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The downtown Toronto skyline on June 15, 2018.

Marta Iwanek/ The Globe and Mail

In key cities around the world, the red-hot market for real estate has abruptly turned cold.

In London, home prices in some of the British capital’s toniest neighbourhoods have slid over the past year. In Sydney, residential property values have tumbled 8.9 per cent, and one economist has warned that Australian real estate is headed for its “deepest downturn” in modern history.

In New York, median prices fell 5.8 per cent in 2018, dropping below the US$1-million threshold for the first time in three years. Even in the high-tech nirvana of San Francisco, where prices are still inching upward, the number of home sales sank to a four-year low in November.

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The cooling trend encompasses a host of specific, local factors such as Brexit, U.S. tax changes and new barriers to foreign investment. Primarily, though, it rests on two broad factors: increasingly unaffordable prices and rising interest rates. Both are likely to be a drag on real estate markets for the foreseeable future and spell the end of a decade of glorious returns for investors and homeowners.

“Home-price growth has slowed everywhere, quite dramatically,” said Liam Bailey, global head of research at Knight Frank LLP, an international real estate consultancy in London. His company’s index of prices across 57 countries was advancing at a clip of about 6 per cent a couple of years ago; today, the pace has slid to a mere 3 per cent.

The trend does not bode well for a country such as Canada, where homeowners have piled on unprecedented amounts of debt to buy into the national real estate boom.

After years of rapid growth, Canada’s two most expensive markets are decelerating in line with many of their global counterparts. In the Greater Toronto Area, total home sales fell 16 per cent in 2018 as average home prices slid 4.3 per cent. In the Vancouver region, sales were down 31.6 per cent and the benchmark home price slipped 2.7 per cent.

“You reach a point where people simply cannot pay more,” said Benjamin Tal, deputy chief economist at CIBC World Markets. “We are in a price-searching mode. We haven’t found the price yet in Vancouver and Toronto, but clearly we know what the upper limit is.”


The risk, both nationally and globally, is that falling home prices can spill over into the rest of the economy. In a housing downturn, banks tend to curtail their lending to prevent defaults, while highly indebted consumers rein in their spending to offset the impact of lost housing wealth. All of that slows growth and can lead to further cycles of decline.

To be sure, nobody is predicting a new financial crisis. Home prices are still climbing in many cities in Canada and around the world. The global financial system has more safeguards in place than a decade ago, and outstanding mortgage volumes are growing at about the half the pace they did before the financial crisis, according to Swiss investment bank UBS.

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Canada, however, is particularly vulnerable to a real estate downturn precisely because Toronto and Vancouver have enjoyed such spectacular gains in recent years. The two Canadian cities are among six worldwide that qualify as “bubble risks,” according to UBS. In a recent report, the bank warned that in both Toronto and Vancouver, “rising rates, stricter market regulations or an economic downturn could turn the lights out on the party given the high valuations and strained affordability.”

The darker outlook doesn’t necessarily mean a crash. It may not even mean a serious decline in home prices as long as the rest of the economy continues to grow robustly. But Canadian homeowners and investors should brace themselves for a future in which real estate is a riskier, less rewarding investment than it has been over the past decade. It’s a scenario that is already unfolding in other locations around the world.





In London, buying agent Henry Pryor spends most of his days bidding on houses for wealthy clients and he hasn’t seen a market slump like this in years. “This is a great time if you want to buy something. This is a much harder time if you are 60 or 70 years old and trying to downsize or cash in,” he said. “And I don’t think things are going to get easier any time soon.”

The city’s housing market has been slowing in recent years owing to increased land transfer taxes, moves to tax overseas buyers and stretched affordability. Now, concerns about Brexit have rattled the market further.

Average prices in prime London boroughs such as Westminster and the Royal Borough of Kensington and Chelsea dropped more than 20 per cent from 2017 to 2018, and the number of unsold homes under construction in central London has reached a record high. “Over all, the London market is not looking as brilliant as it was,” said Fionnuala Earley, an economist at Hamptons International, a London-based real estate company.

The average house price across Greater London fell about 0.5 per cent last year, compared with an increase of 1.5 per cent in 2017, according to Hamptons. Ms. Earley said the firm is forecasting prices to fall 2 per cent in 2019 before picking up again in 2020. But even then price growth in the prime market “is likely to be less than we’ve seen in the past.”

