Is Toronto in a Housing Bubble That's About to Burst?
Every year, I have the pleasure of meeting with a panel of economists from the IMF to discuss my research on Toronto's housing market, including potential vulnerabilities. While there is a lot to be concerned about when it comes to Toronto's housing market, the one risk that has not been on my radar for the past couple of years is the risk of a deep and sustained decline in house prices, like the one we saw when the US housing bubble collapsed in the early 2000s.
I mention this because this is often one of the biggest questions and concerns I hear about Toronto's housing market. While home prices are certainly high in Toronto, it's important to remember that high home prices alone do not define a housing bubble.
Let's consider how economist Robert Shiller defines a housing bubble.
"A situation in which news of price increases spurs investor enthusiasm which spreads by psychological contagion from person to person, in the process amplifying stories that might justify the price increase and bringing in a larger and larger class of investors, who, despite doubts about the real value of the investment, are drawn to it partly through envy of others' successes and partly through a gambler's excitement."
Housing bubbles are a behavioural phenomenon where home prices rise rapidly due to an irrational exuberance in the market and a fear of missing out.
Toronto's housing market experienced two bubble periods in the recent past.
In 2016 and early 2017, the Toronto area saw a rapid acceleration in house prices, peaking in March 2017 when home prices rose by 33%/year. While many economists and real estate insiders blamed the rapid boom in home prices on a lack of supply due to "government-imposed barriers," I published a report showing that the boom in prices was driven by a surge in investors buying low-rise homes in the Toronto area's suburban markets, York Region in particular.
Then, in April 2017, prices began to decline rapidly, eventually falling 20% from their peak.
In my February 2021 report, I discussed the second housing bubble that occurred during COVID and eventually peaked in early 2022 before prices fell by just over 20% from the peak.
What made those two periods different from today? Firstly, home prices were appreciating rapidly, and secondly, the rapid appreciation was driven by an irrational exuberance from investors and from home buyers who were driven by the fear of missing out. Home prices in the Toronto area are not rising rapidly, and there is no exuberance among buyers, which means today's market can't be defined as a bubble.
But it's important to note that just because Toronto's housing market is not currently in a bubble doesn't mean home prices cannot fall in the future. It just means that if prices fall, the reasons and the factors driving the decline will be very different from what we might expect when a housing bubble bursts.
Housing bubbles typically burst when the market sentiment shifts from overly optimistic to overly pessimistic - and the shift is often very sudden. When Toronto's housing bubbles burst in 2017 and 2022, the shift in the market sentiment was very rapid, and this contributed to the sudden and sharp decline in house prices that followed.
When a market is not in the middle of a housing bubble, a decline in home prices is often driven by more traditional economic factors, like a recession that leads to job losses and possibly households needing to sell their home. The factors that might lead to a price decline in these scenarios typically unfold more gradually than a bubble bursting.
Another concern among housing economists is how the housing market will adjust to high debt levels and high interest rates. If higher interest rates begin to weigh on household finances in a way that might negatively impact house prices, this shift is more likely to be a gradual one rather than a sudden shift in the market.
In short, if you're worried about a future decline in Toronto's housing market, a sudden decline in home prices like what we saw in 2017 and 2022 when market sentiment shifted, causing those bubbles to burst, is less likely to happen today. In today's market, you want to be more mindful of the economic factors that might weigh on household finances and how those factors are changing over time since this is more likely to impact housing in the near future.
John Pasalis is President of Realosophy Realty. A 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).