Why you shouldn’t become a condo speculator
David Kaufman – Financial Post
If you’re considering purchasing a condo for a reasonable price, with a mortgage that you can afford both now and when interest rates rise by a few points, a plan to live in it for at least a few years and are happy with appreciation that more or less matches inflation, you’re nicely set up to own property.
If, however, you’re among the thousands of Canadian purchasers considering buying a condo at a greatly inflated price, with the maximum amount of leverage you can muster, barely enough income to cover your mortgage payments and a “plan” to rent it out for a while and then resell it for an easy gain when prices skyrocket, you’re a speculator.
Comment: Who says prices are inflated? Toronto real estate prices are based on some 100,000 sales every year. Which means a buyer and a seller – plus their agents. That means there are at least 400,000 people (never mind friends and relatives and their opinions) determining property prices. With around half being condos, and only resale condos, that means 200,000+ people set the prices of condos. Add in another 30,000 new condos – and their buyers, some agents and the builders – and you have a good 250,000-300,000 opinions on the price of Toronto condos. That is called Market Value my friends, and it is exactly the right price. Overpriced products do not sell, simple as that. Thus, Toronto condos are priced exactly right for this market, at this time. Talk of “greatly inflated prices” is as useless and baseless as “corrections” and “bubbles”.
You don’t have a plan, you have a dream. And that dream can easily turn into a nightmare before you can do anything about it.
Comment: But he is right, buying and investment condo with 5% you can barely afford is a Bad Idea. Unless you have 20-25% to put down and are willing to lose a couple hundred bucks a month, stay out of it.
There is a long list of reasons why you shouldn’t enter the condo speculation game. Here are just a few:
1. You can’t diversify your asset
Even if condo prices rise, there’s no guarantee that your specific condo will go up in value. Unless William and Kate move in next door, there is very little that can make your condo appreciate faster than the rest of the city’s inventory. Conversely, any number of events can make your condo appreciate slower than others in the area.
Comment: Areas appreciate, some more than others. But it is rare for one building to not rise with the tide. Buy in a good area and you are safe. Look for future value. The east end, for instance. With the West Don Lands and Pan Am Games, that area will be built up in record time. New parks/infrastructre/homes/stores/offices always bring up values. And along Eglinton, where the subway is going. People like transit and a new subway line will increase value. Look at Sheppard Ave for example.
2. Prices do not always go up
Pick up the phone and call anyone who lives in Arizona, California, Nevada or Florida and ask them if real estate prices can go up forever. While you have them on the phone, ask them how much fun it is to be an active real estate speculator when the music stops.
Comment: Around here they do. This is not Arizona, California, Nevada or Florida. This is Toronto. And we have only had 4 down years since 1966. That means prices rose in 43 of the past 47 years. So yeah, prices do always go up in Toronto. Never mind inflation… there is a reason movies don’t cost a nickel anymore.
3. Leverage: Your best friend, your worst enemy
Without leverage, speculating on condos wouldn’t be much fun, since you probably couldn’t even afford to buy one. With leverage, a gain of, say, 10% on the value of the asset will result in a 50% return on equity if you are able to finance 80% of the purchase with a low-cost mortgage. Of course, a 10% decline in value will result in a 50% loss of equity. A 20% decline — really just a correction to where prices were two years ago — would be a total wipe out. Anything beyond that and you would be underwater and sending cheques to the bank long after your condo is owned by someone else.
Comment: Prices have not risen 20% in the past two years! To suggest that is devious at best. And people buy condos to rent out, not to flip. The value year to year is not as important. Buy with 20% down and hold it for 10 years. You pay a bit towards it while having the bills paid by the tenant. Even – though the chance is SO SMALL as to be imossible – if prices are flat after those 10 years, you have paid off most of the mortgage. Thus, the $300,000 condo you bought with $60,000 down is now an asset with $180,000 in liquid value. So you tripled your money in 10 years with 20% down and no price appreciation. Even with slow price growth, less than inflation, you could see your condo rise by $100,000. So now you have made $280,000. Not bad, for two rather conservative scenarios.
4. Lack of institutional buy-in
When was the last time that you heard of a condo speculation fund? Never. Why? Because professional investors don’t make unreasonable assumptions about the performance of their assets, and they consider rainy day scenarios when making their investment decisions. Condo speculating is akin to booking tickets on an airline that pilots refuse to fly on because of safety concerns. You probably — and probably is the key word — won’t crash, but why take the risk.
Comment: Huh? There are REITs, Real Estate Investment Trusts. They don’t necessarily specify, but I am sure some of them invest in condos. And offices. And other properties. Are there no Circus Speculation Funds? No? Well does that mean circuses are a bad idea? It is a strange and not useful line of thinking.
There is nothing wrong with buying condos. I’ve lived in condos for more than 20 years. I’ve even made some money on the way out on a couple of occasions. But I would never buy a condo as a speculative investment. It’s gambling, pure and simple. And the odds are not always in your favour.
Comment: Buying to rent out is never a bad idea, as long as you have a decent down payment and you do your homework. Buying to flip, true speculation, is totally fraught with danger. This article seems to be missing the point and directing all the cautions and warnings to the wrong type of condo investor. Flipping anything is hard to do well and can be very dangerous. Buying an investment property is much easier and just takes some patience, brains and money.
Contact the Jeffrey Team for more information – 416-388-1960
Laurin & Natalie Jeffrey are Toronto Realtors with Century 21 Regal Realty.
They did not write these articles, they just reproduce them here for people
who are interested in Toronto real estate. They do not work for any builders.
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