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People walk alongside the River Thames as the sun sets behind The Shard in London, on Dec. 3, 2018.

SIMON DAWSON

The signs of a slowing market can be seen almost everywhere. Last fall, a new 33-storey luxury-condominium project called Centre Point stopped selling units because offers were just too low. The company concluded that the lowballing reflected growing uncertainty and said it saw “no point in chasing a market that is increasingly detached from reality,” said Mike Hussey, chief executive of the developer, Almacantar S.A. It had sold just half of the 82 units, which ranged in price from £1.8-million ($3-million) to £55-million.

At the Shard, a 95-storey landmark completed six years ago, the owners have yet to sell 10 luxury apartments at the £50-million asking price, and some developers have taken to offering free cars to entice high-end buyers.

And it’s not just the luxury market that’s taking a hit. A recent report from UBS found that sellers across the city are slashing prices, with houses taking much longer to sell. The share of “reduced” property listings has increased to 39 per cent, said the report, which tracked 100,000 listings across London; two years ago, it was less than 20 per cent. Meanwhile, the number of days houses stay on the market has jumped to 128, up from a low of 77 in 2016. “The London housing market remains weak, and our update shows few signs of improvement,” UBS analyst Osmaan Malik wrote.





If there is one simple, overarching explanation for the growing fatigue in the global real estate market, it is that homes have become too expensive for mere mortals. Since 2014, house prices have surged in after-inflation terms worldwide and in late 2017 surpassed the peak they reached in the run up to the financial crisis, according to a global housing index compiled by the International Monetary Fund.

In many cities, home prices are out of touch with local paycheques. In Hong Kong, for instance, a skilled service worker would require more than 20 years of his or her total income to buy a 650-square-foot apartment near the city centre, according to UBS. “House prices have also decoupled from local incomes in London, Paris, Singapore, New York and Tokyo, where price-to-income ratios exceed 10,” the UBS researchers wrote.

Prices are soaring in relation to rents, too. The growing gap between the two suggests a fundamental disconnect between the price of residences and the underlying ability of those residences to generate cash.

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In half the cities covered by the UBS study, the cost of a modest dwelling has climbed to more than 30 times the annual rent on similar properties. To put that another way, a prospective landlord in these cities would have to continuously rent out a typical property for three decades simply to recoup the initial purchase price. Factor in taxes, maintenance costs and other expenses, and the math becomes even uglier. It makes sense only in a low-interest-rate environment, where other investments also offer negligible yields. “House prices in all these cities are vulnerable to a sharp correction should interest rates rise,” UBS warns.

The problem for property owners, of course, is just that: Interest rates are rising. They are going up in almost every country – slowly, to be sure, but unmistakably, as central banks begin the long process of restoring borrowing costs to more normal levels. “There have been very big shifts in monetary policy over the past year,” said Mr. Bailey at Knight Frank. “It’s the beginning of the end of very low mortgage rates.”

Just as low interest rates allowed home buyers to take on larger mortgages and bid up home prices, higher rates are likely to have the opposite effect. “We’re moving from a low-interest-rate environment to a higher-rate environment,” Mr. Bailey said. “Therefore, we have to expect to see lower capital-gains growth over the next few years.”

How much lower will returns fall? In the United States, home prices still look quite reasonable in relation to underlying rents, according to Goldman Sachs. It expects nationwide price growth to slow but still average 2.9 per cent over the next three years.

Other countries appear far more vulnerable. In Sweden, New Zealand and Canada, home-price-to-rent ratios have surged over the past two decades; these countries would experience significant corrections if their home-price-to-rent ratios were to fade back to more historically typical levels.

Things may not be quite that simple, though. A complicating factor is the presence of foreign buyers. In many of these apparently pricey markets, international capital has been blamed for driving prices beyond the reach of local buyers. Both British Columbia and Ontario have recently enacted measures to discourage foreigners. So have Australia and New Zealand. But if home prices were to fall significantly in any of these markets, foreign buyers might find the bargains too tempting to pass up.

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Predicting the behaviour of foreign buyers is difficult, warns Jonathan Miller, president of Miller Samuel Inc., a real estate research firm in Manhattan. At the moment, for instance, high prices and rising interest rates are encouraging those buyers to look beyond pricey New York. So are recent changes to the U.S. tax code that limit how much in the way of state and local taxes a homeowner can write off against federal taxes.

