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Speculators super-heating the Toronto real estate market

This home in East York, Toronto that's listed for sale, March 6 2017.

Fred Lum/The Globe and Mail

Speculators are buying up residential real estate all around the Greater Toronto Area and possibly pushing house prices into bubble territory.

That conclusion doesn't come from an international think tank or non-governmental organization but a brokerage at the epicentre of Toronto's market in sizzling Leslieville.

Investors could be responsible for a chunk as large as 25 to 30 per cent of all sales in the GTA, according to the special report by Realosophy Realty Inc. The report is titled Freeholds on Fire: How Investors are Driving Up House Prices in the Greater Toronto Area.

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The study was undertaken by Realosophy president and broker John Pasalis, who noticed a twist in market psychology. People began moving from the time-honoured principles of real estate investing – that the cash flow from renting out the property should cover the expenses – to the assumption that it was okay to lose money every month because bigger gains would come from the sale of the property later on.

"When we began to see investors act on the assumption that the price of houses will continue to rise indefinitely, we started shifting from a market driven by an investor's mindset to a speculator's mindset," says Mr. Pasalis. "This is one of the big red flags that economists point to in terms of housing bubbles."

Read more: In Toronto's hot market, why are these homes still for sale?

He worries that the trend is pushing regular buyers out and creating a dangerously overheated market. He'd like to see more government action and tighter lending practices.

Mr. Pasalis says the biggest surge in the zeal for rental properties was found in Durham Region, where demand has increased more than 400 per cent in about four years in such areas as Whitby, Ajax and Oshawa.

The study also found significant investor demand in Aurora, Newmarket and Richmond Hill.

Mr. Pasalis, who established his real estate business on Queen Street East, says he was prompted to drill down into the statistics because so little data on the amount of speculative activity in the market is available from government sources.

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He set out to measure investor demand by looking at all sales posted on the Multiple Listing Service of the Canadian Real Estate Association, then checking to see if the new owner listed the property for lease shortly after they bought it.

The number crunching also reveals that approximately 95 per cent of investment properties purchased in 2016 are losing money every month, which suggests that the buyers are counting on price appreciation to produce a profit.

Because Realosophy has the price investors paid for their properties, along with their property taxes and the amount they leased the property for, the researchers were able to estimate how profitable the investments are, Mr. Pasalis explains. They also assumed the investors had a down payment of 35 per cent of the purchase price.

The assumption of a down payment of 35 per cent is reasonable, he says, but he adds that not all buyers fit that assumption. Many foreign buyers are paying cash for all or most of the purchase. Many domestic investors, by contrast, are using debt. Many borrow against the equity on the principal residence to come up with the down payment for their investment properties, he says.

Effectively, the entire purchase of an investment property is being financed by debt in these cases.

Mr. Pasalis worries that this intense investor behaviour is typical of an expanding bubble. It not only prices out regular buyers, he says, but sets up the potential for a correction that will affect all property owners.

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"Everybody suffers."

He believes policy makers could be taking steps to lessen any potential damage.

For example, lenders currently underwrite mortgages for residential investment properties as if they are owner occupied homes, resulting in a loophole that allows buyers to finance money-losing investment properties largely with debt. Mr. Pasalis is calling for these loopholes to be closed by tighter lending practices.

He's also in favour of some form of a foreign buyers' tax.

Lorena Magallanes, who specializes in the condo market, also senses a drastic change in the behaviour of buyers. Ms. Magallanes says nearly every unit is drawing a bidding war so far in 2017. Even a small studio or one-bedroom, one-bathroom unit downtown will spur competition, she says.

"Six months ago the market was very different from where it is now."

Ms. Magallanes, who is one member of the "Condo Chicks" team at Stomp Realty Inc., is also seeing a lot of investors rushing to buy. As many as 50 per cent of the bidders who come to the table have money coming from overseas, she estimates.

Ms. Magallanes recently sold a two-bed, two-bath condo downtown to a buyer from Europe. Eleven parties competed for the unit.

She also believes a foreign buyers' tax would be a positive move to slow the market in Toronto a little bit. Many investors who were buying in Vancouver have shifted to this city after the B.C. government imposed a 15 per cent foreign buyers' tax on purchases in the Vancouver region.

She also hopes for an increase in listings to take some of the pressure off of buyers.

Ms. Magallanes and her team are encouraging clients who own a few condo units to consider selling a portion of their holdings while the demand is so hot.

"If they are investors who have a few listings, we are telling them to sell – we have buyers."

She is still optimistic about the market, she says, but there is no harm in pocketing some of the profits.

Mr. Pasalis was prompted to delve into the numbers after he became aware of a shift in the type of calls he was getting. Starting in 2015, he noticed more potential clients were contacting Realosophy to buy properties strictly for investment purposes. Some prospective buyers were based overseas while others were local, and they were mainly interested in detached or semi-detached houses and townhouses – instead of condo units.

He believes his analysis actually underestimates the number of investors because it only captures those who choose to post their rental properties on the MLS. Some may leave homes vacant or post their listings on other sites.

For Mr. Pasalis, dinner party conversation can be unsettling.

"When we start to hear from those eager to buy money-losing investments because prices must always go up, it's time to ask ourselves if we have reached that tipping point."

Within four hours of listing this property, an offer was placed on this King Street West neighbourhood condo
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