Why New Condos May Be a Bad Investment

Our housing market has been strong and home values have significantly increased over the past several years due to:
-Too little construction of new housing, and
-Underinvestment in single family housing
-A decade of historic low interest rates
-Speculation in housing for house flipping,
-More investors (mom and pop) as well.
-Private/alternative credit/mortgages is helping.
-The magnitude of the population boom!!! This is the biggest story in Canada.

The increases could all be in the rear view mirror though… especially for presale condos. The next few paragraphs will outline why presales in general may have issues.

Immigration in Canada
OK, so in Canada, by and large, we have citizens, permanent residents (one step removed from citizenship), and temporary residents (work permits or study permits).

Before 2019, there were about 200,000 temporary residents coming to Canada per year, along with approximately 500,000 permanent residents.

However, over the past three years, we’ve seen the numbers grow for temporary residents from 200,000 to a whopping 800,000 people per year. So in 2022 and 2023, we had nearly 1.3M new people coming to Canada to study, work and eventually get their citizenship.

1,300,000 new residents per year is a mind boggling number. This is 3.25% of our population every year!

And, once someone is in Canada, it’s very easy to get a permanent residency because if someone has studied in Canada and if they are already here, they get more points towards being able to apply for their permanent residency.

This is why the rents have increased… The country has been bursting at the seams. This is one of the reasons why rents and housing have increased so much.

I’m pro immigration but it has to make sense with our capacity as a country to absorb all of the new people. It seems like jobs are one thing but housing is another.

Light at the end of the tunnel? The Government is now decreasing these temporary residents who are allowed to come in. The number of total study permits given out is going to be cut by 35%; however, in BC, due to proportionality of how many study permits we have issued, our study permits will be cut in half.

Additionally, Canada’s immigration minister Marc Miller said that we’re going to target temporary foreign workers and decrease their share of the population from 6.2% to 5% over the next three years.
This is actually a crazy number to think about… How can we decrease Canada’s share of temporary residents? We have to kick some out…

We’re going to see a reduction of roughly 200,000 temporary residents per year. So we had a growth of 800K in temporary residents per year for three years and now we’re going to be minus 200,000. This is a full 1M person swing in people.

I feel like the country and the economy are sleeping on this.
As a complete aside, if you’re an investor… how do you mitigate your portfolio against this type of change in Canada’s demographics? Or, how do you take advantage of it?

But here’s the issue though. If we have less immigration, we’re going to have less growth in the economy.. fewer people spending money, and fewer people needing to find housing. And, where do students and temporary workers find housing? In condos and specifically, smaller rental condos.

This is one aspect of what’s happening in Canada right now.

Mortgage Pressures
We have another problem: a sizeable portion of mortgage that are with a fixed-payment variable rate mortgage, and also fixed-rate borrowers who are renewing their mortgage in the next ~2 years.

About 1/3 of the mortgage market is variable and about 80% of these variable rate mortgages have fixed payments. With these mortgages, as interest rates go up, less and less principal is being repaid. This is the part of the mortgage market that’s the most at risk.

When these fixed-payment variable rate mortgages renew, they will reset to the higher rate, and reset to the original amortization schedule. This is a double whammy of payment shock (payment shock is when there’s a shock in a mortgage payment due to increases in interest). So if we roll this forward, for this cohort, the median increase in payments will be about 60%.

Example: A borrower gets a $500,000 mortgage with a shiny 1.10% variable rate in 2021. The payment on this mortgage, at 30 years amortization was $1,631, of which, at the outset, $458 was interest and $1,173 was principal.

Over the past few years, interest rates have skyrocketed 4.75%, and the borrower’s current monthly payment did not even cover the interest of $2,437 per month. The difference in total payment ($1,631) and interest ($2,437) provided for a potential capitalization (adding to) the mortgage, or an increased payment ($806) by the borrower to cover the interest.

Notwithstanding, let’s assume that the borrower paid little to no mortgage off over the course of 5 years and it’s now 2026 and time to renew…

If we were to renew at a rate of 4.5%, and now at an amortization of 25 years, the new payment would be $2,767, or approximately 70% higher than the original payment. This is a huge blow to someone’s budget and potential spending lifestyle choices.

OK, so let’s go back to the renewals again. Because most mortgages are on 5 year terms, and since we had a huge boom in origination (new mortgages) in 2020, 2021 and the first half of 2022, we’re going to have a huge renewal cycle in 2024-2027. These mortgages, which includes fixed rate mortgages as well as the fixed-payment variable rate mortgages, are the problematic ones…

We have a fairly light renewal year in 2024 (2019 was a slow real estate year and only 15% of mortgages are renewing), 25% of all mortgage renewing in 2025 and then it’s almost 35% in 2026. This is two years of fairly high renewals in 2025 and 2026, which coincides with the 5 year gap when rates were ultra low.

