Toronto Is Running Out of Rich People (to Sustain the Housing Bubble)

August 9th, 2014 by Potato

I normally like to look at the housing market from the bottom-up using a rent-vs-buy analysis. After all, you have to live somewhere and that’s the key to deciding what to do with your own life — the macro stuff will work itself out eventually over many years. I still like reading and thinking about the macro stuff, it just wasn’t really my area of expertise for analysis and Ben Rabidoux used to post a lot about it. But he’s not posting any more so screw it, let’s have a look at the Toronto market with some Fermi-esque math.

In 2013 the overall average price of a detached house in Toronto (416) was $842k; 11.4k such houses traded hands, according to TREB. Some of those would have been $500k crack shacks, while others would have been multimillion dollar mansions bringing the average up. TREB doesn’t publish median figures. Up in subwayville/North York a “normal” house runs for about $700k so let’s take that as a reasonable average for the city based on those numbers.

How much income do you need to carry a $700k house in Toronto?

Property tax would be about $5,600/yr.
The mortgage, if you want to use 4.5% to give yourself a small buffer against increasing rates, and assuming 20% down, would run $37,356/yr.
Utilities, insurance, maintenance, etc. we can ballpark at $10,000/yr.
Rough total with these minor contingencies/conservative estimates: $46k/yr.

Assume that the owners of such lavish mansions have other things to spend their money on (cars, daycare, hot yoga, Muskoka cottage, pusateri’s, retirement savings) so they want to limit their spending on shelter to something reasonable like 45% of their pre-tax income. That means they need to make over $100k to afford a house at this level. At least. Of the roughly one million households in Toronto, fewer than 120,000 180,000 290,000 of them have household incomes over $100k. How many houses are there to buy at those prices? If the average detached house turns over every 10 years, then there are only 110k or so.

That doesn’t look so bad: as long as everyone who has the income to do so is behind the current prices and willing to ignore traditional affordability rules-of-thumb (forever), they can be sustained.

Except that about a third as many semi-detached houses traded hands last year at an average price exceeding $600k, so we’re looking at at least another 1,000 sales and 10,000 units or so of semi-detached houses over our $700k threshold. A quick scan of MLS also tells us that there are still a few thousand units that cross our $700k level, even though condos may have an average price of less than half the detached/semidetached class. That’s another 15,000 or so rich families we need to be committed to the expensive property cause, getting us well within the error bars of the total number of rich people available.

Looking closer at that estimate of detached houses, it comes out kinda low — mining the StatsCan data suggests that there are closer to 300k detached houses in Toronto [edit: or if you have the power of Ben Rabidoux to find the correct table rather than subtracting others, you can say it is precisely 275,015].

I’ve heard the argument more and more lately that the housing bubble is just a new reality in Toronto: the days of an average or middle-class family owning a detached house — even in the burbs near the subway — are over, and such things are only for the rich. Condo living or extreme commuting are the new normal. Except current prices are so insanely high we don’t even have enough rich people for that narrative to make sense.

Toronto’s going to run out of rich people before all the houses can turn over. Fixing the income numbers, I can’t say definitively that Toronto doesn’t have enough rich people to support the house prices any more, but we’re still cutting it kind of close. The question circles us back to many people needing to commit to stretched affordability to keep the prices up, and with prices increasing every year how stretched can affordability get before it all falls apart? Unfortunately that’s been a question for a few years running now, and kind of depends on how insane people are willing to let things get. The longer interest rates stay low, the more willing people are to stretch every last dollar and throw out their contingency for rate increases. So the median detached house price is right now $700k. At what point does it rise enough that the question I raised here does become an issue — when is affordability stretched so much that there aren’t enough rich for all the houses? Maybe when the median price hits $875k, another 25% increase from here? So like, 2 years at current price increases?

[Edit: I had a report that put the percentage of households with incomes over $100k at 18%, and I had the total number of households as about a million. In the original post I multiplied those out to get 120k, failing once again at simple math. That report was based on 2005 data, I’ve since been informed the 2011 census figure is 26% of 1.1M households.]

