If you’re looking into Toronto real estate investments, chances are you’ve stumbled upon the term “cap rates.” Let’s unravel the mystery—what are they, why do they matter, and why the standard calculations might not tell the whole story? Let’s break it down!
What Is Cap Rate?
Cap rate, or capitalization rate, provides a gauge of the rental income we earn from leasing an investment property. Real estate investors like it because it helps compare how well a property’s rents are doing compared to others.
How is Cap Rate Calculated?
To find the cap rate, you divide the yearly money you make from renting (called annual net operating income) by the property’s value.
The net operating income is the rent you get minus costs like utilities, insurance, property tax, condo fees, maintenance, and accounting for vacancies.
- No Appreciation Included: Cap rate disregards property appreciation, so always check total returns, including appreciation, for a holistic view.
- No Mortgage in the Mix: Cap rate excludes mortgage costs, a vital factor in risk assessment. Higher leverage may mean better expected ROI but comes with increased risk.
- Use Current Market Value: Base cap rate calculations on the property’s current market value for accuracy, especially if purchased years ago.
- Renovations Matter: Consider the actual market value post-renovation, not just the renovation cost, to avoid inflated cap rates.
In essence, cap rates offer insights into an investment’s rental income potential. However, a word of caution—use it as part of a comprehensive analysis, considering property appreciation and real market value for informed investment decisions.
What Are Typical Toronto Cap Rates Today?
Cap rates depend on interest rates.
If it’s more expensive to borrow money, investors want higher cap rates to make their investments worthwhile. This adjustment in the market can happen by lowering property values, raising rents, or both.
Typical Toronto Cap Rates (as of November 2023):
- Toronto condo cap rate is at 3-3.5%
- Toronto single family home cap rate is at 3.5-4%
- Toronto multi-family home cap rate is at 4.5%+
- Toronto accessory dwelling unit cap rate is at 8%+
What Is A Good Cap Rate?
We prefer low-risk real estate investments and aim for at least break-even cash flows.
Ideally, we want a bit of positive cash flow after covering the monthly mortgage, allowing us to add to our emergency fund or handle unexpected expenses. We’ve seen how crucial this is as interest rates rise.
It’s not straightforward because when interest rates are lower, the percentage of the mortgage payment that goes toward the principal is higher. So, to break even, you need a bigger buffer on the cap rate above the interest rate.
When rates are higher, the principal paydown percentage is lower, requiring less of a gap between the cap rate and interest rate.
As of January 2024, we are aiming for a 5.5% cap rate to break even.
Improving Cap Rates: Strategies for Investors
You can make your investment returns better by getting more rent on the property, such as:
- upgrading a unit
- adding more bedrooms to a unit
- increasing the number of units in a house
- adding a backyard house
Insights for Toronto Real Estate Investors: Additional Considerations
If you’re diving into Toronto real estate investing, there are some important things to know:
City and Property Differences: Cap rates (a measure of investment return) can be different for various property types and cities. But here’s the scoop: Toronto is a standout. The city’s real estate appreciation tends to be better and steadier compared to other places in Canada. So, when you’re figuring out your strategy, consider Toronto’s strong appreciation as a big plus.
Learning from Toronto Condos: Toronto’s condo market teaches us a valuable lesson. Condos might seem like an easy win with high growth in the mid 2010’s, but here’s the secret: balancing that potential with better cap rates in Toronto houses is a smarter move – aiming for lower risk and better long-term returns.
Neighbourhood Matters: Fancy areas might have lower cap rates because they cost more to get into. But hold on – these spots often give you more stability appreciation. It’s a bit of a trade-off, but it can be the right choice for someone looking for a safer Toronto real estate investment.
Value-Add Gains: Thinking about sprucing up an older Toronto home? Smart move! Renovations don’t just pump up your rental income; they also speed up the increase in your home’s value. With Toronto’s array of older homes, there’s many potential value-add projects waiting for you.
How We Can Help
If you’re feeling a bit overwhelmed about where to put your money in the real estate game, don’t worry – we’ve got your back! Our experts are here to understand your goals and help you find the ideal investment property.
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What Toronto Real Estate Investment Is Right For You?
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