How Supply & Demand Influence the Success of Your Pre-Construction Condo Investment in 2021

How Supply & Demand Influence the Success of Your Pre-Construction Condo Investment in 2021

Basic business knowledge says when demand for a product is high, and supply is low, prices tend to be higher. Conversely, when the demand for a product is low, and supply is high, prices tend to be lower. The real estate market is no different.

For instance, the Federation of Rental-Housing Providers of Ontario and Urbanation found that Ontario needs 200,000 rental units over the next decade to keep up with demand. And according to their report, the current rental housing supply gap in Ontario has actually doubled since 2017.

In the GTA alone, the real estate market saw sharp price spikes in 2016-2017, which had many buyers priced out of the market. Today, prices keep rebounding, and we are still yet to see the bubble burst.

2018 saw dips and a slowdown in purchases in the early months, while 2019 saw a return to the natural rhythm of the real estate market. Now Toronto is being called one of the most expensive cities in Canada as it climbs the world's list of the most expensive housing and rental markets because of low supply and high demand.

Here are the specifics on how supply and demand influence the success of your pre-construction condo investment in 2021.

4 Factors That Influence Supply in 2021

Active Listings
Active listings in the real estate market play an important role when it comes to supply. More active listings on the market mean more homes for homebuyers to choose from if we assume that everyone in the GTA can afford to buy a home. The reality is that in the City of Toronto, "renters comprised 47% of the City's household in 2016. And over the last 10 years, the number of renters in the city has increased at a greater rate than owners (17% compared to 5%). Young adults aged 20 - 34 and adults between 50 - 69 years comprised the biggest increase in renters. The number of family owner households has increased at a lower rate (5%) than family renter households (13%), indicating that more families are living in rental housing either by choice or necessity", according to the Inclusionary Zoning Assessment Report: Housing Need and Demand Analysis May 2019.

So, when we talk about supply in 2021, active listings in rental properties have become the most in-demand real estate type.

New Homes
When there's a mismatch between real estate supply and demand, new homes fill the gap. However, there needs to be enough new homes built to keep up with the demand. Just last year, the market report from the Federation of Rental-Housing Providers of Ontario (FRPO) and Urbanation showed that Ontario is facing a shortage of 200,000 rental units over the next decade. We've witnessed record population increases, strong job growth, and lower homeownership rates. All of these factors have pushed the demand for rental housing higher than what FRPO initially forecasted back in 2017.

The report shows that in order to meet demand, the Province needs to play catch up with lagging rental construction activity that has worsened the rental crisis. And analysts are expecting that the pre-pandemic demand for housing will return once the economy rebounds from the reopening of borders. 2020 delays in new project launches and housing starts, coupled with pent-up demand due to unsatisfied appetite for new housing, have fueled the high housing demand for decades to come.

Permits
In new home and condo construction, permits influence the supply of housing. In Ontario, the process for a developer to gain a permit is quite rigorous, which subsequently prolongs the process of bringing new housing to the market. Where there tends to be a lower supply of homes, there also tends to be higher home prices. Plus, once a developer submits an application to the city and receives a permit, there are still challenges ahead of them that can prevent the properties from being built. Permits don't necessarily mean a greater number of homes will be built.

A new community of homes or a pre-construction condo project still has to be financially viable for the developer to proceed with construction. If the units do not sell at a profit, or construction costs and/or interest rates increase, it could lead the developer to no longer go through with the project, even if they have a permit to do so, which further limits the housing supply.

Land Use
Land is also an integral part of supply as it almost always has restrictions of some sort when it comes to the construction of new housing. Take the Places to Grow Act for the Greater Golden Horseshoe (2005), for instance. According to the Act, together with the Greenbelt Plan, Oak Ridges Moraine Conservation Plan and the Niagara Escarpment Plan, developers are restricted from building on 2 million acres of land reserved and protected from development until 2041. Although this land is protected, The Growth Plan for the Greater Golden Horseshoe (2006) has outlined 25 Urban Growth Centres as regional focal points for accommodating population, employment and housing growth.

Demand in the Greater Golden Horseshoe is driven by population growth, low vacancy rates, and other complex socio-economic factors. The Growth Plan addresses these challenges by encouraging a mix of housing types, particularly high-density housing that can accommodate a range of household sizes in locations with good access to transit and other amenities. Looking back 15 years, 80% of newly built homes were low-rise, while 20% of homes were high-rise. Today, we see a stark contrast, with 70% of new homes being high-rise communities compared to low-rise homes accounting for just 30%. The supply in low-rise residences is just not there like it used to be, creating more pressure on the high-rise supply.

5 Factors That Influence Demand in 2021

Interest Rates
Interest rates in 2021 are one of the drivers for high demand when it comes to housing in Ontario. Low interest rates mean low borrowing costs meaning that homebuyers have more buying power through a mortgage and can consequently spend more on a home. If we take a look back at the 1970s and 80s, mortgage rates in Canada were in the double digits. Many people did not see the purchasing of a home as feasible. Therefore, the housing demand was down.

