The Four Parts Of Toronto Income Property Returns
Did you know the majority of returns from income properties in Toronto don’t actually come from rental income? When you look at total returns, it’s composed of four main parts. Understanding how to make money with Toronto income properties will help you make better investment decisions. Let’s dive in!
How Do You Make Money With Toronto Income Properties?
Total Returns vs. Capital Required
The first step to making money with income properties in Toronto is to get one! Since property prices do vary, we recommend you to look at returns against the capital you put in so that you can make more objective comparisons.
When you purchase an income property, you can buy it outright if you have a lot of cash (which is very few people). Most people purchase it with the help of a mortgage. Getting a loan to buy real estate makes sense because lenders offer low borrowing rates on Toronto real estate since it’s backed by a physical, appreciating asset.
With a mortgage, you’re able to put a small portion as a downpayment and then pay for the rest with borrowed money at low interest rates to generate a higher rate of return on your income property. A mortgage allows you to make better use of your capital, which means you can generate a much better return on investment with the same property.
Here’s a comparison of Year 1 Total Returns on the same property in Toronto, but with one scenario being purchased outright and the other scenario with a mortgage (2.59% per year, 30 year amortization, 20% downpayment):
| No Mortgage | With Mortgage | |
|---|---|---|
| Purchase Price | $900,000 | $900,000 |
| Downpayment | $900,000 | $180,000 |
| Closing Costs | $30,450 | $30,450 |
| Capital Required | $930,450 | $210,450 |
| Net Operating Income | $44,256 | $44,256 |
| Less: Mortgage Payments | $0 | $34,476 |
| Cash Flow | $44,256 | $9,789 |
| Equity Gained | $0 | $16,123 |
| Market Appreciation | $14,550 | $14,550 |
| Forced Appreciation | $0 | $0 |
| Total Return | $58,806 | $40,453 |
| Return On Investment | 6.3% | 19.2% |
As you can see, the return on investment (calculated as Total Return / Capital Required) is significantly higher with a mortgage. This in the power of leverage for income properties! Now that you understand how to objectively compare returns against capital requirements, let’s discuss the four parts of income property returns.
Return 1: Cash Flow
Cash flow is the net cash you receive after you collect rent and deduct all operating expenses and monthly mortgage payments.
Toronto condos have lower cash flows because you don’t get as much in rent and there are higher operating costs, mainly due to condo fees. Toronto houses are bigger and can typically be split into two or more units and generate more rent. On top of this, Toronto houses have lower operating costs without condo fees.
Let’s see how much better cash flows are in Toronto income properties that are houses compared to condos:
| House | Condo | |
|---|---|---|
| Purchase Price | $900,000 | $500,000 |
| Downpayment | $180,000 | $100,000 |
| Closing Costs | $30,450 | $14,450 |
| Capital Required | $210,450 | $114,450 |
| Rent | $55,200 | $25,200 |
| Less: Operating Expenses | $10,944 | $5,820 |
| Less: Mortgage Expenses | $34,476 | $19,152 |
| Cash Flow | $9,780 | $228 |
| Cash Flow / Capital | 4.7% | 0.2% |
Return 2: Equity Gained
When you make mortgage payments, you’re paying interest on the loan and paying down a portion of your loan so you return less to the bank when you return the loan. With an income property, this amount is taken from the rent you collect, so your tenant is helping you build more equity on your property.
Depending on the terms of your mortgage, you may gain equity quicker if you have a shorter amortization period of 25 years. We typically recommend a longer 30 year amortization period, so it’s easier to stay cash flow positive.
With the same mortgage terms (2.59% per year, 30 year amortization, 20% downpayment), your rate of return from equity gained is similar regardless of the type of property you’re looking at in Toronto:
| House | Condo | |
|---|---|---|
| Purchase Price | $900,000 | $500,000 |
| Capital Required | $210,450 | $114,450 |
| Equity Gained @ Year 1 | $16,123 | $8,957 |
| Equity Gained / Capital @ Year 1 | 7.7% | 7.8% |
Return 3: Market Appreciation
As a long term investment, Toronto real estate increases in value over time since it’s driven by strong economic fundamentals. In fact, real estate in Toronto has appreciated over 8% per year in the past 10 years.
