I’ve been following Toronto’s Real Estate market closely over the last 18 months while applying Macroeconomic concepts to it. It’s been an interesting learning experience to me and I’d like to share my thoughts on the matter here.

I’ll preface by saying that the following is just my interpretation of what’s going on. I’ve tried to present as much raw data as I can. I encourage you to make up your own mind, but try to keep an open mind.

Ok, so you don’t have to be an economist to understand that something is amiss in the Real Estate markets of Canada’s largest cities, Toronto and Vancouver. I’m going to focus on Toronto in this article. I live there so I understand the dynamics of the city. It’s also the largest city in Canada so what happens here significantly and directly affects the Canadian economy.

Statistics

In the last year, home prices in Toronto have surged 33%. The average detached house now costs $1.4M (as of June 2017).

This growth has affected condo prices, and prices in smaller suburbs around the GTA. Average home prices in the suburbs are also close to $1M.

The median household income was $75K in Toronto in 2014, Let’s assume it is $80K today.

Household debt to income levels are now over 160%. This means that a family earning $100K has a debt of $160K.

Green line shows monthly new home price index. New homes mean all new homes, not just detached homes. Orange line shows Condo prices.

“Ok, so prices are going crazy and people aren’t earning a lot more money than they were before. We already knew that.” Don’t worry, I’ll get to the good stuff soon.

Before we start, here are a few simple concepts that you should be aware of.

Simple Concepts

Interest Rate

Simply put, The Federal Interest Rate is the cost of borrowing money, as set by the Bank of Canada (BOC). The BOC will regulate interest rates to ensure that inflation stays around 2%. However, changing the interest rate affects the economy in different ways, as we will see below.

Relationship between Interest Rate and Housing

A low interest rate means people can borrow more money since they will be paying lower interest on their mortgage.

Relationship between Interest Rate and Economy

Interest rates are often lowered to boost sluggish economies. Low interest rates mean that companies can borrow money cheaply to invest in building goods & services, which in turn will boost the economy.

Relationship between Interest Rate and Foreign Exchange Rates

Low interest rates mean reduced foreign investment, because investors do not get a high return on their money. This makes the Canadian dollar less likely to be bought, which lowers the value of it. Therefore, prolonged periods of low interest rates can cause inflation.

Home Equity Line of Credit (HELOC)

A HELOC is a mechanism by which a home-owner can take out a loan from the bank. If your house has gone up in value, you can take that equity out of the house at a low interest rate.

Example of HELOC If you bought a house for $1M (with $200K downpayment), and it has now gone up to $1.5M, you just made $500K on a $200K investment. But you can’t get access to this money until you sell your house. In these situations, you can get a HELOC. The bank would give you $500K (or however much you want, upto 65% of the value of your house), and in return you would pay the bank a low interest rate. HELOCs are often used to consolidate debts since the interest you pay on them is quite low. However, they can be dangerous as we will soon find out.

So, what’s actually happening in Toronto?

First, let’s talk about what is not happening.

I don’t think this market is being fueled by foreign buyers coming and buying up properties in bulk. I don’t trust TREB but their data suggests that only 5% of all property may be bought by foreign buyers.

This means foreign buyers bought about 5,000 properties last year in Toronto. That number seems reasonable to me.

No, prices are not going up because “Toronto is like London, New York and Paris.” Toronto is not one of the financial, cultural, or metropolitan capitals of the world. Not yet.

Based on my research, I think the Real Estate Market in Toronto is being fueled by three factors:

Fear of missing out (FOMO): A situation where an individual feels they will miss out on something if they don’t act now. Cheap credit: Ability for an individual to borrow money and pay low interest on it. Speculation: A situation where an individual takes a high-risk position in an asset because they think it will go up.

These three factors directly feed into each other causing a vicious cycle. Let’s demonstrate with an example of a fictional Toronto couple.