CANADIAN REAL ESTATE FLASHES ANOTHER BUBBLE WARNING – A FLATTENING RENTAL CURVE
It’s not just Canadian home prices showing bubbly signs, but rental prices are following too. The cost of renting an apartment in the suburbs is rising much faster than in the city. Economists call this the flattening of the bid-rent curve, or rental gradient. Basically, the discount for being located further from amenities is disappearing. People are so panicked about paying more, they’re willing to pay a premium today, to avoid pain later. When prices move entirely in anticipation of future rises, you’re looking at a bubble.
The Bid-Rent Gradient (or Curve)
In a normal market, the cost of real estate is higher closer to a city’s central business district (CBD). Higher real estate prices tend to be reflected with higher rents as well. This makes sense since the CBD has the highest concentration of amenities. Further from the center generally sees prices reduce, as commute times rise. This is called the bid-rent curve, or rental gradient. A sharp concentration of high prices diffuses and gets lighter as you get further out.
Longer commute times aren’t a monetary cost, but they are an opportunity cost. People without money tend to pay it with their time, in exchange for more space. In healthy markets, households balance their time with the amount of land consumed.
Huge properties are great, but a two-hour commute totally blows chunks. Likewise, small properties are less than ideal, but beats spending hours on TransLink. Interest should be self-balancing in a healthy environment. People trade-off time for cost, and this theory goes back hundreds of years. Farmers were one of the earliest markets studied for commute times and land prices. All of this breaks when people become exuberant though.
When people are exuberant, the primary concern is avoiding being “locked out” of the market. No time for lifestyle balance, because there’s no time. We’re running out of land, remember? Even though these people may not be consciously speculating, they are making speculative assumptions.
No one will be able to buy property outside of a few elite landowners. This is the last chance a generation will be able to buy property without inheritance. Prices won’t fall, so it doesn’t matter how much I pay, because I’ll never be underwater. These are all common assumptions that need to exist in a bubble. Oh, and I almost forgot, the one we’re talking about today — it doesn’t matter where you’re located. Proximity to amenities doesn’t matter, because it’s this or nothing.
One professor of land economics concisely explained, “[in a] bubble, the principal concern is not having any property, pushing up the relative price of low-amenity properties.”
Toronto Rental Prices Are Rising Faster Outside of The City
There’s evidence of prices rising faster in the suburbs for almost every major city. We’ve talked about this trend in home prices, so let’s look at rental prices today. More specifically, one-bedroom leases in the City of Toronto, and the surrounding region.
Over the past year, the further away a rental apartment was located, the more prices increased. Within 5 km of downtown Toronto, the average price fell 12.05% in May, when compared to a year before. As you get further away, we can see the decline in annual price change get smaller. Eventually, it starts to increase consistently after 40 km from the city center. The rapid climb further from the city has rents flattening. Amenities became less important than securing tenure, in a city with rising vacancies.
Toronto Average Rental Price By Distance
The annual percent change for the average absorbed one-bedroom rental lease for May 2021, by distance from city center.
| Distance (in km) | Change (percent) |
|---|---|
| 5 | -12.05 |
| 10 | -8.03 |
| 15 | -8.42 |
| 20 | -6.39 |
| 25 | -5.36 |
| 30 | 5.49 |
| 35 | -4.84 |
| 40 | 7.86 |
| 45 | 3.08 |
| 50 | 15.34 |
| 55 | 10.3 |
| 60 | 8.76 |
| 65 | -3.03 |
| 70 | 8.6 |
Source: TRREB; Daniel Foch, Broker; Better Dwelling.
The Premium For Being Located Near Amenities Is Shrinking Fast
The discount for being located further away from the city center was decent just a year ago. As you got further away from downtown Toronto, the average price of a one-bedroom fell. Sharply. In May 2020, it was 7.3% cheaper to rent 5 km outside of the city center. It generally got even cheaper as you got further out, dropping 22.8% for people leasing 30 km away. The market reached a peak discount of 31.6% for properties located 60 km away. The discount then shrinks, as you get into a place with specialized inventories.
Toronto Rental Price Discount From City Center
The discount in price for the average one-bedroom rental, compared to renting in the city’s central business district (CBD).
| Distance (in km) | May 2020 | May 2021 |
|---|---|---|
| 5 | 0 | 0 |
| 10 | -7.26 | -3.02 |
| 15 | -7.66 | -3.85 |
| 20 | -11.75 | -6.06 |
| 25 | -10.87 | -4.09 |
| 30 | -24.81 | -9.81 |
| 35 | -18.69 | -12.02 |
| 40 | -22.75 | -5.26 |
| 45 | -20.14 | -6.4 |
| 50 | -27.89 | -5.43 |
| 55 | -30.1 | -12.33 |
| 60 | -31.63 | -15.46 |
| 65 | -23.52 | -15.68 |
| 70 | -19.16 | -0.18 |
Source: TRREB; Daniel Foch, Broker; Better Dwelling.
Those discounts have significantly flattened over the past year. Last month, the average discount for renting 5 km from the city center was only 3.0% in May 2021, about half that of last year. Locating 30 km from the center only saw an average discount of 9.8% from the center. That’s less than half the size a year before. The peak discount is seen 65 km from the city, and it’s only 15.7% — almost half the 31.6% seen last year, 60 km away. There is a definite flattening of the rental curve.
It’s similar to real estate bubble contagion theory, where bubbles spread to the burbs. Some justify the surge in suburban prices as a temporary work-from-home trend. Though, as previously mentioned, bubble experts still consider a shock-driven bubble to be a bubble. Besides, every market peak sees the bid-rent gradient flatten. Historically, people tend to just really want fresh air during expensive markets. It’s totally not about price either, because they would be fine with a 10 to 20 point drop in value. Oh, you don’t think that can happen? Prices will only go up? Exactly, market assumptions accompany this change in “preference.”
Rent prices are following the path of home prices, demonstrating frothy activity. Flattening of the bid-rent curve was just one of the many oddities seen recently. Rental prices have also increased with rising vacancies. Landlords are capitalizing on the fact people think they’ll be locked out of buying. Keeping properties empty while property values appreciate is another one. Large landlords are hoping rents adjust towards the lofty property prices.
In a bubble, fundamentals don’t matter. Amenities don’t matter. Vacancies don’t matter. The only thing that does is how much the next person is willing to pay.
Story by: Better Dwelling
