How To Get Into Toronto Real Estate & Grow Your Wealth Sooner As A Young Real Estate Investor!
Your life keeps changing over time and how you structure your real estate portfolio may very well change with your stage in life. In this video, let’s zero in on the younger real estate investors in Toronto. We’ll look at your goals and constraints to help you better navigate the Toronto real estate space and highlight three important strengths that you can put to your advantage so that you can better grow your wealth with real estate in Toronto.
Real Estate As A Home
Your real estate portfolio can be split into two buckets. In one bucket, you have your own home. In the second bucket, you have your real estate investments. It’s a good idea to put some money into each of the two buckets at any stage in life but the key is the understand how much you should be putting in each bucket at each stage.
Before we go there, let’s learn more about the home bucket first. If you’re in Toronto, a home is a good investment as long as you don’t around too often. Instead of having your money just go down the drain in rents, you’re able to benefit from stable appreciation and these gains are tax free.
At a modest 4% appreciation per year, after you subtract expenses at around 1% and your interest at 1.6% with a 20% downpayment, you’re still getting a healthy 8.6% ROI per year. So, your home is great passive way to build wealth. The downside of putting money in a principal residence is that you don’t get cash flows, and in fact, you’ll have to take money out of pocket each month to carry the home, which make it harder for you to save more money to invest.
In case you’re wondering how things will change if you go with a lower downpayment using a CMHC mortgage, the ROI actually stays more or less the same. At at 15% downpayment, your expenses go up by half a percent because of mortgage insurance, but your leverage goes up to 6.7x, and so your ROI isn’t that different at 8.1% per year. The big benefit here is that a lower down allows you to get started in real estate sooner, which helps your returns snowball sooner which means you can generate more returns over time.
Real Estate As An Investment
Now let’s take a look at the second bucket, which are your real estate investments. Even though capital gains are taxed, you benefit from extra rental income so your post-tax returns end up better than a principal residence. Assuming you make $100K a year, your rental income will get taxed at around 25%. And when you sell your property, your capitals will probably push you to the highest tax bracket, so this means your capital gains are also going to be taxed at around 25%.
So based on 2.5% net rent yields on an investment condo in Toronto, you might be getting around 19% in ROI per year after tax. You’re negative cash flowing less than a principal residence, but you’re still negative a few hundred bucks a month. Toronto houses have better net rent yields close to 4%, so a house will give you a post tax ROI close to 25% per year. And instead of negative cash flows, the houses we recommend will cash flow positive few hundred bucks each month.
How Much Should You Allocate To Your Home Vs. Investment?
A lot of new and younger investors decide to get started in real estate because they see it as a great way to build wealth quickly. If this is also what your goal is, then it’s a good idea to put a heavier weight on the investment side which generates better returns and leaving a smaller portion for your principal residence.
When you understand this, you also have to remember your constraints: you’re limited compared to more experienced investors because you have less money saved up and a lower salary, so instead of buying a bigger investment property and a separate smaller home, you’ll have to get a bit more creative if you want start sooner.
Condo With Roommates & House Hacking
Instead of buying a condo all for yourself, you can buy a two bedroom condo, live in one of the rooms and rent the second room to a roommate who will pay you rent. In this scenario, instead of having 100% of your money in your principal residence generating 8%, half of it is now in the investment bucket so you’ll bump up your 13.5%. At the same time, your rental income will help with cash flows so you can save more money to reinvest compared to if you were to pay for the entire condo yourself.
If you have a bit more capital, you can take it up a notch with house hacking. Essentially this is your condo roommate situation enlarged to a house. As another example, you can buy a starter house in Toronto for around $950K, live in the basement and rent the rest out. In this case your investment portion gets bumped up to two-thirds. Houses have better rent yields than condos, plus you have a bigger portion as your rental, so now your average ROI becomes 19.3% which is even better than the condo situation. At the same time, your cash flows are better so you would be able to save more quickly. Plus, your absolute gains are higher so this can help you cash-out refinancing quicker for your next property.
Advantage 1: You Have More Free Time
Now being young isn’t all negative and in fact, you have three important strengths that you can put to your advantage.
The first one is that you probably have a lot more free time than other investors! What this means is that if you take on more value add opportunities, you’ll be able to generate even better returns actively. It works best for houses in Toronto since there are century old homes that sell at a discount because they need work. If you’re able to renovate and upgrade them, you’ll be able to get an extra good bump in appreciation.
Now after I say this, you might be wondering if house flipping is a good idea. For those who don’t know, when you flip a house you would buy a house for a house for a cheaper price, putting in major renovations, so that you can hopefully sell the upgraded property for a profit. If you ask us, we’d say no because we’re long term investors and the risk adjusted returns are just not really worth it.
Here’s why. Let’s say we buy a house for $1M. We put in $100K to renovate it, work on it for 6 months and successfully sell it for $1.2M and make $100K. But don’t forget to subtract your other costs. Closing fees were around $35K, and selling fees are around $55K, so essentially after all that work we only make $10k, and this gets a further haircut once you factor in income taxes and all of this assumes that the real estate market stays more or less stable.
But what if the market drops 7% which is essentially what happened between March & July this year? Instead of being worth $1.2M after renos, the selling price goes down to $1.12M which means we’d only make $20K. Then after we take out the closing and selling costs, we’d actually be at a loss of $65K. If in the short term, prices can go up and down and house flipping makes you very vulnerable to the downside, so once you factor in that added risk, it’s not the best use of your time or money.
Advantage 2: You Have A Longer Investment Period
Your second advantage also has to do with time: you have a longer investment period compared to everyone else which means you can take on higher risk. Now this might sound contradictory to what I just said about house flipping, but even though taking on higher risk for a short investment period doesn’t make sense, this risk gets reduces if your investment period is longer and you’re able to ride of the volatilities and that’s why upgrading and holding your investment property is a better idea.
As a young investor, your longer timeframe also means that you’re the best candidate to take on the biggest leverage to capture those higher returns, as long as you can comfortably pay for the higher carrying costs. A longer timeframe also means you can choose higher risk properties that might be undergoing gentrification. If you hang onto them for long enough, you’ll have the potential to generate better returns after the area gets re-developed.
Advantage 3: You Have More Flexibility
Finally, your last big advantage is that your life is pretty flexible at this stage. Of course it’s better to have a fancy home all to yourself in a nice neighbourhood, but I wouldn’t say that this isn’t as crucial right now. If you’re able to stick it through for a few years, you’ll be able to grow your real estate portfolio more quickly and end up in a better position later on in life.
Let’s take a look at this example where you spend the same amount of money on a house in year 1. In the first case, you own the house all for yourself, so it will take you around 11 years before you build enough capital with your home to possibly buy a second property. But if you started with house hacking, you’ll probably have enough capital built up by year 4, so you can grow your investments faster and most likely end up with a nicer home in the long run.
How We Can Help
What I just talked about is a generalized roadmap, but of course, everyone is a bit different. If you want to get started with real estate investing and decide to work with us, we’ll dig into your specific goals, requirements and preferences and customize a real estate solution that best fits your need.
We’re a full service team, so our team also provides renovations guidance, leasing and property management if you need it. Just connect with us if you want to learn more about our services!
Do You Want Help With Real Estate Investing In Toronto?
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