The decreased ability to write off local levies has hit real estate owners hard in highly taxed jurisdictions such as New York, New Jersey and California. It has, however, encouraged new buying interest in smaller centres in more lightly taxed states. “Foreign buyers are looking for upside like everyone else,” Mr. Miller said. “They’re not buying condos in Manhattan these days. They’re buying strip malls in Houston.”





Most analysts believe housing-market downturns in Vancouver and Toronto are largely due to domestic policy changes. But there are also factors that both cities have in common with other global centres facing downturns.

Most notably, affordability in Canada’s two most expensive cities became an overriding issue as prices soared beyond the reach of many buyers. That factor has been compounded by a series of interest-rate increases that began in the summer of 2017, as well as the new federal stress-test rule introduced on Jan. 1 last year, which requires buyers to prove they can still afford their mortgages even if interest rates were to climb significantly higher than the rate they negotiated with their banks.

Brad Henderson, CEO of Sotheby’s International Realty Canada, says many buyers and sellers are uncertain about how to proceed. “Sticker shock and buyer fatigue” have combined with a broader unease about global political and economic uncertainty to keep buyers on the sidelines, he said.

“If you’re afraid of recent gyrations in the stock market, if your portfolio is down, you feel less wealthy, you’re not inclined to make major purchases.”

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A crane is seen at a condo development under construction as condo and office towers fill the downtown skyline in Vancouver, on March 30, 2018.

DARRYL DYCK/The Canadian Press

Bank of Canada Governor Stephen Poloz has acknowledged the unexpectedly large role that policy changes have played in sparking the downturn, saying this week that housing activity has been weaker than expected in recent months and “is taking longer to stabilize than we expected."

“This may be because of the various municipal or provincial measures that have been taken. Or it may be that the economy is more sensitive to the combined effects of the new mortgage underwriting guidelines and higher interest rates,” he said at a news conference on Wednesday.

The adjustments are still playing out, he added, “and it is always difficult to judge where the market will stabilize once froth has been removed.”

Real estate agent Shawn Zigelstein, who is based in Richmond Hill, north of Toronto, says the negative news about the mortgage stress test and higher interest rates is having a psychological as well as practical impact. Some buyers are sitting on the sidelines because they believe they won’t qualify for enough mortgage to move up to a better home, he said, so they haven’t even tried asking for a loan.

“It’s the perception of the potential costs, that’s what I believe. They don’t know the exact numbers … People are ruling it out before they search.”

As in other global cities, reduced foreign-capital flows are also playing a role in Toronto and Vancouver. While foreign investment does not drive housing markets in Canada the way it does in bigger markets such as London, it adds another tailwind, especially in certain pockets of Vancouver and Toronto.

Declining foreign investment in Canada is largely due to tighter enforcement of Chinese capital controls, said Mr. Tal of CIBC, making it harder for wealthy Chinese investors to get their money out of the country to buy real estate abroad.

“The foreign investment aspect is not huge, but it’s important,” Mr. Tal said. “I speak to many people in the industry who tell me Chinese money is not coming because it’s simply more difficult to get it out.”

According to Statistics Canada, non-residents bought 7 per cent of new detached homes and 11 per cent of new condos built in the Vancouver region from 2011 through 2017. In the hot market years of 2016 and 2017 in particular, non-residents bought 14 per cent of new condos.

Toronto mortgage broker Ron Butler, who runs Butler Mortgage Inc., believes the reduction in foreign capital flows is having a more significant impact on the Vancouver and GTA markets than many people realize. Foreign capital doesn’t just come from non-residents, who are subject to the provincial foreign buyers' taxes, but also from Canadian citizens or landed immigrants who have ties to other countries, particularly China, and have historically used money from abroad for home purchases. Mr. Butler argues that foreign money may have represented as much as 20 per cent of new home financing in recent years, based on the mortgage applications he sees.

“We feel that money will disappear in Canada this year," he said. “There will be a big reduction.”





A real estate assembly of houses marked for demolition stand next to a billboard advertising a future condominium to stand in their place, in Toronto, on Jan. 6, 2019.

CHRIS HELGREN/Reuters

So far, the market downturns in both Vancouver and Toronto have largely been driven by the detached-house markets, which are typically the highest-priced homes in both cities. If the pain spreads to the condo sector, however, the market declines will be even sharper.

The total volume of detached home sales fell almost 17 per cent in the Greater Toronto Area in 2018 over 2017, and the average price for all detached homes sold last year was down 4.4 per cent. Overall sales in Toronto were their weakest since 2008.

