The Toronto Real Estate Bubble Is So Big It Breaks The UBS Index – Better Dwelling

Toronto real estate has once again assumed its natural position as one of the biggest bubbles in the world, according to a Swiss banking giant. UBS released its 2024 Global Bubble Index, an annual scorecard of the riskiest real estate markets in the world. Toronto climbed into 5th place, but managed to lower its risk score after seeing improvements in 3 out of 5 subindexes. A look at the methodology reveals Toronto didn’t see improvements in these areas, but Canada’s full embrace of frothy home values is breaking traditional bubble risk indicators.  

Toronto Real Estate Rises To 5th On Global Bubble Risk List

Toronto real estate remains one of the  highest risk cities for a bubble. It managed to land the 5th spot on the bank’s annual list, advancing two from last year. UBS labeled it “elevated” risk for a bubble, the second highest warning they issue. 

“An elevated risk of a housing price bubble is evident in Los Angeles, Toronto, and Geneva,” explains UBS in its report. 

Source: UBS. 

Despite the rising rank, the risk score Toronto received has actually been falling. Advancing higher on the list actually has to do with other cities de-risking faster than Toronto, at least according to the methodology used. That brings up an important question though—how do they actually measure the index? It turns out Canadian real estate is so frothy, the methodology used fails to capture the extent of the risk. 

Toronto Real Estate Prices Still Have The Highest Bubble Warning

Toronto’s elevated bubble risk rank is the city’s aggregate score. Breaking it down, UBS actually created 5 sub-indexes to measure market growth. The first two are price-to-income and price-to-rent ratios, both used to measure how disconnected home prices are from income. 

Toronto scored “high” for bubble risk when it came to both measures of price. Home prices and value are greatly disconnected from their fundamentals, and have the highest risk label assigned. In other words, few can afford a home on typical incomes in the region. Most people think of this when they hear a bubble, but it’s only two of the five measures used.  

Source: UBS.

Canadian Real Estate Prices Rising, Normalizing Toronto Disconnect

One notch lower at “elevated” bubble risk is the city-to-country ratio. This measures the relative gap between home prices in a city to the country it’s in. The wider the gap, the more disconnected prices are from reality. The assumption here is that a frothy city will see prices fall and get closer to national index home prices. 

It’s rare that bond prices across the country will rise closer to a frothy market, but that’s what happened in Canada. Toronto home prices have pulled back slightly over the past few years, but more importantly national home prices have surged over this period. This indicator is less a sign of Toronto prices normalizing than it is a sign that the rest of Canada is becoming more frothy.  

Toronto Mortgage Risk Minimized By Using National Data

Toronto managed to score low risk for a bubble when it comes to mortgages. This is the lowest threat-level, and may sound like commentary on mortgage delinquencies or credit quality in the region. It actually measures the change in mortgage debt-to-GDP, with a stable or declining ratio viewed as lowering the bubble risk. 

Canada is unusually optimized for this measure, helping to lower the bubble risk for Toronto. First, there’s the issue of credit reporting—Canada is unique in that its national data only includes mortgage debt held by institutions. A significant portion of higher-risk debt is excluded, such as high interest private mortgages, increasingly used in cities like Toronto. Unlike the U.S., this segment of subprime lending is typically excluded, helping to minimize outstanding mortgage debt and reducing official delinquencies. 

Then there’s the issue of Canada’s aggregate GDP, a problem that people increasingly are starting to notice. Most population growth follows economic growth, resulting from rising household wealth and output as relegated in the per-capita GDP. This boosts population growth, since wealthier households mean more consumption and jobs, attracting more economic migrants looking to get in on the boom. 

Most risk models assume this is the order, and rising aggregate GDP follows the growth as a result. No country is dumb enough to try and boost immigration, boosting aggregate demand and applying downward pressure on wages first. This would lead to a rise in aggregate GDP, but it wouldn’t mean the same thing since it’s accompanied by falling purchasing power and lower per-capita GDP. Scratch that—one country would make that mistake. 

Canadian per-capita GDP just made the largest non-recession decline ever. As households and productivity falls behind, aggregate GDP climbs simply by the addition of more people. In short, mortgage debt is underreported and GDP growth is boosted but only by the addition of more people. The index sees no risk since it’s rare for a country to seek a massive inflow of economic migrants while unemployment is rising and mortgage borrowing is falling. 

When Toronto mortgages are isolated, they present significant concerns that are becoming worse. Mortgage delinquencies are climbing much more sharply than the rest of Canada, and are at the highest level in years. The distribution is also heavily concentrated in overleveraged investors.

The goal of the mortgage measure in the bubble index is to show stability. It may show that Canadian mortgages are stable, but it certainly doesn’t show Toronto is. In fact, it completely misses a number of mortgage factors that reveal significant stress. 

Toronto Construction Bubble Risk Is Low… If You Don’t Look At Toronto Construction Data

Last but not least, Toronto’s construction score is low for bubble risk. It doesn’t measure Toronto construction as many would assume, but looks at the change in ratio of construction activity as a share of GDP at the national level. The assumption here is a real estate bubble consumes more productive resources, and allocates them towards warehousing people. A stable or falling ratio generally means things are stable or improving. 

Once again, Canada’s aggregate GDP bias skews this one. The measure also fails to address composition in any way, so the state pumping billions to prop up demand isn’t a factor. A growing population pushing aggregate GDP higher but driving less demand for housing is also indicative of the reduced quality of life. Not only are more people consuming less, but shelter costs are so detached from incomes that the population growth decreasingly contributes to housing demand. 

Fewer people being able to purchase or rent a home doesn’t sound like a good thing, right? That’s exactly what’s happening in Toronto, where the population estimates are soaring but home sales are near record lows and the rental vacancy rate has climbed to the highest levels in nearly a decade.  

None of this is to dismiss the validity or seriousness of the position on the UBS Bubble Index. Being ranked the 5th largest real estate bubble risk in the world is a significant risk. Regulators should be concerned—typically this warrants tightening of credit, instead of dismissing and delaying the adoption of global risk standards. 

Toronto’s improvements in 3 out of 5 bubble subindexes based on national data emphasizes how different this one is. Rather than isolating risk, policymakers sought to improve relative risk by attempting to inflate national demand. Now the issue has become such a large and unusual problem, even traditional measures of risk fail to capture just how disconnected Toronto real estate has become. 

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