Breaking Point
It’s 1997, and condo (new builds) sales in the Toronto and Hamilton areas have just totaled 3,157 for the first half of the year—oops, that is actually 2024! Condo sales in this area have plummeted by over 72% below the 10-year average and have now returned to 1997 levels. Remember, this area also experienced massive population growth of over 50% during the same period, with more than 2 million new residents.
What are the reasons behind this drastic drop in sales? To start, construction costs have exploded. The average construction cost is now $1,529 per square foot to build, compared to only $606 ten years ago. In regions outlying the GTA, costs were $484 per square foot in 2014 and are now $1,153 per square foot. Another reason is rising interest rates. In 2014, the prime rate was 3%, and today it is 6.95%. The math is simple: costs have more than doubled while borrowing costs have also doubled, leading to a breaking point.
Sellers, such as condo developers, have not yet woken up to this reality. They continue to ask for prices that are not reflective of the current environment. It is painful to realize massive losses or write-downs on these very expensive projects, but that is going to be the reality. Fewer new units are being planned, projects are being canceled, banks are increasing loan loss reserves, and people are walking away from deposits in some cases.
Meanwhile, our governments (federal, provincial, and municipal) all talk about affordable housing. They are looking at funding projects—the City of Vancouver just bought an apartment complex. The government should stay out of the home-building business, other than to ensure that building codes are logical and adhered to by builders. In Calgary, the city is granting developers money to convert commercial high-rise buildings into residential apartments. Yes, I said grant, not loan! So, the money is not repayable to the city and, truly, to the taxpayers. There have been 15 approved projects to date. But the numbers still do not make sense. In the latest project, there will be almost 390 new units once the conversion is complete, with 25% deemed to be affordable. These affordable units are 550 square feet and will rent for about $1,750 per month or $21,000 per year. 550 square feet is designed for one person, maybe two small people. The city will be granting $31 million to this project. Let’s consider the impact of this $31 million grant.
Using some assumptions, let’s say those units have 1.5 people in them. This means that 146 people benefit from this $31 million grant immediately. That works out to $212,000 per person, with zero ownership since it is rental housing. The only winners are the investors and developers. However, if we used that same money to build modest multi-family homes along well-traveled routes with public transportation access, the value could be created for all parties involved. Make the units 1,400 square feet so a family of four could live there—stacked townhomes with small backyards where children could play, rather than in high-rise buildings. The most expensive city in Canada to build in is Vancouver, and according to the 2024 Canadian Construction Cost Guide, stacked townhomes can be built for $220 to $300 per square foot—the average being $260 per square foot or $91,000 per person. This means that 340 people could live in “affordable housing” for the same amount of money.
Despite these government initiatives to address affordable housing, the effectiveness and cost of such measures remain in question. Meanwhile, broader economic factors are also evolving. With new home sales slipping, slower demand for durable goods, reduced consumer spending, and lower inflation, the central banks are finally moving on interest rates. It appears we will see another 50-basis point move in Canada before the end of the year and most likely a 50 to 75 basis point decline in the US. The world’s second-largest economy, China, is heading towards a zero-interest policy. I have been writing about the impending interest rate cut for a few months now, and it is finally happening. As we move towards a lower interest rate environment, value investments such as banks, telecoms, pipelines, and utilities will become attractive. Once rates are much lower, real estate investment trusts will likely come back into vogue.
