With Sales Gauge at Decade Low, Toronto Home Prices Set to Drop

(Bloomberg) -- The latest data on Toronto housing show a sharp decline in sales in Canada’s biggest city has yet to trigger a drop in prices. A major indicator of market conditions suggests it will soon enough.

The ratio of Toronto sales to new listings slumped to 41 percent in May, according to Canadian Real Estate Association data Thursday. That’s the lowest since 2008 and near the bottom of the range for what economists generally consider a balanced market.

The gauge is a pretty good predictor of home prices and what it’s showing -- based on the typical historical relationship between the two variables -- is that a modest price decline is probably in the cards.

According to Bloomberg calculations, the 3-month moving average of the sales to new listings ratio explains almost 60 percent of the variation in Toronto benchmark home prices five months later. A sustained ratio of 40 percent implies small, single-digit annual price declines in about half a year.

Just such a soft landing is the prevailing view of most economists, as well as the Bank of Canada. Home prices in the country’s financial capital after all have been climbing steadily for years, and the recent run of annual gains in excess of 30 percent was bound to end. Even amid the sales decline in May, Toronto benchmark prices were up 1.2 percent last month.

The soft landing predicted by the model however assumes a smooth and orderly correction, whereas Toronto housing dynamics seem out of control. Predictions based on historical relationships are less robust in more extreme situations.

So, will the landing be soft or hard?

Soft Landing Case

In its semi-annual financial system review last week, the central bank said a sharp price correction in Toronto and Vancouver is unlikely because strong underlying fundamentals “support the idea that a downturn in prices would be limited.”

That view was given additional credence this week when Governor Stephen Poloz and his Senior Deputy Governor Carolyn Wilkins jolted markets by suggesting the economy may have firmed enough to withstand a gradual withdrawal of stimulus. In effect, the policy makers are saying they’re comfortable enough with the situation in Toronto and Vancouver real estate to risk the potential fallout from higher borrowing costs.

Here are some further arguments for a soft landing:

• As the central bank pointed out, about 40 percent of the 300,000 immigrants who settled in Canada last year moved to Ontario. That bolsters demand. And land-use regulations are often cited as a constraint that will prevent excessive supply from coming on the market.
• The “world-class city” argument stipulates Toronto should be compared with London and Tokyo rather than Ottawa when it comes to real estate valuations, given its status as a major metropolis and North America’s third-largest financial center.
• Vancouver’s recent experience is easing some concern that the market is vulnerable. The imposition of a tax on foreign buyers in the Pacific Coast city last summer spurred declines in sales and prices, but the latest data indicate those are rebounding.

Hard Landing

In January, sales as a share of new listings rose above 90 percent, smashing a record. The decline in that metric since then has been over 50 percentage points, which is the largest and the sharpest in data back to 1988. The only comparable decline in the metric was in the late 1980s, when it fell from 71 percent to 30 percent. And that move, which was followed by a record price drop, took two years to play out.

Much will depend on whether the sales to listings ratio continues falling.

Market psychology is key. There’s been plenty of speculative demand in the market, and any fear of a correction could send investors running for the exits. And a wave of new construction is about to hit the market. Data this month from Canada Mortgage and Housing Corp. showed year-to-date single family completions in Toronto rose to 4,937 units in May -- the most since 2008 and up 19 percent from 2016.

Even the conventional model suggests that in the event the sales to listings ratio starts hovering at about 30 percent, price declines could start hitting double digits.

To contact the reporter on this story: Erik Hertzberg in Ottawa at eschmitzhert@bloomberg.net.

To contact the editors responsible for this story: Theophilos Argitis at targitis@bloomberg.net, Chris Fournier