The Risk of a Real Estate Bubble in Toronto and Vancouver
The spectre of a property bubble bursting haunts many global cities, from Miami to Tokyo, driven largely by the intricacies of central bank policies and market imbalances. Canada’s largest cities, Toronto and Vancouver, sit uneasily within this precarious global real estate landscape. According to the recently released UBS Global Real Estate Bubble Index, Toronto faces an elevated risk of a property bubble, and Vancouver’s risk remains moderate. Both cities, shaped by unique economic, demographic, and policy factors, are emblematic of the complexities facing housing markets globally.
The Global Real Estate Context
For more than a decade, housing markets in major cities around the world have been buoyed by historically low interest rates, ample liquidity, and a booming demand for residential property. Since the 2008 financial crisis, central banks have slashed interest rates to stabilize economies. However, this had an unintended consequence: it turned residential property into a one-way street of upward price pressure.
Toronto and Vancouver, much like other major cities, became hotbeds of property investment, with prices soaring to unsustainable levels.
However, the post-pandemic inflationary spike, accompanied by aggressive interest rate hikes, has triggered a correction in some markets. Major European cities have seen property values plunge by as much as 25% in real terms. In contrast, cities like Sydney and Vancouver, buoyed by severe housing shortages, have avoided sharp declines. As central banks across the globe wrestle with inflation and housing affordability, the risk of a housing bubble looms large over some cities while others appear more insulated.
Toronto: On the Brink of a Housing Crisis?
Toronto's property market has been in overdrive for years, fueled by rapid population growth, strong investor demand, and historically low mortgage rates. However, as the UBS Global Real Estate Bubble Index reveals, Toronto now finds itself in a precarious position, with an elevated risk of a housing bubble.
One of the most significant drivers of this risk is the affordability crisis. House prices in Toronto have far outpaced income growth over the past decade, pushing many would-be buyers out of the market. At the peak of the housing boom, it was not uncommon to see modest family homes selling for over a million dollars, a figure that seemed unthinkable just a few years prior. The sharp rise in interest rates, while aimed at curbing inflation, has exacerbated this housing affordability gap.
For instance, workers in Toronto can now afford 40% less living space than they could in 2021. This deterioration in affordability has led to a drop in sales volumes as many prospective buyers cannot afford to enter the market. Yet, prices remain high, mainly because homeowners are reluctant to sell at a loss, and many have locked in low interest rates on their mortgages. As a result, even as demand weakens, the Toronto housing market is frozen in place.
Toronto has experienced strong population growth driven by immigration and a booming tech sector. This influx of new residents has kept demand for housing relatively high, particularly in the rental market. But with rents rising faster than incomes, many residents are struggling to keep up, leading to growing calls for government intervention in the housing market.
However, slowing growth in full-time jobs will act as a counterbalance to population growth. It is difficult to see how any household without two full-time jobs can afford a home in Metro Toronto.
Vancouver: A Moderately Risky Market
In contrast to Toronto, Vancouver’s property market appears somewhat more stable, though it too is not without risks. The UBS Global Real Estate Bubble Index ranks Vancouver as having a moderate risk of a housing bubble, down from the elevated risk it faced just a few years ago. Vancouver, like Toronto, has experienced sky-high housing prices, but several factors have helped to stabilize its market.
One of the most significant factors is the city’s severe housing shortage. Vancouver is hemmed in by mountains and the ocean, leaving little room for outward expansion. As a result, the housing supply has long been constrained by restrictive zoning rules, and prices have been driven up by the scarcity of available properties.
However, recent legislation introduced by the provincial government requires Vancouver and the municipalities around it to change their zoning bylaws to allow four to six units on a standard lot. The legislation was intended to increase housing density and the supply of triplexes, townhouses and row homes across the province. We don’t yet know how this sudden shift in potential housing supply will impact the Metro Vancouver market. If the constrained supply narrative is incorrect, what keeps Vancouver’s property prices higher than Toronto’s?
However, unlike Toronto, Vancouver has seen real rents increase significantly in recent years, rising by around 10% in real terms since 2021. This surge in rents, coupled with Vancouver’s relatively slower home price growth, has helped to ease the bubble risk. Incomes in Vancouver have also grown at a faster pace than in Toronto, further contributing to the city’s more moderate risk profile. Still, the affordability crisis in Vancouver remains acute, particularly for renters and first-time homebuyers.
Unfortunately, full-time employment might be shrinking rather than growing. If the trend continues, it will put tremendous pressure on governments to put the brakes on population growth.
The Role of Central Banks and Interest Rates
Central banks play a crucial role in shaping the trajectory of housing markets, and both Toronto and Vancouver are no exception. The Bank of Canada’s aggressive interest rate hikes over the past two years have significantly cooled the housing market, but the effects of these hikes have been uneven.
In Toronto, the rise in interest rates has had a particularly pronounced impact, as many buyers are highly sensitive to changes in financing costs. First-time buyers, in particular, have been priced out of the market, while existing homeowners have largely stayed put, leading to a sharp drop in transaction volumes. This dynamic has created a paradox: even as affordability worsens, prices remain high due to the limited supply of homes for sale.
Vancouver, by contrast, has been somewhat more insulated from the effects of rising interest rates. The city’s strong rental market and international demand have helped to cushion the blow of higher borrowing costs.
Looking ahead, the anticipated interest rate cuts by the Bank of Canada could once again ignite demand for housing, particularly among first-time buyers. As financing costs become more attractive, the pendulum could swing back in favour of buyers, leading to renewed price growth in both Toronto and Vancouver.
However, any resurgence in the housing market will depend on broader economic conditions, including wage growth, employment levels, and inflation.
Political Risks and Potential Interventions
The housing crisis in Toronto and Vancouver has prompted growing calls for government intervention. From rent controls to foreign buyer bans, policymakers are grappling with how to address the affordability crisis without further destabilizing the housing market.
In Vancouver, the provincial government has implemented measures aimed at cooling the market, including a foreign buyers’ tax and a speculation and vacancy tax. These policies have had some success in curbing demand from international investors, but the city’s housing shortage remains a major challenge.
Toronto, meanwhile, has seen less aggressive intervention, though there are growing calls for rent controls and other measures to address the affordability crisis. However, any intervention in the housing market carries risks, as overly restrictive policies could deter investment and exacerbate the housing shortage.
A Delicate Balance
Toronto and Vancouver, two of Canada’s largest cities, find themselves at a crossroads. While both cities face significant risks of a property bubble, the dynamics shaping their respective housing markets are complex and multifaceted. Toronto, with its elevated risk, faces a more immediate threat driven by an affordability crisis, high interest rates, and a lack of new housing supply. Vancouver, while more stable, is not without risks, particularly as the city grapples with a severe housing shortage, rising rents, and deteriorating employment.
As the Bank of Canada navigates the delicate balance of curbing inflation without destabilizing housing markets, the future of Toronto and Vancouver’s property markets hangs in the balance. Whether these cities can avoid a housing bubble burst will depend on a range of factors, from interest rate cuts to government interventions and broader economic conditions.
One thing is clear: the road ahead for both Toronto and Vancouver is fraught with uncertainty.
