Are Toronto Condos A Good Real Estate Investment For 2022?
Toronto Condos: Current Cash Flows
If you buy a starter Toronto condo in today’s market for around $600,000, here’s how cash flows might look like.
You can rent it out for $1,850 and, after you deduct operating expenses, you will have around $1,300 in net rent before your mortgage. Now as a percentage of the purchase price, you’re looking at a net rent yield of 2.6%, and this is what we like to call our cap rate and what we typically use to compare how one property’s rental income stacks up to another.
Then, if you deduct a mortgage with 20% downpayment and an interest rate of 1.7%, you’re looking at minus $390 in negative cash flows at the end of each month.
Toronto Condos: Adjusted Cash Flows Based On Forecasts
But we just talked about why this might not be your actual cash flows. What’s happening these days is that you lock in your purchase price today, but you don’t actually get your property until your closing date, which is usually 2-3 months later. If we’re in February right now, this means you might be renting your condo out in April or even in May. And since so many things are on the move, your rent and cash flow situation might actually look a bit different.
Let’s look at the interest rate side first. We all know rates are supposed to go up, and the consensus right now is telling us that rates are probably going to come up starting this spring. On average, the big banks are expecting interest rates to go from 1.7% now to 2.1% by Spring of 2022.
Then let’s look at rent projections. According to rentals.ca, we’re expecting higher rents everywhere across Canada by year-end. But by far, the best rent growth in Canada is expected to be in Toronto, with the bulk of the growth happening in the first half of 2022. In fact, by around April or May, rents might be 8% higher than what they are now, and after that, rents might go up another 3% by the end of the year.
So, let’s redo our rent and cash flow projections based on these new forecasts to see what things might actually look like if they pan out. We’d be looking at close to $2,000 in rent, and our condo cap rate would rise to a higher 2.9%. On the other hand, rising interest rates mean our monthly mortgage will be higher. But as you can see, higher rents still trump the interest rate increase, giving slightly better negative cash flows at $336 per month.
Now, let’s take a look at the cap rate difference between condos and houses. Normally, the cap rate for condos are around 1.5–2% lower than houses, and this is why many people prefer freeholds if you can afford them. Nowadays, the cap rate on houses is closer to 3.5-4%, and we just said the cap rate for condos is 2.9%.
So the cap rate gap between condos and houses is getting smaller, which means 2 things.
First of all, condos might be either selling at a discount or freeholds are a bit overpriced right now. Either way, this makes buying condos now a better deal compared to before if you look strictly at cap rates.
Secondly, a 2.9% cap rate is very similar to what condos were at before the pandemic. The difference right now is that interest rates are still much lower than what they were in early 2020. For the same condo in early 2020, you would have gotten around $700 of negative cash flow if you rented it out as a long term rental but now it’s closer to $300. At the moment, your net rents are better and your cash flows are better.
Cash flows are typically tightest when you buy the property and it gets better as rents go up over time. But what you find right now is that condos are easier to hold as an investment right from the start. Even though you’re still cash flowing negative, it’s not a big of an amount in the beginning and it’ll probably take you less time to reach cash flow positive state compared to early 2020, which is another plus.
Toronto Condo Appreciation
Besides rents, let’s look at appreciation, which is the other half of the investment picture. I’m hearing more people talk about investing in Calgary condos because of positive cash flows.
A better comparison is to look at cap rates and you’ll see that these Calgary condos have around a 4% cap rate, which is 1% better than Toronto condos. But rent growth in Toronto is expected to grow a lot faster than in Canada, so it’s possible for Toronto to catch up later on.
Take a look at the 2022 real estate price forecast from the Canadian Real Estate Association. In terms of appreciation, Alberta’s prices aren’t expected to grow nearly as quickly as Toronto. So in the grand scheme of things, when you add up cap rates and appreciation, you’ll find that Toronto will actually perform much better than Calgary as a whole.
And then if you zoom into Toronto properties, you can see that in the long run, condo appreciation isn’t that far off compared to houses. But in the past few years, condo prices have definitely trailed behind houses, which means there is a chance that condos might start catching up to average things out.
Should You Invest In Toronto Condos In 2022?
There’s a few things going for Toronto condos. We’re expected to eventually from from a. Pandemic to an endemic situation, and that means more and more people are going to revert back to downtown living. This means end user and renters might start to pick up more, and so demand and prices might rise quicker on the condo front. Eventually, we expect that faster rent growth and a lower purchase price point might just be the right formula for Toronto condos to outperform Toronto houses in the short term.
- If condos prices grow 5% quicker than houses in the short term, then investing in a condo will still be better than investing in a house for the first 2 to 2.5 years. After that, houses will start performing better.
- If condos grow 10% faster than houses, then that’s a bigger plus, which will make total returns on a condo better for the first 4 to 5 years.
- If condos grow 15% faster than houses, then we’re looking at a 6-7 year period where condos will outperform houses.
We’re big on investing in freeholds, and if it seems like we’ve shifted gears, we haven’t! We are still big on investing in freeholds. If you’re planning on holding your real estate investment for the long run, we still think houses are better in terms of long term rent yields and appreciation.
But what we’re trying to say is that there is a special opportunity in condos right now for the right investor. First of all, houses cost more than condos, so if you can’t afford a house, then condo investing is a good option right now because things are pointing up for condos in the short term, plus they can still give you good returns for the long term.
The second thing is that condos are newer and easier to manage, so they’re good for people who want a more passive experience and don’t mind chipping in a few hundred dollars each month to support the property. Just note that, on the flip side, being a passive investment doesn’t give you much room for value-add options. If you buy a condo, you can’t add a secondary suite, build that laneway house or garden suite to bump up your returns even if you want to.
And finally, the big one. Yes, you might be able to get better short term returns by investing in a condo rather than a house in Toronto, but that’s really contingent on whether condo prices grow faster than houses in the short term and by how much. We think that if you have a shorter investment horizon, then investing in condos is a better choice for you.
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