upgrade, move for work, or for other reasons. The Toronto Real Estate Board only reports existing home sales and listings.
Pre-Sales and Construction Completions: Most new homes are sold via pre-sales before the construction has started. These are predominantly apartments and townhomes. Data on pre-sales is private and difficult to find, but construction starts (reported by the government) are a very accurate lagging indicator of pre-sale activity.
Rising supply releases the upward pressure on prices caused by demand.
Months of Supply of Existing Homes
While the total number of homes for sale is a key supply metric, shown below, the ratio of listings to purchases expressed in months of supply better indicates where prices are headed. This is because months of supply show the relationship between supply and demand. If supply and demand drop together, the market balance is maintained, and price pressures remain unchanged.
Supply has been surprisingly tight throughout the pandemic and is now trending upward.
Mortgage Delinquencies and Foreclosures
Financial distress leads to rushed or forced sales - more supply.
Pre-sales and Completions
New Construction:
Across Ontario many more homes are under construction than was typical a few years ago.
As these projects are completed in the next 18 months, they might come onto a soft market. While many of the homes under construction are pre-sold, their new occupants will be vacating or selling their current residences.
Pre-sales:
Pre-sales are purchases of unbuilt and completed brand-new homes from developers. Typically, a developer must sell 70% of homes in a building before they can start construction, so housing starts are a good indicator of successful pre-sales.
Pre-sales are purchases of brand-new homes from developers. Pre-sales have moderated significantly in the current weaker market.
The below chart provides good data for Toronto where the market appears to be cooling. Based on housing starts, pre-sales in other Ontario markets appear to be cooling off too.
Popular Sentiment
Popular sentiment can be volatile and easily influenced by the latest headlines. Sentiment can shift quickly, as witnessed in the past two years.
Canadian Consumer Confidence
The Ipsos-Reid and Nanos Canadian Confidence Index shows that Canadian consumer confidence has improved significantly, and confidence in real estate values has improved. Roughly 45 per cent of Canadians believe home prices in their neighbourhood will rise over the next six months.
Although consumer sentiment is a key factor contributing to real estate price trends, sentiment on its own is not an accurate predictor of future prices.
Conclusion
Here is a quick summary:
Core demand is weaker because higher interest rates and inflation have eroded home-buying budgets. Also, full-time employment is trending downward simultaneously with strong population growth.
Non-core demand is weaker due to the high cost of rental financing and rising condo maintenance fees driven up by insurance and energy costs. Finally, the government's imposition of a foreign buyer ban removes some potential buyers.
Existing supply is rising, and there are record numbers of homes under construction, many of which will complete in the next 18 months.
Consumer confidence in real estate is mildly negative.
While it is not guaranteed, the current conditions dramatically increase the risk of a significant market correction. Abbotsford has already experienced a house price drop greater than 20 per cent since the market peak, which we would consider a major correction.
See our Ontario Home Price Forecasts
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