Is Canada Propping up Condo Investors to Prevent Prices From Falling?

While most media headlines regarding Toronto’s condo market have focused on the record number of units listed for sale, there is a bigger and more troubling risk that few have considered. Many of the newly completed condominiums in Toronto are not worth what investors paid, which raises an important question.

Are Canadian policymakers and financial institutions artificially supporting investors to prevent condo prices from collapsing? I believe they are, and I think this problem will only get worse in the years ahead. 

Warnings in 2020

In early 2020, I published an article on Move Smartly titled Why Investing in Pre-Construction Condos Could Cost You Money

At that time, the average price for pre-construction condos in downtown Toronto was around $1,500 per square foot, whereas resale condos sold for about $1,000 per square foot. This stark difference in pricing raised concerns about the sustainability of such premiums, particularly if the resale market did not continue to appreciate at the same pace. Investors banking on future price increases could find themselves in a difficult position, holding properties worth less than their purchase price.

Looking at the condominiums that will be completed in 2024, it’s clear that my concerns about pre-construction condos not being worth what investors paid are playing out just as I suggested they might. 

55 Mercer Street: A Case Study

A telling example of the challenges of the pre-construction condo market is the development at 55 Mercer Street, a downtown Toronto condominium completed in early 2024. I analyzed twenty recently rented units to better understand the price investors paid and the net rental income earned on these units. 

Investors of these units paid an average purchase price of $855,000, equating to about $1,539 per square foot and an average unit size of 555 square feet. In contrast, the average resale condo price in the same neighbourhood is $870,000, equating to $1,029 per square foot and an average size of 845 square feet. This is not an apples-to-apples comparison since 55 Mercer is a newer building and will be superior to many of the older existing resale condominium units. 

The monthly cash flow for these units can also be easily estimated since we know the price each unit was rented for. We can also easily estimate the monthly maintenance fees and property taxes based on the information from the comparable existing units for sale. Assuming the average buyer had a 25% down payment, the rental income from these units fell significantly short of covering costs, resulting in a negative cash flow of around $1,700 per month for investors.

When writing this article, 27 condominium units had been listed for sale at 55 Mercer, but only one had been sold. The unit sold for roughly 19% less than its original purchase price. This decline is likely representative of the approximate market value for units in the building. On a per-square-foot basis, the condos are worth more than the average condo in the neighbourhood but not worth what the investors paid. 

The primary reason that newly completed condos are not worth what investors paid is that resale prices have not appreciated since 2020. The chart below is from the condo website, showing the average price per square foot in the King West neighbourhood in downtown Toronto. Prices increased between 2020 and 2022, when interest rates fell to a record low, but have since declined to their 2020 level. 

Are Banks Bending the Rules?

Normally, when a property declines in value between the time the buyer purchases it and the closing date, banks will only underwrite the mortgage based on what the property is worth (the appraised value), not what the investor paid for it.

For example, if an investor paid $800,000 for a unit that declined in value by 20%, banks will only provide a mortgage of up to 80% of the appraised value of the property - which is $640,000. A buyer who planned to make a 20% down payment ($160K) based on the original purchase price would have found that their original down payment covers the decline in the property’s value. They would have to contribute an additional $128,000, which serves as the 20% down payment required based on the lower appraised value. 

When hundreds of condo buyers in a project scheduled to be completed all have units worth less than what they paid for them, we would normally hear some rumblings among industry insiders about distress. We would hear stories about investors who didn’t have the additional capital required to get their mortgage or investors who didn’t qualify for a mortgage at today’s much higher interest rates. But we haven’t heard any stories of distress.

I have heard from many reputable people in the real estate and mortgage industry that financial institutions are bending banking rules to help these investors get a mortgage. Banks use "blanket appraisals," which assume that newly completed condos are worth their original purchase price despite lower market values.

This means that the condo investor does not need to come up with additional funds on closing when their unit is worth less than what they paid. However, it also means that banks may be issuing mortgages equal to 100% of the current market value of these properties in some cases.

This practice introduces significant long-term risks. By not adjusting appraisals to reflect current market conditions, banks may be inflating the true value of their loan portfolios and misrepresenting the loan-to-value ratio on this debt.

Furthermore, our government's decision to allow banks to bend the rules to accommodate real estate investors raises questions about its promise to restore generational fairness in Canada. When our government changes mortgage rules for one segment of the population, older and wealthier real estate investors, it does so at the younger generation's expense.

Young potential home buyers have a right to be furious about these trends. The real estate playing field was already stacked against them, and by protecting investors from the consequences of their bad investment decisions, our government has transferred the costs of these mistakes to younger buyers in the form of condo prices that are higher than they otherwise would have been. 

