Over the past couple of years we’ve heard Mark Carney and Jim Flaherty escalate their concerns about condo markets in Toronto and Vancouver but we have yet to see the federal government introduce any concrete policies to try to cool things down.
One of the key problems with Toronto’s pre-construction condo market is that it is almost entirely fueled by speculators. Speculators are buying condominiums in the very early stages of a project with the expectation that prices will go up significantly once the building is completed.
This is a problem because for most consumers, real estate makes up a huge part of our individual financial portfolios as we seek out the financial discipline and sense of personal security that home ownership offers. Speculators, on the other hand, pursue the same assets for very different motives - high risk, short-term profits. (When referring to speculators, we do not mean investors who purchase to rent out condos as they are holding these assets for the long-term.) These are conflicting motives that threaten the health of the asset class for everyone.
This is why (John's note: and believe me I am very surprised by this myself) we are about to argue for more taxes. Many taxes are ill-thought out, poorly conceived and executed instruments that do not deliver their theoretical benefits, but that does not negate the good that these policy instruments can do with the right goal in mind - in this case, to protect an entire asset class for the benefit of all.
It’s time for Flaherty to cool Toronto’s pre-construction condo market by introducing policies that curb speculation.
Many speculators buy pre-construction condos with no plan to ever take ownership of the condo they purchased. Speculators will flip, or assign, a pre-construction condo unit to another buyer before the condo is ever completed, profiting on the increase in value from the time they purchased it.
Five years ago builders used to discourage assignments, due to administrative cost and the potential for a high level of speculation to discourage other buyers, by charging the assignor a fee ($2,500-$5,000) to assign a unit. Today assignments have become such an important part of pre-construction condo sales that many builders are now advertising that they do not charge investors anything to assign their unit.
The problem with assignments is that it facilitates speculative behaviour. It encourages people to buy and flip in a very short period of time. These speculators are hurting the condo market because they are not investing in the asset they are buying for the long term. They are profiting by selling paper contracts.
While Ottawa may not be able to prevent assignments they can introduce policies designed to curb them, for example, by introducing a tax on the capital gains realized from assignments.
The basic idea is pretty simple. If a greater portion of a speculator's profit is going to the government in the form of taxes, it lowers their incentive to assign their unit. They'll either hold on to the condo at least until completion or will avoid making the investment entirely.
Some speculators actually take ownership of their investment condo only to list it for sale immediately after the condo registers. These speculators should also be subject to a higher tax rate on their capital gains if they sell their condo within several years of the condo registering.
This idea is very similar to the one discussed above. Investors who flip/sell their investment condo immediately after it registers are not in the market for the long term. They are speculators looking to profit from the appreciation in the asset's value.
These kind of taxes are effective because they can be designed to act as a financial disincentive to speculators without impacting buyers who intend to use their condo as their principal residence (or to rent their units out).
The idea of introducing a tax to prevent a speculative bubble is nothing new. In 2009, the Chinese government, fearing a bubble in the real estate investment market, introduced a similar sales tax on the sale of investment properties that were held by the owner for less than five years.
To date, Flaherty has taken a different approach. Flaherty prefers to ring rhetorical alarm bells about an overheated condo market in the hope that the market will heed the warnings and correct itself. This is not a very prudent strategy. Advances in behavioural economics show that consumers (including consumers of financial and other investments) are not the prudent, rational creatures we once imagined ourselves to be. We can rationalize a lot of different behaviours including gambling and begging for bailouts after the fact.
Flaherty needs to step in to curb the rampant speculation we are seeing in the pre-construction condo market. The US sub-prime collapse showed us what happens when we wait for markets to correct themselves - smash landing anyone?
John Pasalis is the President and Broker-Owner of Realosophy Realty Inc. Brokerage in Toronto. A leader in real estate analytics and pro-consumer advice, Realosophy helps clients buy or sell a home the right way. Email John
Urmi Desai is editor of the Move Smartly blog and is responsible for strategy and marketing at Realosophy Realty Inc. Brokerage. A leader in real estate analytics and pro-consumer advice, Realosophy helps clients buy or sell a home the right way. Email Urmi