Part 2 of 3 where local actuary and Sky View Suites Partner John Melinte, debunks fears of the local Toronto real estate market bubble.
We also tried to try to quantify the impact of changes in key factors during the last 9 years. We started with inflation and decreases in mortgage interest rates. Here’s a breakdown of how these two factors contributed to the average price increase: 1. Inflation was responsible for roughly 19% of the increase (out of a total of 100%). 2. Mortgage interest rates decreased by roughly 3% per year during the period. Mathematically, this means that for the same monthly mortgage payment (based on a 25 year amortization), a buyer can now afford a mortgage loan amount that is 60% higher than before! So, between inflation and lower mortgage rates, we could now explain almost 80% of recent price increases. At this point we got lazy and decided that all “other” factors (including foreign money) were responsible for the remaining 20% of the increase. But one question still remained: Why would buyers be willing to agree to a 60% higher purchase price for the same property? One could argue that the majority of buyers look only at their initial monthly payment and tend to ignore the risk of rising interest rates. While this may not seem like rational behaviour for an investor, buying a home (especially for personal use) is often an emotionally charged decision. Still, we felt like there may be something more to it. For example, the last 3-4 years have seen much less movement in mortgage rates and still high price increases. At this point we developed a theory – what if average metrics were not really based on the same homes? How many renovations, flips and complete rebuilds has Toronto had in the last several years, and how was this activity impacting real estate values over the last 3-4 years? This was NOT an easy question to answer. The first logical step was to try to identify properties that had been subject to significant “value added” activity (such as major renovations, or complete rebuilds) in the last 3-4 years. Obviously, this type of extensive activity would be less frequent and more difficult to identify in condos, so we decided to stick to houses for the purpose of this exercise.