Cash Flow Or Appreciation: What Makes The Best Real Estate Investments In Toronto!
Cash flows vs. Appreciation – these are two important parts of real estate that investors typically talk about!
- But what is actually more important in the grand scheme of things?
- Cash flows are dropping and it’s easy to put a lot of focus on this because it’s a tangible metric, but should you put that much focus on it?
- And when someone tells you a certain property generates x amount of ROI, how do you make sure you compare it properly with other ROI numbers that other people give you?
How We Calculate ROI
When you look at your return on investment (ROI), you’re looking at a number that compares your total returns to your total investment.
Total returns are made up of rental income, market appreciation and value add appreciation.
We like to use the actual total investment, including the downpayment, closing costs, renovations, and holding costs. This would naturally be lower than someone else’s ROI figure if they calculate ROI based on downpayment alone.
Total Returns: Rental Income
Now going back to the returns. The first part is rental income, and this figure is pretty clear, even if it’s a projection especially if you ask our leasing team. Our leasing team has 20+ active leases at any time, we know what actual market rents and vacancies are like.
Rental income is important to a certain degree. It gives you holding power because it helps pay your operating expenses, your mortgage interest and your principal paydown. But in another video, I mentioned that despite rents dropping, changes to rent don’t actually make a big dent in ROI.
To put things into perspective, a drop of over $420 in rents per month on a $1M property mean a drop of $5,000 in rents per year. If you divide $5,000 by the total investment capital of around $250,000 (assuming a downpayment of 20% plus other upfront costs), this is only equivalent to a 2% drop in ROI. This isn’t that big of a deal in the grand scheme of things so it’s important not to over focus there.
What’s more important is that rents do help you hang onto your property securely. We’re conservative investors so we like to choose positive cash flowing properties that can carry itself. In Toronto, these are your freehold properties with starting prices at around $900,000. If you’re thinking about a Toronto condo instead and you have sufficient income to stably pay for the extra $300 – 400 of negative cash flows from month to month, then that’s okay too.
Total Returns: Value-Add Appreciation
The next part of returns, your value add appreciation, is also pretty concrete. For example – If you put $100,000 into the $1M property, your property price might go up by $250,000 which means you pocket $150,000. $150,000 on $400,000 of total capital translates to a one time 37.5% ROI from just value add. As you can see, you can get a big bump in returns if you want to put in the value add and there are more of these opportunities on the freehold side as well.
Total Returns: Appreciation
Appreciation is the biggest wildcard in real estate investments and this is what you need to pay extra attention to. 3% vs. 8% in annual appreciation is a big difference after you factor in leverage. A 5% difference in appreciation assumptions at 4 times leverage can mean a 20% difference in ROI – that’s a huge difference. This is why if you’re looking at an ROI number from someone, you need to understand the assumptions behind that!
The Most Important Factor In ROI
If you look carefully at this breakdown, you can see that even at low rates of appreciation, appreciation makes up the biggest part of the total returns pie. So it should be your priority to find real estate investments that have the highest long term real estate return potential.
The suburbs outperformed Toronto because of COVID-19 but this won’t last forever. If you look at long term historical appreciation or future growth potential , Toronto wins hand down. In the end, the focus for economic recovery starts in the core. There’s limited room to build up supply in Toronto, whereas finding land to grow isn’t a problem in the suburbs.
Immigration which fuels demand is highest in the core. Migration back to Toronto will make a slow recovery because people like to be where the real action is. So when things bounce back, you might see periods of slower growth in the suburbs, whereas Toronto will have factors that continue to prop its price upwards.
How We Can Help!
We’re Toronto real estate investors ourselves, and our team manages over 200 doors for clients! We know what it takes to be a successful real estate investor – financial valuations, what types of investments actually make sense based on your experience, requirements and preferences, how to really get a property up and running, including renovations, leasing, and we can even take care of property management for you if you don’t have time yourself.
We like to think of working with us as a partnership. We want to grow with you so we take time to review your portfolio, look for efficiencies and plan out a long term road map so that you can optimize your returns in the long run. So when you’re ready to invest in real estate, we’re ready for you!
Do You Want Help With Real Estate Investing In Toronto?
We’d be happy to learn more about your situation and help you find the best investment opportunities for you.