TORONTO (Reuters) - Prices will cool in Toronto's booming condominium market in the year ahead, but concern about a bubble is overblown as demographics and strong investor demand will insulate the market from a crash, economists at Canada's largest bank said on Tuesday.
The research department at Royal Bank of Canada waded into the debate over whether Toronto's roaring real estate sector represents a bubble with a seven-page report predicting prices in the city's condo market will cool by between 2 percent and 7 percent in the next year but will not collapse.
"The historic condominium apartment boom in the Toronto-area market is not necessarily a sign of excess or of a bubble," RBC senior economist Robert Hogue wrote in a research note.
He said the condominium market in Canada's largest city still has a lot of strengths, pointing to a rising population, a shift in the mix of available housing, rising rental demand, and strong interest in buying condos as investments.
Still, recent changes to mortgage insurance rules and looming interest rate increases will reduce the flow of buyers into the market, and there are risks that the type of units bought by investors may not match future demand, Hogue said.
"If we are not in the presence of a bubble, does it mean that prices will keep going up in the Toronto area? Not necessarily. In fact, we expect the current upward pressure on home prices to ease substantially by next year, with condo prices possibly coming down a notch or two," easing by 2 percent to 7 percent from quarterly peak to trough.
Hogue noted the Toronto area is growing by about 38,000 net new households a year even as legal constraints on urban sprawl prevent growth in new single family homes. As a result, buyers and builders have turned to condos to meet demand.
While Canada's housing market at times seems to echo the 2008 housing bubble in the United States, there are several differences. Canada did not suffer the financial crisis to the same extent as the rest of the world in 2009, mortgage interest is not tax deductible as in the United States, mortgages are not repackaged and resold among lenders, and the subprime market is very small.
While construction appears to be booming due to the presence of many cranes on the city's skyline, the long three-year building period before completion means the pipeline is "not proof of excess".
Tighter financing rules and cooling demand may mean some proposed condo projects may not go forward, but that only serves to diminish the risk of a wave of condo units flooding the market in the future, Hogue said.
He also noted that unoccupied condos represent about 7.5 percent of units completed, about half the average since 1980, while the rental vacancy rate edged down to 1.1 percent last year despite an 18 percent increase in condo rental units.
"Unless household formation dips substantially, we would not expect the emergence of any oversupply reaching levels that would threaten the stability of the market," he wrote.
Still, the market is not without risks, he added.
With no hard data on the size of the investor segment of the market -- somewhere between 15 percent and 60 percent of purchases -- Hogue said a disconnect may emerge between the type of units investors like and the type demanded by end users.
"If too many investors make wrong calls on the types of units that will ultimately be occupied, thereby inflating demand for certain classes of apartments, this could lead to oversupply in specific market segments (e.g., small one-bedroom apartments)."
The economist also said a lack of affordable new single family homes may mean a two-tier market emerges as condo demand cools.
"In effect, we could well see the emergence of a two-tiered market: a soft condo segment, and a resilient single-family home segment. Recent price data already give hints of such a split, as detached home prices have been outpacing those for condo apartments by a significant margin so far this year," he wrote. (Reporting by Andrea Hopkins; Editing by Peter Galloway)