Is the Toronto condo market going to see a re-run of the 1980s?

For those of us old enough to remember, the late 1980s to early 1990s was a bleak period for real estate in Toronto. 

Back in the mid-1980s, baby boomers worked themselves into a home buying frenzy. They were spending an average of about 55% of their household income on mortgage payments. Home and condo prices were at an all-time high. Then, in 1989, the Bank of Canada raised interest rates by 1% over the course of 1 week. That may not sound like a lot, but some people with variable rate mortgages (or those with upcoming renewals on their fixed rate mortgages) could no longer afford their mortgage payments and were forced to sell, starting a 6 year long slide in real estate prices. 

Currently, with downtown Toronto condo prices at an all-time high and mortgage interest rates at relative lows, some people fear that history is repeating itself, and that we’re heading for big dip in downtown Toronto condo prices. However, there are many important differences between then and now.

First, affordability – today, while it may seem that prices are out of whack and people are over-extending their buying power, the numbers show that the average amount of household income going towards mortgage payments is closer to 30% (as opposed to the 55% back in the 1980s). Interestingly enough, 30% also happens to be quite close to the threshold that most Canadian banks now use in order to determine whether they’re willing to give you a mortgage. 

Which leads me to another important difference between then and now: the increased stringency with which our banks are giving out mortgage loans today – the details are beyond the scope of this article, but suffice it to say that Canadian banks are being hailed globally as a model for financial stability and responsible lending criteria by economists and financial experts around the world.

Third – a different breed of investor. In the late ’80s (much like now), investors held a significant proportion all condos. The difference is that those investors were flipping them quickly for short-term profit, which of course meant they were not prepared to carry them for a long period. Today’s investors have a longer-term outlook and are prepared to carry the condo outright, or rent it out if need be (sometimes overseas investors will rent out their condos to their local friends and relatives). Also, some investors are renting out their condos as short-term fully furnished rentals (with companies like ours www.toroontofurnishedrentals.com) in order to try to generate higher cash flows. 

More importantly, a lot of the foreign investors are purchasing properties outright (with cash) – as such, they don’t have to worry about a mortgage, so an increase in interest rates is not going to force them to sell. This is not to say that interest rates are not an important factor in real estate prices, they certainly are, but for certain market segments (like downtown Toronto condos), they’re not nearly as important as they once were. 

The other thing to consider is that fiscal policy is very different today than it was 25 years ago. The Bank of Canada raising interest rates by a full 1% over so such a short period as they did in 1989 would be unheard of today. Furthermore, there are many indications that demographic pressures in developed nations combined with more gradual global economic growth will continue warranting a low interest rate environment for many years to come. Scenarios similar to what’s been happening with interest rates in Japan over the last 20 years may become the norm rather than the exception (Japan has had low and sometimes zero interest rates for about two decades).

Having said all that, of course there’s no guarantee that the real estate market won’t fluctuate, like anything else. Also just like anything else, the short term fluctuations can be much more volatile than the long-term trends. Trying to flip a property in a short amount of time can be quite profitable, but it can also be quite painful. The key to minimizing risk with real estate is to treat it as a long-term investment – if you’re able to do that, you’ll be able to ride out any temporary dips in the value. For example, ask a baby boomer that bought a house or condo in the 416 area code at the peak of the market in the late 80s and managed to hold onto it until now … ask them how much their investment is worth today and if they regret buying it and you shouldn’t be surprised to hear that despite all the short-term fluctuations, it’s performed quite nicely over the long run.