About 10 years ago, you’d often see new condo investor marketing pieces with projected carrying costs for a specific unit spelling out the monthly mortgage payment, condo fee, taxes and expected rental rate at completion.

Ben Myers operates the boutique residential real estate advisory firm Bullpen Research & Consulting Inc.

At the time, there were complaints these investor-return projections shouldn’t be allowed, as the forecasts for monthly rentals at nearly $3 per square foot were absurd.

Fast-forward a decade; some units in newly completed condominiums in Toronto are achieving rents of more than $4.50 per square foot, and some rental apartment developers are underwriting deals at over $6  per square foot.

However, new condo projects in downtown Toronto which would have sold for $800 per square foot in 2016, are now selling for $1,200 per square foot. Even with the higher level of rental inflation we’re experiencing, positive cash flow will be difficult to obtain when these high-rise towers complete in 2022 and 2023. You rarely see those investor marketing pieces being flogged anymore.

The mom-and-pop condo investor will soon disappear completely. Toronto developers have admitted their investors are affluent buyers looking at long-term holds for capital appreciation. There are fewer investors of this type, which means fewer new condo sales and fewer new condo sites.

With less new condo demand, where will that take the market? Will those mom-and-pop investors who purchased in 2017 sell off en masse at completion, resulting in a Phoenix-like oversupply and decade-long value adjustment?

Vancouver’s downsizing market trend

In Vancouver, the downtown market produces a lot of large suites which are purchased by move-down empty-nesters coming from multi-million dollar, single-family homes while areas like Burnaby, New Westminster, and Richmond still cater to mid-market buyers and domestic and foreign investors.

There is still a robust pre-construction market despite the higher prices.

Michael Ferreira of Urban Analytics Inc., a Western Canada-based market data and advisory firm, points out that:

“Average values for new condominium product in Downtown Vancouver now range from $2,000 to just over $3,000 per square foot. A number of factors have contributed to a substantial rise in Downtown condo prices; construction costs approaching $600 per buildable square foot for the luxury product Downtown condo buyers are demanding, and development charges and fees imposed by the City of Vancouver, which can range from $400 to $500 per square foot. Add on ever-increasing soft costs and marketing costs and you can see how you get to requiring the sale prices we’re experiencing today.”

Ferreira points out the downtown Vancouver market is similar to Manhattan because of the increase in international developers buying-up development sites and units:

“The condominium development landscape in Downtown Vancouver has undergone substantial shift in recent years with the arrival of new offshore development capital that has increased competition for properties, thereby causing a massive spike in land prices; per buildable land prices exceeding $500 are not unusual for prime Downtown condo development sites. Higher prices have also led to a shift in the profile of Downtown condo buyer; from primarily local to a mix of higher net worth local and international buyers.”

Toronto could go the way of New York City in another way as well: mega mixed-use downtown towers funded by private equity firms, pension funds, and family offices with complicated capital stacks. These towers get under construction without residential pre-sales, with huge super-luxury condominium suites aimed at the city’s elite and global investors.

Exploding the condo investor myth

A common, yet false belief, is that if investors were not present in the Toronto market, all of those investor-held units would be freed up for end-users, and the market would have a similar level of demand, yet (somehow) lower prices. However, the higher down payment requirement, higher prices, risk of cancellation, and four-year period between pre-construction purchase and occupancy are all deterrents for first-time buyers and other owner-occupiers.

There are a lot of future headwinds for Toronto high-rise developers: fewer pre-construction investors, higher interest rates, higher construction costs, higher land costs, higher development charges, rent control, foreign buyer taxes, uncertainty with the new planning appeals process, and added risk associated with the new TOCore planning framework. With these new impediments it is more likely developers will focus on higher-margin luxury units, and ignore the first-time buyer and mid-market product.

The Toronto housing market is going to look a lot more like today’s markets in San Francisco and New York, as opposed to Phoenix or Miami in 2009. To politicians and pundits calling for fewer pre-construction condo investors: be careful what you wish for.

Ben Myers is the President of Bullpen Research & Consulting Inc. He produces market demand reports and residential pricing recommendation studies for builders, lenders and landowners in Toronto and Ottawa. He assists in the underwriting and due diligence of real estate development opportunities from a revenue and land value perspective. Find him at www.bullpenconsulting.ca or on Twitter at @BullpenConsult