When's The Real Estate Bottom? Is It A Good Idea To Invest In Toronto Real Estate In 2022?
Introduction
Real estate sentiments went from, “I have no idea where the market is going,” to now, “it’s definitely going to fall, so when is the best time to get a deal?” I think this is a big change, and this clarity is giving investors more confidence again.
The bad news is this. Yes, prices will probably go down before they go back up, and we’re in the same boat as those investors. The good news is that there are a lot of investors in Toronto who have cash on hand and are ready to buy when the market goes down. This makes me optimistic that Toronto real estate will have good support.
I’m also getting this question more often now. Some people want to know if this discount is really a better deal, since interest rates are much higher now and will keep going up quickly over the next couple of months. So in this video, let’s figure out the answer.
Are The Real Estate Discounts Worth It?
Real estate returns come from rental income and appreciation. As rates continue to rise quickly, freehold cash flows in Toronto, which have been slightly positive even today, will soon turn negative because rents haven’t been able to keep up.
But in the long run, you will notice that cap rate, which is basically your net rent yield, tend to lag interest rates by a few months. This is because real estate investors don’t have much room to move when it comes to their cash flow.
When interest rates go up and cash flows change, one of three things will start to change to bring cash flows back to where investors are more comfortable with them: 1) Prices would have to go down, or 2) rents would have to go up as landlords pass on higher costs, or 3) a mix of the two would have to happen.
In the medium term, rental income is pretty stable, and if we look at similar properties, the entry price is what makes the biggest difference in return. When you plot real estate prices on a chart, you’ll see that they tend to follow a trend line that shows how much average prices go up. The market can overshoot by 5–10% above the average, and it can also overcorrect by 5–10% below the average.
To be honest, I’m in the camp of “time in the market” over “timing the market”. Things tend to average out in the long run, and timing matters less. If you get a 10% discount off the average price and hold on to the property for 20 years, you still beat the market, but only by an average of 0.5% per year. On the other hand, a 10% premium isn’t that big of a deal in the long run, either.
If you only have a short time to invest, the entry price will matter more. Over 5 years, a 10% discount means that you make about 2% more each year, on average or 10 percent more after leverage. That’s the bigger difference, which is why many investors are waiting on the sidelines to grab deals.
How To Spot The Real Estate Bottom
If you’re also looking, you might be wondering, “When is the best time to buy?” So here are a few clues that might help you figure it out.
Let’s look at the trend line again. In the past few months, prices for investment properties have gone about 10% above the trend line, but they are on their way down. So you can start to keep track of this, and when prices drop below 10% from the peak, you’ll know that prices are likely dipping below the trend line.
Cash flows are the second thing to keep an eye on. I’ve already said that investors have a certain tolerance for cash flow that doesn’t change much. If interest rates go up by another 1 percent, cash flows will start going negative. Remember that rents tend to lag interest rates, so prices will probably have to go down first to compensate for cash flows.
Look at this as an example. At the current rate of 2.4%, a $1.25 million property will bring in $150 per month in cash flow. But if rates rise by another 1%, cash flows will drop to -$270. So, if we still want similar cash flows as before, prices will have to go down to $1.12 million, which is approximately a 10% drop.
Next, I would look at the trends from month to month for more information. Prices don’t usually go down for only one month in a downturn. After the data comes out for the first month, more people get scared off, so prices usually go down for a couple more months. If we look back to 2017, this is basically what happened. Both semis and condos in Toronto fell for three months straight before bottoming out and the market turns around from good news.
So again, you’d probably see a short window where things look really bad: major rate hikes, rents stalling, and prices dropping from month to month. That’s when buyers would have the most bargaining power.
How To Lower Your Real Estate Investment Risk
Lastly, I want to say again that nobody knows for sure where prices will go, and it’s very rare to be able to catch the exact bottom. Also, remember that there are always pros and cons to entering at different times.
When the market is more normal, cash flow is more stable, which means you have a better ability to hold on to your investment and it’s technically less risky. You might be able to get a great deal right now, but holding power is weaker, so it is a riskier time to invest.
As a safety tip, you might want to go with a higher downpayment if you can afford it. This increases your holding power and lets you take full advantage of discounts on the market. We’d recommend going with variable mortgage so that when things settle down and your cash flows look better, you can refinance and pull out the extra money, which will improve your leverage.
How We Can Help
If you are interested in entering the Toronto real estate market and want an expert team to help you figure out a plan on how to proceed, let’s chat!
We can look at your requirements and preferences and then match you up with the best investment property that fits your needs. After we help you buy it, our team also provides renovation guidance, leasing and property management if you need it. Just connect with us if you want to learn more about our services!
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