Blue Book: 2021 Greater Toronto Area Outlook

Share this page

Share this page

Share page link via email

Share page link via Facebook

Share page link via Twitter

Share page link via Google Plus

Share page link via Linkedin
bookmark
print

Greater Toronto Area. Click here to play video.

Robert Kavcic | March 31, 2021 | Economic Insights

Robert Kavcic | March 31, 2021 | Economic Insights

BMO recently held a virtual event to provide an in-depth discussion of the annual Blue Book. Douglas Porter, BMO Financial Group’s Chief Economist, provided an overview of the macroeconomic indicators across Canada, while I discussed the provincial economic trends.

While we expect Ontario’s economic recovery to be in line with the Canadian economy overall, things are a little more sluggish in the Greater Toronto Area as the region has been slower to lift COVID-19-related restrictions. The situation should pick up steam heading into 2022 as we approach herd immunity and unleash pent-up demand.

The labour picture is mixed, not surprising given the diversity of the Greater Toronto Area’s economy. While industries such as finance and professional services have recovered to pre-COVID levels, service sectors such as entertainment, recreation and culture are still suffering staggering job losses.

The real estate market is similarly fractured, largely driven by migration out of large cities. While a gradual outflow is normal, the pandemic accelerated the pace as people search for more space. That’s why even as prices for detached, single-family homes have soared, the condo market has remained stagnate. The result is a booming market in the outskirts of the Greater Toronto Area while the region’s core is struggling.

Despite these challenges, the longer-term outlook provides some reasons for optimism. The biggest long-term drivers of job growth are going to be in areas like technology, professional services and finance, which are mostly concentrated in the urban areas. And at the end of the day, the Greater Toronto area will always be a draw for the larger businesses. Realistically, 2022 could be the year when this region starts to rebound toward its pre-COVID economic activity.

Read the entire Blue Book here.

Transcript

Robert Kavcic:

Great. Thanks a lot, Doug, and thanks everyone for coming on. I'm going to cover a few specific issues, namely the job market, the housing market, which I know everybody is interested in, and a little bit on a fiscal policy. I'm going to do so with an eye on the GTA specifically as we go along.

First things first, when you look across Canada at the economic outlook by province, the one key feature here is that everybody has really been in this together. One of the things we usually caution in a normal year is that the Canadian headline growth numbers really do mask a lot of big regional differences across the country. Pre-COVID, Ontario and Toronto specifically, for example, were running much stronger, much harder than the rest of the country combined. This time around, everybody kind of fell into the pandemic together, just given the nature of the shock. Now, everybody is posting extremely strong growth numbers coming out of it.

You can see on the board there that Ontario was hit a little bit harder and Toronto specifically as well in 2020, obviously, being the biggest urban market and the most congested market and subject to more rigid lockdown measures through the height of the pandemic. It was just kind of the nature of the shock here that we're going to see a deeper decline in this part of the country.

The flip side is that we're coming out at a relatively strong pace now. We're probably going to see close to 6% growth in Ontario this year. We see the province actually leading the country by 2022, and the subtle difference here is that Toronto has been a little bit slower to reopen and remove some of these COVID-related restrictions, although we are starting to finally see some movement on that front now. We're going to look a little bit, probably, sluggish still in the GTA this year, but as we get into 2022 and presumably as we reach something near herd immunity and the more rigid restrictions on things like restaurants and entertainment and travel start to come off, that's when we're really going to see the GTA pick up some ground. I do think that there's going to be terrific amount of pent-up demand or pent-up psychological energy out there in the economy for those sectors that are going to drive a pretty strong rebound in the GTA market by the time we get into around the 2022 area.

With respect to the labor market, just given the nature of the hit here in this part of the country, the deterioration in the job market has been pretty significant. We did see a move up to double-digit unemployment rates. If you look at where employment is versus a year ago, Ontario's down at the bottom of the list. I think nationally we're about 4.5% below pre-COVID levels of employment. In Toronto, specifically, we're about the same magnitude down. We're about 4.5% down in Toronto as well. Below the surface is where it becomes a little bit more interesting and more telling. I'll flip over to this chart here that looks at the employment performance by sector. What you're looking at here is-- so as you go from left to right on this chart, we have a few industries marked, but as you go from left to right, you're looking at a better relative employment performance versus where we were in February 2020, just before the pandemic started.

Then, as you go up the scale from bottom to top, you move up the wage ladder. The key thing here is that when you consider the fact that Toronto is obviously the big urban market in Canada, and a lot of the industries that dot the landscape here, like the accommodation and food services, culture, recreation, that kind of stuff, theaters, those are the industries where we're still seeing job declines of anywhere from 15% to 30% plus versus where we were last February. The flip side is that as you go up to the right on this chart, you see some industries like finance and professional services where not only have we already recovered the COVID losses, we've actually seen job growth push 3% to 5% above pre-COVID levels. For Toronto, specifically, you kind of have this very fractured labor market where finance jobs and tech jobs have been able to shift online and actually maintain if not increase the level of employment. At the other end of the spectrum, the restaurants, the bars, the theaters, and things like that have really not come back at all. That's one aspect that's kind of fragmented the Toronto labor market itself.