The Troubled Road Ahead

Canadian policymakers and financial institutions appear to be bending mortgage rules to help investors because they have a vested interest. Many of Canada’s big banks are the primary lenders financing the construction of new condominiums, and for banks to get those loans paid back by builders, the investors who bought units in the project need to take ownership of their units - which means they need a mortgage.

If too many investors find that they can’t close on their units, this could jeopardize the entire project and, in a worst-case scenario, could lead to the condominium failing to register and possibly the builder defaulting on their debt. While this rarely happens in Canada, many condominium projects in the United States failed during the financial crisis when investors refused to close on their units because property values plummeted well below the original purchase price.  

Policymakers find themselves in a tough spot. 

Sweeping these problems under the mat by offering investors blanket appraisals and hoping nobody notices has served banks well so far, but this approach has its downsides and limits.

When considering the downsides of this approach, Canada’s policymakers are sending a clear signal to real estate investors that governments will do everything in their power to mitigate their bad investment decisions - particularly when this also protects Canada's big banks. 

Several years ago, Peter Routledge, the head of Canada’s banking regulator OSFI, said this about the impact real estate investors were having on Canada’s housing market. 

“Secondary buyers -- the investors -- they're making investments to generate a return. That's a free-market economy, more power to them”

Peter Routledge, BNN Bloomberg 2021

The challenge with Routledge’s free-market economy is that by bending Canada’s mortgage rules to help real estate investors qualify for a mortgage, policymakers are ensuring that real estate investing in Canada does not operate as a free-market economy. 

Investors get all the upside benefits when their investments perform well, but they do not bear the full cost when they make a bad investment - because governments are there to help them avoid any loss. When investors don’t lose money when making a poor investment decision, policymakers are creating a government-supported moral hazard problem that will only encourage more investors to use and view housing in Canada as a speculative asset that policymakers have a direct interest in ensuring is a lucrative investment with minimal downside risk. 

Canada’s approach will also have its limits, which will be tested in the years ahead.

Over 90,000 condominium units are still under construction in the Toronto area, and the future outlook for those units looks even more challenging. 

Of the condominiums completed this year, the market value of those units is, on average, 10% below what investors originally paid for them.

In the years ahead, the difference between what newly completed condominiums were purchased for and what they will be worth on the resale market will only get worse (assuming resale prices don't increase).

What will happen when banks accept blanket appraisals for newly completed condos purchased for $1,800 per square foot, but the market value for those units is only $1,300 per square foot?

We’ll end up with a situation in which the mortgages on these units exceed their market value. 

Our government is going to extraordinary lengths to keep condo prices from falling, and the market will test those limits over the next 12-24 months. 

Where Do We Go From Here?

Where we go from here depends heavily on our government’s policies and approach to handling the problematic conditions ahead. 

Policymakers can continue doing what they have been doing, encouraging banks to break Canada’s banking regulations to support the bad investment decisions of this small sub-class of real estate investors. This would avoid a broader systemic crisis of condo projects failing due to too many buyers defaulting on their purchases.

If newly completed condo projects begin to fail, the negative consequences and economic side effects would be significant.

While policymakers have some control over managing the overpriced new condominiums that will be completed in the years ahead, they have far less control over what happens in the resale market, which currently has a record number of units available for sale. The future direction of condominium prices in the resale market in the short term is largely out of our government’s control.

If condo inventory continues to increase, we could see some downward pressure on condo prices, further widening the gap between resale prices and the prices pre-construction condo investors paid for their units. 

To mitigate this risk, our government could reverse its plans to reduce the number of non-permanent residents in Canada over the next three years. If the federal government follows through with its plans, Canada’s population will go from growing by just under 1.3 million to approximately 300,000 people annually. This dramatic decrease may contribute to future downward pressure on condo prices and rents.

But if our government wants to keep condo prices and rents as high as possible to mitigate the potential negative side effects of the overpriced condos scheduled to be completed in the years ahead, it may reverse course on these plans. Extending Canada’s current population boom isn’t guaranteed to drive prices and rents higher, but at a minimum, it would help raise the floor of any declines. 

Finally, buyers and sellers in Toronto’s housing market will want to keep a close eye on the trends I highlighted above because it’s unclear how far policymakers will go to keep prices from falling. I would encourage readers to subscribe to our Move Smartly blog here and our Move Smartly YouTube channel, where I frequently discuss trends that might influence their real estate decisions.

Have questions about your own moves in the Toronto area as a buyer, seller, investor or renter? Book a no-obligation consult with John and his team at a Realosophy here:

John Pasalis is President of Realosophy RealtyA specialist in real estate data analysis, John’s research focuses on unlocking micro trends in the Greater Toronto Area real estate market. His research has been utilized by the Bank of Canada, the Canadian Mortgage and Housing Corporation (CMHC) and the International Monetary Fund (IMF).

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