So far, Canadians have managed to deal with the floating payments (Scotiabank and National Bank). However, we have no idea how much weaker this segment of the variable rate mortgage population is in consumer spending; something that’s problematic for the economy.
There’s a softening in consumer spending and softening in business investment. It’s probably not reflected in economic data… save for delinquencies (non-payment of credit) are on the rise.

The economy likely won’t be able to handle so many borrowers who have “payment shock” (CBC’s Renewal Cliff Video) and the bank of Canada may be forced to decrease the rates faster and further than expected. Maybe by end of summer or early fall, it’s going to be more clear that things are going to start breaking in Canada.

So I think we’re going to start seeing more rate cuts and potentially even 0.5% rate cuts as opposed to 0.25% at a time. This might not happen in July or September, but I think it’s a distinct possibility for 2025.

Something else to think about… we include mortgage interest costs in our inflation numbers. If we keep mortgage rates high and more people renew at higher rates, inflation will continue on the upswing. It makes no sense because we’re chasing our own tail. If we back out mortgage interest costs, we’re already at lower inflation numbers and we should be on the 2% target for inflation.

Advanced: but some people say: “well, what about the US? We can’t raise our rates that much higher than the USA or that will decrease our dollar.”To that, I would say that yes, it’s definitely possible our dollar will get hurt because the US and Canada have vastly different economies at this time. Additionally, mortgages, due to the nature of 15-30 year terms in the US, do not impact American CPI/Inflation the same way it does in Canada. The increase in rates in the US has not affected every day consumers as much as it has in Canada. So yes, we’ll diverge, and we’ll likely have a decrease in the Canadian dollar vis-a-vis the US.
Again, as an investor, how do you take advantage of the potential that the Canadian dollar will decrease against the greenback? I’ve heard a few opinions on this and so far, I’m not taking any action.

Condo Speculation
There are risks in the presale and pre-construction market.

For years, developers have priced preconstruction (developments that have not started construction but are being presold) at a premium. Buyers were willing to pay more (per square foot) for the ability to complete a purchase of a home in the future.

By and large, many (it’s said more than 80% in Toronto – I don’t know the Vancouver number) of the people who purchased these properties were investors and speculators and they either:

1. never intended on living in the property and intended the property to be a rental,
or
2. never intended on completing the purchase, intending on selling the property prior to completion to take advantage of appreciation.

But what happens in the future where we roll forward, and we have to close? If the property did not appreciate enough, a buyer could be underwater on the purchase price and the value at completion. This means that the buyer would have to either sell at a loss (speculators) or put in a whole lot more down payment so they can close/purchase the property. Additionally, even if there was *value* to the condo currently, the rental income doesn’t cover the mortgage payments, let alone the condo fees and property taxes.

There have been a lot of fire sales (quick sales at discounted prices) and the condo market in Toronto is at a standstill and prices are decreasing. We haven’t seen fire sales yet in Vancouver but a running joke right now is:
Q: What’s the difference between a common cold and a downtown condo?
A: You can get rid of the cold but you can’t get rid of the condo!

OK Eitan, Get to the Point
I feel like new construction condos could be a bad investment, not just because there are inherent risks with developers and completion dates, but because:
1. There are going to be fewer buyers and renters due to immigration policy changes
2. Mortgage payments will continue to increase for many borrowers, providing for a possibility of homes flooding the market, increasing inventory and decreasing value
3. Mortgage payment increases will have severely negative impacts on the economy
4. New condos are priced at a premium over something that can be purchased right away.

Long story short, the biggest reason I think new condo may not be a good idea is due to the decrease to the demand for purchasing and renting condos due to new immigration policies, as well as the increase in payments to the rollover of mortgages maturing over the next 2 years. These two items together are going to be a potent force (one on the demand side – less immigration, and one on the supply side – higher rates forcing sales) to keep some condo prices low.

One last thing to think about: new condos are shoeboxes. Many are built specifically for speculators and investors, without the end user (someone who lives in the condo unit) in mind. I personally think these no-closet, sub-600 sq. ft. condos (and that’s even large for some buildings) have been overbuilt and over-appreciated… Anecdotally, it has been temporary workers and students who have rented and/or purchased these small units. I mean, it’s hard to raise a family in a 1 bedroom and you certainly can’t in a bachelor pad. If you want to invest in a condo, homes that are even 10+ years old are much bigger and more livable; and don’t come with a premium.

*The above article is not investment advice.
**A new condo or presale *can* be a good idea if it’s the right property. Every development and every situation is unique – my sentiments are a generalization; I don’t want to get in trouble with all of my Realtor partners .

Why New Condos May Be a Bad Investment

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