If you break the returns down by year and property type, you can see that Toronto condos have a higher price fluctuations compared Toronto houses, mainly due to more speculative investors in the condo market. This means that houses are lower risk compared to condos with more stable long term investment returns.
| YoY Price Change % | House | Condo |
|---|---|---|
| Jan 2011 | 0.1% | 5.3% |
| Jan 2012 | 17.8% | 1.9% |
| Jan 2013 | 5.0% | 2.9% |
| Jan 2014 | 16.6% | 2.3% |
| Jan 2015 | 6.8% | 2.0% |
| Jan 2016 | 5.5% | 9.0% |
| Jan 2017 | 28.6% | 15.5% |
| Jan 2018 | -3.0% | 17.2% |
| Jan 2019 | -5.8% | 6.6% |
| Jan 2020 | 18.9% | 12.0% |
| 2011-2020 Average | 9.1% | 7.5% |
| 2011-2015 Average | 9.3% | 2.9% |
| 2016-2020 Average | 8.8% | 12.1% |
Return 4: Forced Appreciation
Since condos are relatively newer in Toronto and don’t need renovations, the value add is not significant. If you upgrade older houses in Toronto, you’ll bring up the value of your property, usually for a lot more than what you put in. This added value is forced appreciation!
As you can see, forced appreciation can increase your returns significantly, and it’s really obvious in year 1. Over time, forced appreciation returns are diluted since it’s a one-time increase in value. Because your property price is brought up after renovations in year 1, you’ll also benefit from higher levels of market appreciation throughout your investment period if you renovate your property.
Also note that we kept the cash flows the same in both cases for simplicity, but cash flows post-renovations are typically higher, which makes returns with upgrades even better.
| With Upgrades | Without Upgrades | |
|---|---|---|
| Downpayment | $180,000 | $180,000 |
| Closing Costs | $30,450 | $30,450 |
| Renovations | $100,000 | $0 |
| Capital Required | $310,450 | $210,450 |
| Year 1 | With Upgrades | Without Upgrades |
|---|---|---|
| Cash Flow | $9,780 | $9,780 |
| Equity Gained | $16,123 | $16,123 |
| Market Appreciation | $27,050 | $14,550 |
| Forced Appreciation | $150,000 | $0 |
| Total Return | $202,953 | $40,453 |
| Year 5 | With Upgrades | Without Upgrades |
|---|---|---|
| Cash Flow | $55,037 | $55,037 |
| Equity Gained | $84,928 | $84,928 |
| Market Appreciation | $287,274 | $218,203 |
| Forced Appreciation | $150,000 | $0 |
| Total Return | $577,239 | $358,168 |
How Can We Help?
If you’re good with spreadsheets, you can easily create a template to calculate total returns yourself. But if you want an easier way to calculate total returns, we created a free tool for your Toronto income properties. After inputting your income property’s details like price, renovations, interest rate, and investment period, our calculator will display your total returns and a breakdown of returns by cash flow, equity gained, market appreciation.
Since the money you make from income properties are from four different sources, there’s a higher security of returns even when one income stream is affected. With a mortgage, you can put your cash to highest and best use to generate even better real estate investment returns.
Ultimately, the best Toronto income property for you is one that fits your requirements, preferences, and experience. This means you shouldn’t choose a property just by looking at the highest returns. For example, the returns of properties requiring major renovations can look attractive on paper but it’s not easy. So, we recommend starting off with a simpler project first to understand the basic first.
If you’re new to real estate investing in Toronto, we’re happy to help. We can analyze your investment profile through a free discovery call, then give you our best suggestions on how to get started with income properties in Toronto.