7 Responses to “Toronto Is Running Out of Rich People (to Sustain the Housing Bubble)”

  1. Save. spend. splurge. Says:

    But what would that mean for the market in Montreal? :)

  2. Potato Says:

    The longer narrative version of this:

    I was walking home from work and passed a house with a for sale sign, and another, and then one with a sold sticker across. Then one that had sold a few weeks ago and the sign was just removed. And I thought: who is buying these houses? That one was $800,000. If you use the affordability rule-of-thumb of 4X income, that’s a $200,000/yr household. And there’s another, and another, and another. And this is just down a few blocks that happen to lie between me and the subway station. There are hundreds and thousands of such houses all around me.

    I thought about how far the street numbers ran in the 2 km grid — about 350 houses. I counted up the number of such streets in the grid (most of the houses in the area are on east/west streets), and there are about 7,000 detached houses in between any set of four major streets. And then multiply that out by each plot: Bathurst, Yonge, Bayview, Leslie, Don Mills — 25,000 or so primo houses (rounding down for the ravines), just up in the tippy-top of the subway range. Many of those are two or three times as much as the $800k figure I’m using in my mental math.

    I know we live in the neighbourhood and aren’t making that much despite having three graduate degrees* between us — we can only make it work because we’re frugal and are being subsidized by our landlords.

    That led me to wonder if there were even enough households that rich to make the prices sustainable. Of course, low interest rates throw traditional affordability out the window, but even stretching things to 7-8X income is there enough eventual demand to keep prices this high forever?

    So last night I did some quick digging to try to get my head around the scale of the problem. From some work on income inequality it’s easier to find figures on how many households are over the $100k mark (though I haven’t yet found the granularity on those over $200k) in both Toronto and the 905 — so I have a reasonable degree of confidence in the ~120k households figure. It’s harder to come up with the number of houses that are out there, which I thought would be the easier part to dig up (between the city, the post office, and Stats Can I figured it would be an easy number — I had to do some interpolation on Stats Can data).

    On the other side of the coin, people are stretching more and more — what is a reasonable estimate of too stretched? Could someone go to 10X or 12X income given the low rates? How house poor are Torontonians willing to get?

    So the question is what happens when we run out of rich households? Forget condos and specuvestors — for all those that think detached houses are different “because they’re not making any more,” how do these current prices get sustained? Yes, maybe Toronto’s gotten so dense that the average person will never be able to afford private greenspace — rented or financed — but we’re not even talking about average people anymore, but the top 10% having to stretch to buy at these prices. What happens if we run out of rich people? That will happen sooner than the sales volume/turnover suggests, as the divergence in house prices and incomes makes an ever smaller segment of the population responsible for a growing pile of costly real estate.

    This inevitably attracts conspiracy theories (there are way more rich people than Stats Can knows about because people hide their income) or mumbo-jumbo about globalization (non-resident HAM are buying up the houses). There is a kernel of truth to both of those narratives, and they’re intrinsically difficult to get hard data on. That makes them persistent and capable of driving irrational behaviour in those who don’t fit into either category. But it’s locals who pay their taxes who are our neighbours in these cases. In some cases driven by fear (they know a guy who knows a guy who was outbid by HAM so they outbid some other guy in the next frenzied auction).

    And of course the owners of the entire housing stock will be a mix of the rich and/or overstretched paying up for current prices and the old owners who bought when they could afford to do so. Like most discussions of fundamentals, this provides no timeline for the correction (with an upper bound of perhaps 10 years).

    * – though mine are not helping to launch me into the upper decile/quartile of Toronto incomes by any stretch of the imagination because science.

    @SSS: sorry, haven’t really looked at Montreal.

  3. Potato Says:

    Basically my point is: trees don’t grow to the sky.

