Are Toronto Condos A Good Investment?
Freeholds might be a better investment, but they also require more capital and more active management. If you don’t have $250,000 saved up or you don’t want to deal with managing an older property, then a condo is still a pretty good investment, especially with all time low interest rates right now. In this video, I’ll walk you through what returns to expect and key things you need to keep in mind if you are planning on investing in a Toronto condo today.
How To Make Money From An Investment
Fundamentally, you’re making money from an investment if you’re getting more gross returns than total expenses. In other words, you’re making a spread. And when you’re borrowing money to invest, then this spread will be magnified because of leverage. If you don’t know what leverage means, you can learn all about it in this video below.
Investment Returns Breakdown From A Toronto Condo
According to listings.ca, a Toronto one bedroom condo in December 2001 was $175,000. At the end of December 2020, 20 years later, the average Toronto one bedroom condo is now at $590,000. This translates to an annual appreciation of 6.3 percent per year. If you want, you can argue that past results are no indication of the future. So, we can keep appreciation conservative and assume a 3 percent annual appreciation moving forward for Toronto condos.
On top of appreciation, we have rents coming in as well. With a $500,000 condo, right now you can get $1,875 in rents each month, so that’s equivalent to 4.5 percent of the property price. Of course, owning a condo also comes with costs. Operating expenses on a $500,000 condo are around $550 per month or 1.3 percent of the property price each year. We also have to pay interest on our mortgage. Let’s assume we’re borrowing 80 percent of the property at a rate of 1.5 percent, so this is equal to 1.2 percent of the property price.
From a net returns perspective, we have gross returns of 7.5 percent from appreciation and rents, minus 2.5 percent of expenses. This means we’re still gaining 5 percent of the property price in net returns each year. Next, let’s factor in leverage. At a 20 percent downpayment plus closing costs, we’re somewhere between 4 – 5 times leveraged. This means our actual net return on investment is around 20-25 percent per year, which is really good.
Cash Flow From A Toronto Condo
So here’s what to watch out for. I mentioned at the start that freeholds are a better investment. It’s not just because of better total returns, but because it also has better cash flows which makes freeholds a safer investment. A condo has lower cash flows, so this means you have weaker holding power, making it a riskier investment.
Let me talk about this a bit more. With investment properties, you can’t access your appreciation gains each month so this reduces your actual cash flows. On top of this, you have to repay part of your loan each month which further reduces your cash flows. So instead of just looking at your net returns, you’ll have to stress test your holding power to make sure you can cover all of our outgoing cash flows (operating expenses, interest payments, principal paydown) so that you can get eventually capture the attractive annual returns in the long run.
We talked about your annual condo ROI being at least 20 percent per year, but how do cash flows look like? On the incoming side, this is solely from rent at 4.5 percent of the property price. On the outgoing side, it’s also at 4.5 percent of the property price – we have operating expenses at 1.3 percent, interest at 1.2 percent, plus principal paydown of round 2 percent each month. This means if you own a Toronto condo, you’ll just be getting by with no extra cash flows at the end of each month in the best case scenario.
Key Things To Keep In Mind Before Investing In A Toronto Condo
Of course, you’ll have to factor in extra bumps along the way.
First, those numbers assume no vacancies. Historically, Toronto rental vacancies are low, but COVID has changed things up significantly with condos. We went from 1.1 percent vacancies in 2019 to 5.7 percent vacancies in 2020 so this is something that needs to be factored in as well.
There can also be changes in rents. Because of COVID, rents have dropped by 10 percent year on year in 2020 in Toronto condos, so this is another thing to stress test your financials with to make sure you can cover all of your outgoing cash flows when there are drops in rent. Finally, there’s will also be adhoc maintenance and repair issues. Having said that, they tend to be less serious because condos are newer and you pay into condo fees already. If you need a number, our property management team recommends budgeting around 2 to 3 percent of gross rents for condos.
Now when you put all of this together and you’re in a comfortable position to cover your outgoing cash flows, then condos are still a good investment. In fact, many real estate investors start with condos to get your foot in the door first.
Like we mentioned, condos can generate you 20 percent + in annual ROI compared to 7 to 10 percent with stable bank stocks. So condos can help you grow your capital much quicker and if a freehold is something you ultimately want, you will be able to transition into a freehold investment property faster if you put your investment dollars in a condo instead of stocks.