What Trigger Could Make Toronto Area Home Prices Fall?

When thinking about what might trigger a decline in home prices, there are generally two broad categories — a fundamental trigger and a behavioural trigger.

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In a recent BNN interview, I was asked about the possibility of a price decline in Toronto’s housing market this year — my response was that based on the latest trends in the data, it seems unlikely that we’ll see one. 

However, what I wasn’t able to communicate during my live six-minute interview was that the true answer to this question is far more nuanced and, of course, unpredictable.  

When thinking about what might trigger a decline in home prices, there are generally two broad categories — a fundamental trigger and a behavioural trigger.

A fundamental trigger would be something like a traditional recession where job losses actually lead to a decline in household income, leaving some households unable to cover their mortgage expenses and forcing them to sell their home.  

A behavioural trigger is simply a change in beliefs and attitudes about the market. A good example of a behavioural trigger was the rapid change in beliefs that led to the decline in house prices in the second half of 2017 after a booming housing bubble that peaked in the first quarter of 2017.

Many people believe that the cause for the decline in prices was a non-resident speculation tax introduced by the provincial government in April 2017 — but this isn’t the case as there were not enough non-resident investors in the market to account for the roughly 20% decline in average house prices that year.  

The Ontario government’s suggestion that a foreign buyer tax was in the works left many buyers and sellers worried that this may lead to a decline in prices and it’s this fear that pushed sellers to rush into the market to sell their homes and pulled buyers, who feared buying at a peak, out of the market in significant numbers.  

This dramatic imbalance between buyers and sellers, fueled by their pessimistic beliefs about the market, is what led to the rapid decline in prices. There were no fundamental factors that could explain this decline — it was simply the product of a sudden change in beliefs. 

Looking forward, I suspect that a decline in home prices due to fundamental factors is unlikely to happen any time in the near future. There is too much monetary and fiscal stimulus keeping home prices high and that will likely continue to some extent over the next 12 to 24 months until the economy fully recovers. 

But behavioural triggers are a lot harder to predict and from my perspective, it’s this type of trigger that policy makers should be more concerned about.

Behavioural triggers are hard to predict — just what will make home buyers and sellers suddenly shift their beliefs about the housing market en masse? While some shifts may be easier to foresee, other shifts often defy expectations.

The speed at which buyers rushed back into the market following the unprecedented global economic shutdown and uncertainty caused by the COVID-19 pandemic caught many, including our top housing authority, the Canadian Housing and Mortgage Corporation (CMHC) off-guard, while the shift out of urban cities to the outer suburbs and even rural areas of Ontario was perhaps more foreseeable as the impact of lockdowns. For many, the push to work-from-home reduced the restrictions of the daily commute when looking at properties, while also making more living space desirable as entire families stayed at home together.

Once the return of buyers set off a new boom in the market, we saw the return of the type of irrational exuberance characteristic of housing bubbles — as prices start to climb, the fear of missing out and not being able to afford to buy, pushes buyers into market even faster, which further pushes prices up.

While most economists see the rapid acceleration in house prices over the past year as a product of “fundamental” factors, I disagree. Yes, there are fundamental factors leading to higher prices in the Toronto area, such as low interest rates and tight supply, but these factors can’t explain prices rising 30-40% in a single year.

We should not be rationalizing the irrational.

Going back to our original question, what type of a behavioural trigger might lead to a decline in prices tomorrow?

Now that the frenzy in the market is gone, as sales have started to decline and prices have stopped rising as quickly, buyers have more time to think and consider their next steps. If too many buyers actively looking at homes start to think “it’s not worth it,” because they can’t rationalize paying $1.2M for a home that would have sold for $900K a year ago, then we may find ourselves in a similar situation as 2017 where sellers outnumber buyers.

I believe that these will be the key factors influencing the future direction of our housing market over the next twelve months. 

If buyers remain optimistic and are willing to buy a home in the second most expensive housing market in North America then the market will remain balanced.

But if buyers lose interest and aren’t willing to make the significant sacrifices required to buy a home in Toronto, no amount of monetary or fiscal stimulus will change that. 

The Move Smartly Monthly Toronto Area Market Report is powered Realosophy Realty Inc. Brokerage, a residential real estate brokerage serving Toronto and the GTA. A leader in real estate analytics, Realosophy educates consumers at Realosophy.com and MoveSmartly.com and helps clients make better decisions when buying and selling a home.

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