Prices are going up. Toronto is breaking records. Maybe you’ve heard? Maybe you’ve heard this a hundred times in the last week? If you have any interest in Toronto real estate, you have been made keenly aware that, year over year, home prices in Toronto have gone up again. Not only that, but there is a lot of competition for these homes as well. Buyers are having to compete for their new homes and many are not afraid to push well beyond the asking price. Even some condos are starting to receive the competition like they had five to ten years ago.

The question is why?Why are prices continuing to climb?

There are a lot of reasons given to explain Toronto’s long stretch of rising prices. Some real estate insiders will point to our low interest rates (and I would agree to that whole-heartedly). The thing is, interest rates are the same across Canada, and some cities, like most Canadian cities besides Toronto, Vancouver, Victoria and Hamilton do not have the same home price appreciations going on as they did last year. So, it would appear there has to be something that is particular to Toronto that leads to the rising prices. Some also argue Toronto has a healthy and diverse economy that keeps up prices, but I don’t really think that’s enough. Finally, I have read a lot lately about the growing foreign investment in Canada that may drives up prices to some extent because Canada tends to be a little more lax with regulations with foreign investors than many other countries. I would say that I agree, to a certain extent, but I would say most of the time I am in a bidding war, it is almost always with local investors and buyers who want to live where they are buying. I think the one reason for increasing prices in real estate that resonates with me the most is low inventory. For me, that’s at the top of the list as to why prices are so stubbornly upwardly mobile.

In fact, inventory is lower this year in Toronto than last year. One bedroom condos are likely not an inventory problem these days, but houses certainly are. Houses in Toronto have been in a chronic state of low inventory for a long time. And I’m talking about all kinds of houses – detached, semis, bungalows, and row houses. But it’s not just houses any more. It’s condo townhomes and low rise condos, and now, according to my experience, two bedroom condos are becoming more and more in demand and competitive. It’s economics 101: Low supply and increased demand equals higher prices. The bigger question should not be why are prices so high, but why is there low inventory? Why is there not enough of the kinds of housing that Torontonians want to buy? Why not build more of it?

As far at Toronto is concerned, the biggest reason for low inventory has to do with Southern Ontario’s Green Belt Policy. In 2005, Ontario created the Green Belt Policy that states you cannot build on a large swath of land surrounding the GTA, roughly 1.8 million acres of protected land. It is meant to be a smarter approach to development, and I still agree that it is. Toronto said to developers, you cannot build suburban sprawl on land that need our protection like our farmland, wetlands, forests, and our water supply. You need to build smarter. So, developers started building on old parking lots, and industrial lands that have gone out of use to increase densification and reduce sprawl. They were encouraged to build up and not out. Developers quickly learned it was also more profitable to build bigger to sell more units and make more money. The result has been an explosion of condos, but very few additions to new houses. So Toronto continued to grow in population and housing stock, but houses were not being added as new supply. So prices went up for houses.

The thing is, developers also built a lot of the same type of condo: one bedroom apartments. In other cities that have been functioning as big cities for a long time where people have lived downtown for over a hundred years, the developers built one, two and three bedroom condo apartments because people like to live in the city with their significant others and children or require more space for themselves. New York is a great example of this. Statistically speaking, there is a higher percentage of two bedroom condos in New York than Toronto. Toronto’s condo population exploded all at once, and developers in Toronto rushed to build one bedroom units. Even the few two or three bedroom units had trouble selling a decade ago. Condos in Toronto were not seen as a place for kids. So, one bedrooms ruled. The thing is, now that houses are expensive, there are more people buying 2 bedroom condos as a starter home. And some of these people have kids and need another room. Some of these people don’t have kids and need another room. What is important to remember is that the nature of work has changed considerably. So, whether you are a single person or a couple who didn’t take the kid route, it is reasonable to expect that you may be self-employed. It’s a growing trend that more and more people work from home and therefore need an office or a second room. It is possible that some of the future condos may have a higher percentage of two and three bedroom condos, but during the great Toronto condo boom, an overwhelming number of those condo buildings contain one bedroom units. So, two bedroom condos are increasingly in short supply.

The other big reason for low inventory does not have to with the supply of houses, but with the reality that fewer people are putting up their homes for sale. And for this, I partially blame the land transfer taxes of Ontario and Toronto. Yes, the city of Toronto needs money. They have to cover their costs after some of the costs have been dumped on them from the province. Fair enough. The smart thing would have been to raise the property taxes so that everyone can contribute to the money coffers and this revenue stream would not be placed on the shoulders of buyers. Instead Toronto followed Ontario’s lead by demanding a tax every time you buy property. When it came into effect in February 1st, 2008, the land transfer taxes effectively doubled for Toronto buyers. Not only that, but because prices have been going up every year, the cost of land transfer taxes have gone up in turn. So, if I take the cost of a typical 416 detached house in Toronto at $1.17 million, a buyer, in addition to the cost of buying the house and all that’s involved with a moving, lawyers etc, would need to hand over $39,000 in land transfer taxes as well. This acts as a huge discouragement for people who want to buy up to a different house or even downsize once they have sold their home. It becomes too expensive to move. So, people stay put and don’t sell their homes, and add to the low inventory problem.

I don’t want to sound too disheartening, but the low inventory problem will likely be an ongiong thing. There could be some silver linings though. This may encourage the government to improve/increase the transit to bring people beyond the green belt so they can move in and out of the city more easily allowing a shorter commute time for those who want to buy cheaper housing outside of Toronto like in Hamilton -a city in a exciting point of transformation. For those in Toronto who want to live and invest here, it does point to good investment opportunities. These houses, low rise condos and two bedroom condos are likely to go up in value more than the other housing types, and you could take advantage of our certain set of circumstances. If you cannot afford the high prices, look to emerging neighbourhoods or healthy condos with good reserve fund and builders. Do your homework and you could find some investment opportunities in all this low inventory. At worst, if there is a correction on the market, you could wait until it clears, and the low inventory problem will be back once the market is back on track.