Vancouver’s detached house market has seen an even more dramatic decline. The benchmark price of detached homes in the Vancouver region fell 7.8 per cent in 2018 over 2017 – 7.3 per cent between June and December alone. The decline has wiped out price increases going back to the spring of 2016.

The Vancouver market is undeniably still expensive – the benchmark price of a detached home is $1.5-million, and that of a condo is $810,000 – but it is teetering, especially in certain market segments.

The region’s most expensive homes have seen the biggest percentage declines. Since the summer of 2017, house prices on the west side of Vancouver are down 14 per cent, about $500,000, to a benchmark price of $3.14-million. And the double-digit slides are not restricted to the wealthiest areas: Houses in New Westminster have fallen 11 per cent, about $130,000, to $1.06-million since last June, and condos in Port Moody are down 10 per cent, about $70,000, to about $630,000.

Vancouver’s decline is due not just to tougher mortgage rules but also to a list of specific decisions made in British Columbia to slow the market. Both the city of Vancouver and the province have imposed taxes on vacant homes, aimed at speculators who live elsewhere. And in 2016 the province introduced a foreign-buyers tax, which was increased last year, alongside new taxes on homes worth more than $3-million.

To Andrew Ramlo, a market analyst at real estate broker Rennie Group, a key factor in Vancouver’s weakness has been the “staggering” elevation to which prices had climbed, which led to “fatigue” among buyers.

“The sheer high level of where prices had gotten – it put a crimp on affordability for a lot of folks,” Mr. Ramlo said.

The Landing condo development is seen under construction in Langley, B.C., on Dec. 10, 2018.

DARRYL DYCK/The Canadian Press

While condos have propped up the real estate markets in both Vancouver and Toronto in recent years, their fate is uncertain for 2019. In Vancouver, benchmark sale prices for condos fell 6.4 per cent between June and December, returning to the levels of late 2017.

The weakness has left some potential buyers nervous, unwilling to make a move. And condo owners don’t want to sell for less, hoping the decline of recent months is only temporary, according to Steve Saretsky, a Vancouver agent who made his name with careful economic analyses in a popular monthly report he publishes.

Mr. Saretsky sees a difficult 2019 ahead. The number of sales in December plummeted to the lowest point in almost two decades. And prices are starting to fall faster. For him, the crunch could get tougher, with developers behind proposed condo towers possibly shelving their plans.

“This feels like the start of something more substantial,” he said.

Mr. Tal fears Toronto’s condo market could face similar weakness. He points to the high volume of new condo construction in the pipeline in the GTA, which will add to supply. He also cites waning demand from investors who buy condo units for rental; as interest rates rise, it becomes increasingly difficult for investors to earn enough rent to cover the mortgage and monthly condo fees of their units.

The market downturn has a broad economic impact, he adds. With real estate activity accounting for 7.5 per cent of Canada’s economy, he forecasts the current market weakness will shave 0.1 per cent from GDP growth in 2019 and 2020.

“It think the sense is that it’s not over – we haven’t reached the end,” Mr. Tal said. “There’s a sense that we are in the middle of it.”

Toronto real estate agent Scott Ingram is also worried about the frothy Toronto condo market, which has been propped up by investors and has had three years of significant price gains. Over all for the city, the “headwinds outnumber the tailwinds” for 2019, he said.

But he hopes condos will have a softer fall. The inventory remains low, and the lowest end of the market has so far been the strongest, he said. While sales volumes for homes priced over $1.5-million fell 40 per cent last year, there was just a 3-per-cent drop in sales for homes – mostly condos – priced between $500,000 and $800,000, he noted.

It is difficult to predict whether Toronto and Vancouver are in short-term dips or are facing the sort of longer-term corrections that many have warned about for a decade or more. Toronto’s market has been supported for almost 20 years by steady population growth and relative housing shortages, and Vancouver hasn’t seen its market seriously stall in decades. After an early 1980s peak, however, Vancouver took eight years to recoup losses and surpass the previous high.

Mr. Henderson at Sotheby’s predicts 2019 sales volumes will be weaker in both cities, but believes they will remain highly appealing destinations for many buyers. The Toronto region in particular typically goes down the least in a broad real estate downturn, he says, and typically goes back up the fastest.

“I wouldn’t be betting long-term against Vancouver or Toronto,” he said.

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