  4. Potato Says:

    From RECharts (who tried to submit a comment but the blog eated it):

    You are ignoring the fact that many people are simply upgrading. The interest rates are very low and this makes it easy and very tempting for many of them. We are also seeing a process of gradual upgrades and cleaning-up of what used to be less-livable areas of the city. Their central position, a very short commuting time makes them eligible for the buy-renovate-sell upgrade. All-in-all this leads to an increase in median and average prices but this is not necessarily a home appreciation process.

    To find out the number of residential buildings in an area use Canada Post mass mail system. There you can select an arbitrary area and they will tell you how many postal addresses they have in that area, business or residential or combined as per your choice.

    Your math makes sense but fails to explain what is happening in Vancouver which has much elevated prices and they continue to stay at their current level although the investor immigrant program was axed. The only explanation that I could find for this whole phenomenon is low interest rates and these don’t promise to go lower in the near future. As long as we are behind Vancouver we know that there is room for more although I agree with you, it does not make any sense. Who are the buyers? Probably people who are upgrading from condos to SFH, from semis to detached, from TH to semis or detached, people who used to live outside the GTA and are now moving back to TO and so on. Keep in mind areas like Markham and Richmond Hill have higher prices than many areas in TO so you will have to count those people too. They can be sick of commuting and with a consistent amount of equity in their current property. That is a strong motivation to take advantage of higher prices in the GTA by selling there and buying in Toronto.

    Especially for GTA the problem is very complex. I can’t understand it for Vancouver. Calgary is still flying high while the rest of the country is not doing fantastic.

    There was an interesting broadcast piece yesterday on CBC Toronto around noon about real estate. Search the podcast section of their site. Listen to that as well, it will give you a ground level picture of what is happening in some areas or cities. You can also hear Ben Tal’s opinion about the current status of the market and a couple of other interesting bits of info.

    Indeed TREB does not publish the median prices but check my tweets @recharts. You will see there interesting graphs. I stopped posting these a while ago when I understood that this whole thing is heavily manipulated. The CBC piece mentioned above is going to give you a clue. At some point the host will say that there is a lot at risk if this whole thing is going down and I am inclined to believe that this is true. Unless some catastrophic event happens outside of the US and Canada (e.g. Putin makes a bold move or the Chinese lose control of their economy), this house porn as Garth Turner likes to call it will not stop.

    The funny part is that the stock market is not far from this, if not worse. This is mostly an institutional investors’ game, it is rigged and the average Joe lost his faith in the stock market. Financial planners and advisors and their kin. This is yet another reason why everybody prefers to put their money in RE, hence a global change int he optics of the common investor (average Joe). This and low interest rates will push the whole thing higher and higher.

    There are also situations where people invest in a house together. I have seen questions about this in the Personal Finance section of forums.

    I am no specialist in this domain, I tried to learn about it in the last two years and realized that not even the people who do this for a living can figure out where this is going. By the time you have the slightest idea you have lost the game (if you want to play this).


  5. Potato Says:

    Sorry, I haven’t been able to find that podcast, please update with a link if you can.

    There are ways to stick the soft landing, and it involves big, permanent shifts in the living style of the city. As you say, people going in together on houses — whether that’s multigenerational households, people buying together, or subdividing SFH into multiple units. Basically, people making do with less. But those kinds of shifts should be happening on the rental side too and we’re not really seeing that: basement apartments are not going for $1300/mo.

    And Vancouver — many people who don’t believe there is a problem with housing in Canada will say “Except for Vancouver, there’s no housing bubble…” There is some peculiar madness that floats in off the Pacific, it used to affect the Vancouver stock exchange back in the day.

  6. Steve Says:

    Can those high prices be sustained by foreign buyers?

  7. Potato Says:

    Steve, that’s a common go-to. There aren’t really the stats to say for sure one way or the other, but the increase in mortgage debt that’s accompanied the increase in prices suggests that foreign buyers are not a large part of the market. There are just enough of them to produce a few stories of crazy over-bidding that gets the locals fired up, but ultimately 95-99% of the money is coming from the local economy.