What is happening in markets for residential land in the Greater Golden Horseshoe?
December 19, 2017
Serviced land values for single-detached and townhome developments in the Greater Golden Horseshoe (GGH) had been growing at a steady pace between 2005 and 2014 – but then exploded in 2015 (Figure 1). New data released by MCAP, one of Canada’s largest independent mortgage financing companies, shows that prices doubled between 2015 and the fall of 2017. The price of a 30 to 36 foot frontage went from just over $200,000 in early 2015 per foot frontage to roughly $600,000 in the fall of 2017 (Figure 1). These price pressures have also spread into the condo apartment market (once a beacon of stability), where land values have tripled over the same time frame in some areas across the region. The data can be found on the MCAP website at https://www.mcap.com/development-finance/land-value-report (external link) .
On December 7th, Toronto Metropolitan University’s Centre for Urban Research and Land Development (CUR) held an expert panel discussion to explore what is happening with land prices in the GGH. Expert panelists included Mike Czestochowski, Executive Vice President, Land Services at CBRE; Pete Schut, Vice President of Acquisitions and Development at Brookfield Homes; and Diana Petramala, Senior Researcher at CUR. Mike’s discussion centred on the high-rise market, Pete focused on the ground-related market and Diana on the macro market environment.
A video of the two-hour event can be found here. Key takeaways from the event are summarized in this blog entry.
The overarching theme was that the jump in land values has reflected demand/supply imbalances in the new and existing home market. Prices for houses were being bid up and that is what pushed land prices higher. Housing demand has slackened temporarily, but supply constraints will continue to hold land (and home) prices lofty.
The road to Vancouver-like pricing
What a builder is willing to pay for serviced land is largely a function of what they can build on that land and how much they can sell it for. Matthew Taylor, a former Ryerson student and research assistant with CUR, described the MCAP calculation as a residual land value analysis defined by the following formula: Land values = sales price - (costs + profits). As such, it’s really been the sharp appreciation in home prices over the last few years that have bid land values up.
Mike Czestochowski kicked off the discussion highlighting the residual land value concept at play in the condo apartment market. He noted that in the 1990s a condo could be sold for $400 a square foot of living area, which meant that land would sell for $40 a square foot. Currently condo apartments are selling for around $1,000 a square foot and land is selling for for $100 per buildable square foot, moving Toronto prices in line with Vancouver pricing. Figure 2 highlights the surge in purchase price for new high-rise and new low-rise in the GTA.
The key driver behind high flying prices between 2015 and 2017 had been a surge in demand, combined with constrained supply. Pete Schut noted that Brookfield was opening pre-sale offices and selling out within a day in the 905 areas. Diana Petramala pointed out that existing home sales were also rising sharply and heated demand even started to flow over to the more-amply supplied condo market. Some of the jump in demand was likely due to buyer’s entering the market to get ahead of potential interest rate hikes, but also FOPO (Fear of Being Priced Out) and speculation. Existing home sales were even elevated relative to the size of the population.
During this time, housing supply could not keep up with demand. Diana Petramala pointed to the sales-to-new listings ratio as an indication of supply-demand fundamentals (Figure 3).
In the GTA, prices rise at a double-digit pace when this ratio rises above 60 and average prices fall when the ratio falls below 50. The ratio averaged 68 between January 2015 and early 2017, suggesting the bargaining power remained largely in the hands of the seller during this period. Mike pointed out that builders worked down remaining inventory very quickly, falling to decade lows (Figure 4). This even occurred in the condo market where standing inventory is currently sitting at 348 units, compared to a historically typical level of 1,500 to 2,000 units.
Regulatory barriers keep supply from equalling demand
All panelists pointed to lengthy land and building permit approval timelines, changes to the OMB creating some uncertainty and lack of serviceable land for keeping supply restricted. Both Mike and Pete highlighted it can take up to two to three years from start to completion for a new project. Diana Petramala pointed out that supply responds better (although still not greatly) in Vancouver, despite the fact that the region has more physical land restrictions. Presumably, this means that Vancouver has more efficient building permit issue.
Frank Clayton, the moderator for the discussion, asked panelists how much of the rise in home prices they would attribute to regulation costs. Mike and Pete both agreed that 50% of the cost of producing a new home in connection with their business was due to taxes, development charges and regulation costs (or costs of approvals). Diana highlighted that regulatory constraints have also spilled over into the existing home market, by contributing to market tightness.
For more information on the high costs of the building permit process in the GTA, please see a recent joint (PDF file) CUR/RESCON report.
No end in sight for high land values (and home prices)
Panelists agreed there was a shift in the market following government regulation changes over the last year. These changes include mortgage insurance regulation guidelines and the foreign speculation tax implemented by the Ontario government in April of last year.
In contrast, the condo market has sustained momentum. Condo apartments still remain relatively affordable, especially for those trying to qualify for mortgage insurance under the stricter guidelines.
While both Mike and Pete were optimistic that the current slowing in demand for single-detached and home prices will be temporary, Diana cautioned that the weakness in demand could actually spread into the condo market in 2018 with a whole new sweep of federal mortgage regulation changes on the docket for January and the Bank of Canada embarking on a path of rate hikes. Diana noted that while there may still be a lot of pent-up demand, higher mortgage rates are going to keep demand from repeating last year’s highs.
Nonetheless, all three panelists agreed that supply constraints will keep prices lofty
Diana noted that even with a recessionary drop in total existing home sales experienced since April 2017, the market has remained more balanced, which supports the view of a soft landing in existing home prices. A soft landing is one in which home prices at most fall 5% to 10% on an annual basis. Under this scenario, homes will remain unaffordable.
The panelists also highlighted that a supply boom was not on the horizon. Pete referred back to the low level of pre-construction project openings (Figure 4) and he doesn’t see that changing anytime soon.
Frank Clayton asked the panelists how they felt about a recent spike in townhome construction and the City of Toronto’s estimate that 244,000 new units were in the approval pipeline. Will this be enough to cool the market? Pete argued that the townhomes breaking ground now are the result of sales activity two to three years ago and have already been absorbed. Mike said that he has doubts all of these units will be approved by the city, given the public pushback and stringent design build guidelines the city is imposing on builders.
While supply constraints were largely attributed to approval regulations, there was some talk of site shortages as well. The price of land has become too restrictive for single-detached and townhome construction. Condo apartment development may still make economic sense, but even then finding serviced land is hard. The significant rise in land prices means that holders of land are not in a rush to sell. Why would you sell if land is doubling in price every two years? Pete argued that some greenfield land is starting to open up in the 905 area (for example, Whitby and North Oshawa), but this will only help address past supply shortages and will likely be eaten up fairly quickly.
The Greenbelt also came into question. While Mike and Pete were not impressed with the just released proposal to expand the Greenbelt, there was general consensus that the Province doesn’t need to touch the greenbelt to provide a greater supply of serviced sites for ground-related homes. The Province uses such a small share of the land space, that there are other places to build, including the so-called whitebelt. It just has to be designated, approved and serviced.
What’s a region to do about high land (and home) prices?
When you put cooling demand in context with low levels of housing and serviceable land supply, you come out with an outlook for both land values and home prices to stabilize at relatively lofty levels. Land prices somewhat overshot home prices in 2017, and as such might experience slightly less growth in the two years ahead, but will remain high by historical standards. Affordability is unlikely to improve in the near-term.
The panelists agreed that government policies targeted at improving supply would be more effective at improving affordability than demand-side measures. The panelists agreed that a first step would be for municipalities to accelerate approvals and reduce red tape around building approvals. All levels of government should work towards making supply more nimble so as to respond to demand pressures.
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