Garry Marr – Financial Post

It’s just one month, but a new set of numbers from Toronto builders showing condo prices climbing just 2% on a year-over-year basis could make investors think twice.

Comment: Except February is slow every year, this is nothing new. And investors buy new condos to rent them out and have tenants pay down the mortgage. It is not as much about year over year price increases.

The Toronto condo market, the biggest of its kind in North America for that class of housing, is largely based on a capital appreciation. Most investors finance their units knowing that they will be unable to carry them on a cash-flow positive basis based on present rental rates.

Comment: Exactly. It is about monthly cash flow and tenants paying the mortgage.

“If you are negative cash flow and the thing is not going up in price, you are out of there,” said certified financial planner Ted Rechtshaffen, noting at these rates, the condo owner has more reason to worry.

The 2% rate — a return you could get from an online bank — would be in stark contrast to the 7% to 9% annual increase condo research firm Urbanation Inc. says has been the norm for the last five years.

Comment: And you are taking one month out of those past 60 months and trying to make a trend out of it.

But the past February to February, the Building Industry and Land Development Association (BILD) says that new condominium purchases across the Greater Toronto Area were an average of $532 per square foot in February, up from $520 per square foot a year earlier.

“I guess what I would say is the 2% reflects two things,” Joe Vaccaro, president of BILD, adding at that price developers have been able to keep condo prices in check. “The reality is units have shrunk in square footage overall; they’ve gone down by 100 square foot over the last five years on average. You are getting a smaller unit, but to remain affordable, they have turned to more innovative designs.”

At the same time as prices gains are slowing, Mr. Vaccaro said rental rates have been “mostly flat” but he says the real test will come when all the towers now under construction hit the market. “We will have to see what impact that has in terms of the rental market,” he says.

Comment: We hear that same refrain every year, and every year nothing happens. More people buy condos, some sell, builders build more. Same thing will happen next year.

BILD says it’s still early, but so far, high-rise sales for the first two months of the year are down 51.2% compared to a year earlier. The group points out 2011 was a record-breaking year.

Comment: And they can only sell the product they have. If there are no new units to sell… On new project next month and we could be up 138% – and it would be just as meaningless.

The numbers could represent just a short blip because Urbanation says its latest statistics, which were based on the fourth-quarter of 2011, showed prices up 8% from a year earlier. The group says the average sale price was $509 per square foot in the fourth quarter, up from $471 square foot a year earlier.

Ben Myers, vice-president of Urbanation, agrees that many investors in the GTA are not cash-flow positive on those properties, taking the loss because they’ll make money on the underlying condominium.

“It’s hard to say what is cash-flow positive. In the downtown core, at $650 to $700 per square foot with a minimum [20%] down payment, definitely not but a 905 project likely will because they only cost $400 to $450 per square foot,” says Mr. Myers.

The average size of a new condominium in the GTA is 650 square feet per year, meaning based on average price, it will cost you $330,000. With rental rates on average $2.21 per square foot, you could expect close to $1,450 per month in rent.

Comment: Not quite. The average condo in the 416 is $360,000 and rents are around $1,600-1,800. This is from actually working in the industry and not just pulling random stats. But, buying a $330,000 condo with 20% down results in a mortgage of $1,122 a month (if they are not a Canadian citizen, they must put down 35% and thus would have a mortgage of $907). Add in property taxes of $150/month and condo fees of $300/month and you have a carrying cost of $1,572 – and can get $1,600 in rent. Thus producing positive cash flow. Most builders want 25% down, which would make this example $1,048 + 150 + 300 = $1,498.

Even with 2% annual appreciation, the condo is worth $371,600 after 5 years, $410,300 after 10 years. And the amount owing is $213,300 and $171,200 respectively. Which means the owner has $158,300 in equity after 5 year and $239,100 after 10 years. And that is with $82,500 invested – meaning profits of $75,800 (plus the $6,120 in monthly positive cash flow) after 5 years and $156,600 (plus $12,240) after 10 years. Never mind if the monthly overage was put down on the mortgage – the amounts owing would be way less and the profits much higher.

This, my friends, is why investors keep buying new condos. Even with rent of $1,500 the numbers are the same, just without the bonuses in brackets. Never mind if rents go up each year. Or if the average annual increase is more than 2%. We just showed, with VERY conservative numbers, that there is good money in investing in Toronto condos.

But will that rent cover your costs? If you put 20% down, a $264,000 mortgage at even 3% amortized over 25 years, your principal and interest costs would be close to $1,250. Monthly condo fees are about 50¢ per square foot per month on average and property taxes are about 1% of home value. Add in heat and hydro and you are easily under water.

Comment: Wrong. See my math above. And tenants pay their own utilities, always have.

But the condominium game continues to be about capital appreciation and a 2% the return would shrink the pool of investors. “Investors would be leery at 2% and may look elsewhere to put money,” says Mr. Myers, adding a key consideration is many investors put significant cash into a deal, not burdened with a large mortgage payment and looking for a safe long-term investment.

Comment: Wrong again. Condo investment is about yearly appreciation combined with monthly cash flow. Usually monthly cash flow is more important than appreciation.

Brian Johnston, president of Monarch Corp., says he always wonders what type of rental rates investors are expecting. “It’s not apparent to me there is a great return,” he says. “I think it’s mostly capital appreciation. The fallback position seems to be if they can’t sell it or the market is soft, I’ll just rent it.”

Prices are still going up in Toronto’s condominium sector and maybe the 2% bump is a blip but if prices start to fall, or worse yet flatten out, you have to believe condo investors will be checking out in the future.

Comment: Of course it is a blip, you say so yourself above. The past 5 years have seen yearly increases of 5-7%. We need to wait another couple of years to see if it is a trend. One month out of 60 means nothing.

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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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cash flow negative investment condo

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