About every six months or so, another report is published claiming the Canadian housing market is overvalued. The problem with many of these reports is they often use a very unsophisticated and inadequate method to determine these overvaluation claims called the price-to-rent ratio.
I won’t go in to all the reasons this measurement is flawed, but top economists at CIBC, Will Dunning Inc. and Central 1 Credit Union have all pointed out the weaknesses of the data used in these reports; garbage-in data, results in garbage-out conclusions.
CIBC chief economist Benjamin Tal has gone as far as to call these studies “Mickey Mouse.”
One of the problems I identified with these studies is the fact that buyers will often pay more on a monthly basis to own a property than they would to rent it. What I wanted to do is figure out how much more they are willing to spend.
Looked at 10 condominium apartment buildings
With help from our vice-president of VIP sales Julie Barnard, and data from the Toronto Real Estate Board and Urbanation Inc., I took 10 condominium apartment buildings completed over the past five years in the Greater Toronto Area and reviewed all of their resale and rental transactions between January 2013 and December 2014.
To ensure the data wasn’t skewed by the fact that end-users tend to buy larger units on higher floors, and renters lease smaller units on lower floors, I examined only unit ‘pairs’ within the same building.
What I mean by pairs is I took one resale unit and one rental unit of nearly identical square footage in the same floor plate stack not more than three floors apart. I wanted to eliminate any discrepancies or preferences between units by height, floor plan, balcony size, view planes or interior finishes (that is why I looked only at newer buildings which are less likely to include units that are extensively renovated).
The purchaser’s premium
On average within our 10-building sample, purchasers were willing to spend approximately $225 a month more to own than rent the same condominium unit, a 12% premium. This is based on monthly carrying costs using a relatively standard 25-year amortization, five-year term, 3% interest rate and 20% down payment, plus condo fee and taxes, versus the rental rate (the analysis ignores heat, hydro, cable, parking, locker expenses, insurance, costs associated with the down payment, opportunity cost of capital, etc).
The 12% premium was the average, but buyers were definitely willing to pay an even higher premium to own in the most desirable neighbourhoods, with the project in Bayview Village commanding a 22% premium, the Yonge/Eglinton project achieving an 18% premium, and the downtown core project with tremendous lake views having a 13% premium.
When ignoring the one project with a small sample size, the lowest premium was for the Scarborough project, where buyers were willing to pay only 5% more to own than rent the same unit.
Dropping the down payment to 15% (and disregarding mortgage insurance costs), the ownership premium jumps to 17%. If the interest rate was to climb to 5%, the ownership premium would rise to 30%.
It is easy to see how small changes in the mortgage rules or interest rates can strongly influence the decision to buy or rent a Toronto condominium. It should be kept in mind that an increase in interest rates would likely discourage buying and encourage renting, which can often result in higher rents and a subsequent decline in the ownership premium (from the 30% projected).
The relationship may completely reverse if the GTA experiences a long period of declining condominium prices (the ownership discount?), as opposed to our 17-year bull run. After a big bounceback in the Toronto condo market in 2014, we expect the condominium ownership premium to be in existence for some years to come.
The additional worth/pride/security people associate with home ownership needs to be considered when determining the ‘value’ of housing in this country.
Fortress Real Developments
Fortress Real Developments is a diversified real estate development and investment company that partners with established builders and developers across the country. Fortress sources equity capital for the partnership, in addition to providing value-add services such as market research, structuring of debt, marketing, and other realty services. Ben assists in evaluating both the market conditions and projects that Fortress is active in. Follow his blog posts and commentary on the Canadian Housing Market at www.fortressrealdevelopments.com/news or follow him on twitter at @BenMyers29