The other important point here to keep in mind too is if you look at the trend here, the two or three biggest job declines by sector are also concentrated in the lowest wage industries. The flip side is that if you look at the five or six industries in Canada that have posted the best performance on the job front, those are the highest paying industries in Canada as well. When you flip over to the housing market story, one of the big head-scratchers was, "How has the housing market come back so quickly when we have, for a period of time, double-digit unemployment rate?" Just, historically, this doesn't make sense. The reality is, and one of the big reasons why those that came out very early in the pandemic bearish on housing were proven wrong very quickly, is that the vast majority of the job declines and those that are persisting today are very low down on the wage spectrum. Typically part-time, typically younger workers with lower wages. Those are not really where your prying home-buying population resides in the labor market. Those are typically more renters.

If you look at areas like finance and professional services, those higher-paying industries, as we've shown, they've come back very quickly. The demand curve for housing from a job market perspective, when you drill below the surface, has actually improved pretty steadily since the depth of the pandemic.

The other factors pushing the demand curve out here, and you can see record sales levels on the left side of this chart, record low five-year fixed-rate mortgages. We're looking at five-year fixed in 1.5% to 1.7% range. We historically have never seen that. That's kind of fueling this as well. We have seen mortgage credit growth pick up. The big story here on top of that, that it's really driven the demand curve out is the shift in housing preferences. What we're seeing now is the hottest markets in Canada are about an hour and a half to two and a half hours outside the core of the GTA. We're looking at single detached homes. We're looking at big rural properties, and we're looking at recreational properties like cottages and stuff like that. You can choose your adjective. You can come up with the strongest adjective you want to describe these markets, and you're probably not going to do it justice. They're absolutely on fire. We are looking at price gains in some cases that are about 30% to 50% above where they were last February coming into the pandemic. The flip side of that is that the core of the GTA has struggled a little bit more. Not the single-detached market because there is this tremendous demand for space, but the condo market has struggled a little bit. The economics there have changed. Rather than this convergence of jobs and population into the core of the GTA, we're seeing a shift out now.

In fact, if you look at net migration flows from the three biggest cities in Canada to other regions of the respective province, over the last year, we've seen about a 88,000-person net outflow from the core of the big cities. Now, to be fair, typically what you see is a gradual movement out of these cities anyway, but those flows have pretty clearly accelerated since the pandemic started. People just want space and they don't want to be confined in condos. The economics of the condo market have changed a little bit as well.

One of the reasons why we have seen really no price growth in the condo sector, even as single-detached prices are up more than 20% annualized over the course of the pandemic, is that rents are under pressure. We're not seeing the international immigration flows that were supporting those rents. We're not seeing the student flows that were supporting those rents. The short-term rental market which is very travel-driven has really dried up. In a lot of cases, high condo prices and low cap rates were being offset by this push of some supply into the short-term rental market, because you can pull in more cash flow that way.

Now that that market is really on hold, for now, a lot of that has been flipped onto the rental market, and that's pulling rents down as well. You do have this fractured market where you have extreme strength around the perimeter of the city and anything with space but you have more stagnation in the condo market in the core of the city. The question is, where we go from here? This is where it gets a little bit tricky, and in the short term, a little bit concerning. I suspect that over the next six months, as we go through the spring and into the early summer, you're going to see this tremendous strength continue.

Frankly, it's probably going to get to the point where it starts to concern us a little bit and maybe concern policymakers that this kind of price growth is pulling in some speculative activity. Unfortunately, it takes a little bit of time to actually see that show up in the data. My sense is that those wheels are starting to turn right now. Longer-term, one of the things I would say here is that a lot of these trends, they were preexisting anyway.

From a demographic perspective, over the course of 3, 5, 10 years, just the nature of the millennial group and how big it is, we were going to see this gradual shift in demand out of the core of the city to the suburbs and towards larger properties. It just so happened that the pandemic pulled a lot of this activity forward and compressed it into a very short period of time. Hence the dramatic increase we're seeing right now.

The flip side is that if we're borrowing some of this movement from the future, then it stands to reason that as mortgage rates eventually do back up and we're starting to see the first sign of that, by the way, at least in the five-year fixed sector, and as we reach herd immunity and the economies go back to normal, people start traveling again, there's less of a rush for recreational property, and a lot of the migration activity that was going to take place over time has happened, for borrowing that activity from the future, then it stands to reason that after this run in prices, the market is going to settle down, and we could go through a more prolonged period where we see some stagnation in the markets around Toronto.

Are we going to give it all back? I would say no. I would say if you're sitting there hoping to see prices go back to where they were in February of last year, it's probably not going to happen because a good portion of this relative shift and this relative repricing is probably with us to stick. When the heat comes off, I would say we do give a little bit of it back, but I think some of it is here for good. That's the housing story. Of course, I'm happy to circle back to more detail on that, after all, but in the interest of time, I'll shift over to the fiscal picture here quickly.