Today, Interest rates have been the lowest we have seen, with the Bank of Canada cutting the interest rate by a whole percentage point in March 2020. As a result, prospective home buyers looking to get a mortgage can now expect to borrow at a decreased rate. Fixed-term mortgage rates are also on the decline; condo and home buyers alike now have the flexibility to borrow more and aim for a higher home price, or get a better mortgage rate and have less expensive mortgage payments. Additionally, the First-Time Home Buyer Incentive still stands and can be extra beneficial now that interest rates are down.

This low cost of borrowing has fueled the demand for real estate, especially for those who want to get into the investment property market.

The Economy
Overall, the economy and job market are key players in real estate supply and demand. When the economy is doing well, the demand for real estate tends to be higher, and of course, when the economy is down, demand for real estate is lower. However, this new year is already showing strong resilience in the Toronto condo market. The month of January 2021 held December's gains, with sales activity in the 416 nearly doubling that of 2020 on a year-to-date basis. This seems to suggest that, pandemic or not, real estate is still king, especially in the pre-construction condo market.

Not to mention, a recent RBC Home Buying Sentiment poll revealed that Canadians feel more confident about the housing market than the overall economy. This is both interesting and relatively consistent with market realities as Statistics Canada estimated that the Canadian economy posted its largest GDP drop on record in 2020 by about 5%. Not only that, but economic activity was hovering 3% below pre-pandemic levels.

As far as the job market is concerned, if you are struggling to find a job or you're unsure if your job is secure, you're probably not going to be buying a home any time soon. Rental units provide a less commitment-centric style of housing that is necessary for many during the ongoing pandemic.

Affordability
How affordable is real estate in your desired city or town versus your paycheque? Generally, when home prices are high compared to income, demand tends to be less, whereas when home prices are low relative to income, demand tends to be higher. For example, Toronto has a low overall income in comparison to Ottawa. But Toronto's home prices are the second-highest in the country. On the other hand, Ottawa has a higher average income than Toronto and lower overall real estate prices. Now let's talk about rentals. The affordability of renting also plays a part in the demand for real estate. If renting is a lot cheaper than owning a home, the average worker will choose to rent instead of own.

"It's really about the supply-demand mismatch, if you think that Toronto is unaffordable now, you wait, Toronto is becoming like Berlin, like London, like Manhattan," said Benjamin Tal, Deputy Chief Economist at CIBC.

Immigration
Although we're still facing a pandemic, Canada hasn't changed its commitment to bringing over 1.2 million immigrants to Canada over the next 3 years. And the more immigrants there are in a particular city, the higher the demand for real estate will be and the higher the prices for it will become.

Prior to the COVID-19 pandemic, we were already facing a shortage in housing supply. We were simply not building enough. On average, we received 120,000 new immigrants in the GTA but we were only delivering 20,000+ homes when in reality we needed over 45,000 to 52,000 homes to satisfy the average household size of 2.7 people. That's a huge shortfall of over 20,000+ homes. And now with Canada committing to bringing over 400,000 people annually (half of them will stay in the GTA), the GTA will be more in demand than ever!

Additionally, foreign buyers also affect the demand for real estate. The Canadian housing market has attracted many investors looking for a safe place to park their money outside their home countries. Even though these investors do not plan to ever reside here, overseas investors continue to snatch up new units during the platinum access phase. While foreign buyers' tax has been introduced, foreigners with deep pockets may not mind paying it, so tight housing supply and high housing demand will continue.

Mortgage Qualifications
Over the recent years, the Canadian government has been tightening mortgage qualification rules. There was a time when one could get a mortgage with a 40-year amortization, which is no longer the case. Now, the maximum amortization available for someone with less than a 20% deposit is 25 years, while the maximum amortization for someone putting down more than 20% is 30 years. If you are making a decent income and buying in an affordable real estate market then that may not be a problem. But, if you are buying in a city like Toronto, where home prices are high, it may disqualify you from a mortgage on the property you may have hoped for.

The Canadian mortgage stress test has also affected housing demand. If you are buying a property, you must qualify at the greater of your mortgage interest rate plus 2%. This has essentially reduced homebuyers' purchasing power by 20% compared to before the stress test came into play. Today, many would-be buyers choose to sit on the sidelines because they simply cannot afford to buy a home, thus reducing demand in the homeownership market, but increasing demand in the rental arena.

As you can see, there are several reasons to purchase a pre-construction condo in 2021. The housing market in Ontario is a simple game of low supply and high demand, which means that now is a great time to purchase a pre-construction condo as an investment (if you can afford to). The Growth Plan for the Greater Golden Horseshoe (2006) is where one can find the outline for the growth happening in the GGH, and the growth is monumental.

Using a pre-construction condo to get off the sidelines of real estate investing is advantageous in 2021 because condo market values are increasing while the supply cannot keep up - helping you build equity on your income property.