First of all, the provincial level, what we can see here is Ontario is looking at a pretty elevated debt and deficit situation. The way this chart works is it's a very quick and dirty way to compare finances across the different provinces in Canada. As you go up the left scale, you see an increasing budget deficit, and as you go out across the right scale, you see an increase in net debt burden. Ideally where you want to be on this is down in the bottom left corner. There's one last AAA credit rating left in this country, that's British Columbia, but you can see they've pushed up to the right already and that one might be at risk.

If you look at Ontario, so they've moved pretty sharply up into the right as well over the course of the pandemic, and we're looking at net debt that's pushing close to 50% of GDP and, obviously, elevated budget deficit. Again, I would say most provinces are in this together. In Ontario's case, what we've seen over the course of the last few fiscal updates is that they've been very prudent, I would say, in putting these forecasts together, and there probably is some upside either through the revenue channel or through just the layers of spending contingencies that they have in place to deal with this current wave of COVID.

I suspect that we're actually seeing the peak deficit in the province right now and over time, we're going to see that grind lower. The most important thing here, I would say, is that as much as provincial finances have deteriorated, it hasn't been nearly as bad as it could have been because the federal government was the one that really stepped in and did the vast majority of the lifting, the vast majority of the spending. We're all familiar with CERB and the wage subsidy, and the various other programs and the evolution of those programs so I won't go through that. Effectively, at the end of the day here, we're looking at about $275 billion of direct support from the federal government.

The strategy here has been to just provide liquidity and solvency to households and businesses as much and as fast as they could to make sure that when we do get vaccinated, and policymakers do say, "Okay, go back and open up your shop or head back into the office," that there are actually still businesses there to turn the lights back on. That's effectively what we're starting to see play out right now. The downside is that we've been left with this $380 billion dollar hole at the federal level, it's about 17,5% of GDP. It really is, historically, off the charts in terms of the size of the deficit.

Then, going forward, we're obviously going to have to do some-- or see some payback on this in terms of either spending restraint down the road, or potentially some tax increases later on down the line. That's the bad news. The good news that moderates this story and maybe takes some of the concern off of this, this very dramatic looking chart, is that, first of all, when you look across the developed world, Canada is not alone in this. We are all in this pandemic, we all have seen government finances deteriorate very sharply.

Yes, Canada's deterioration has been relatively large because the amount of stimulus we've pushed out has been relatively large, but Canada coming into this, remember, it wasn't a very favorable position as well from a debt perspective. On a relative basis, we had some capacity to take this on and we've done so. The other thing to keep in mind is that the Bank of Canada is absorbing quite a bit of the net issuance here. From a simple debt service cost perspective, as much as debt has increased, and borrowing has increased, the federal government's only spending about seven or eight cents of every dollar of revenue on debt servicing today, because rates are so low.

Just for a very stark comparison, go back to the 1990s and we were spending about as much as 35 cents on every dollar of revenue to service that debt. This looks bad and it's going to take some work to undo but I would say it's not necessarily a crisis situation at this point. Just by nature of a lot of these programs rolling off and the economy being allowed to run relatively hot for the next couple of years, it's going to take a pretty meaningful chunk out of this deficit on its own to something that looks a lot more sustainable within a couple of years.

Finally, I'll just wrap it up before we get to some Q&A with a few points on Toronto specifically. One is that there has been this question that cities have been hollowed out and they're going to be left for dead after the pandemic because of the outflows we've seen. I don't think that's necessarily the case. If you look at where the biggest longer-term drivers of job growth in this country are going to be, areas like technology, professional services, finance, higher educated type service industries, a lot of those are concentrated in the urban areas.

Yes, there has been this shift to remote working, the jury's still out on how much of it is going to stick, are we going to go fully back to the office 100%? Probably not. Are we going to stay completely at home? Probably not either. It's just there are pros and cons to both, and the reality is it's probably going to fall somewhere in between. I do think when these restrictions come off and Toronto is allowed to "open back up", there is going to be a pretty strong move back into the city. Now, from a commercial real estate perspective, it might look a little bit different than in the past.

Your office might look different. The rents might be lower because there's just less absorption to have if firms are working X percent from home, and the rents might be a little bit lower, the cap rates might be higher, but I think at the end of the day, the core of the GTA is always going to be a draw for these bigger businesses. While we might see some repricing and a little bit of a different look and feel in the city, I do think that demand is going to pick back up.

Longer-term, I think that's where we're going. It's going to take some time to get there, and I would suspect that if we are going to see vaccination roll out on this more optimistic timeline, that's great news for Toronto. Realistically, 2022 might be the year when you start to see the big major markets start to get more traction and come back to life that looks a little bit more like it did pre-COVID. Longer-term, I would say I'd be still quite comfortable with Toronto being a driver of relative economic strength in this country. I will stop it there, and hand it over, and Doug and I, and the group, of course, are happy to take any questions.

Robert Kavcic

Director and Senior Economist

Robert has been with the Bank of Montreal since 2006. He plays a key role in analyzing economic, fiscal and real estate trends in Canada. Robert regularly contribut…(..)

View Full Profile >

Read the entire Blue Book here.

This is part 4 of a 7-part series on

Blue Book: 2021 Greater Toronto Area Outlook

PART 1