What’s Ahead for Toronto Real Estate For 2021 to 2022?

What's Ahead for Toronto Real Estate For 2021 to 2022?

The Toronto real estate market is heating up again but this time there’s a lot more moving parts like more prices sensitivity as home prices have already gone up double digits in most markets this year already, and a recovering economy means interest rates and rents are also on the rise. In this video, we’ll talk about how all these factors come together to steer different submarkets in the Greater Toronto Real Estate Area including the GTA suburbs, Toronto condos and Toronto houses.

Why Investors Choose Real Estate

If you’re choosing what to invest you, you’re choosing the best option out of what’s out there. Right now, real estate continues to outshine the rest. In terms of stocks, inflation and supply chain concerns continue to dampen recovery stocks. In terms of growth stocks, interest rate concerns are now lowering current stock prices and overall, there’s much lower upside potential in stocks compared to a year ago. Rent yields still perform better than bond yields, even if you’re purely looking at yields.

On a relative basis, real estate looks like a pretty attractive option from an appreciation and rental income perspective, and even better after leverage, so this is why we continue to see steady interest from new and returning real estate investors.

Key Driver For Real Estate Ahead

Having said this, the overall real estate market took a breather for most of Q2 and Q3 2021. And after getting settled in after the summer, investors are becoming more active again. At the current moment, the real estate market is very strong, but supply hasn’t come back at the same pace, so what we’re left with is more buying competition, causing real estate prices to soar again.

But unlike what happened in Q1 2021, there is one prominent theme this time around that is significantly different and I’ll walk through this a bit more so you can see it more clearly. Since the start of the pandemic, real estate prices have been climbing. This was actually okay because interest rates were dropping, so the two end up cancelling each other out. In other words, it was okay up to a certain point.

Beyond that point, prices continued to climb and there’s no more room for interest rates to go up. In fact, rates are expected to head up sometime next year. We’re now in a situation where any upward movements in interest rates or upward movements in prices will negatively impact a home owner’s holding power. And so, a real estate market’s holding power will be the biggest factor that might steer their prices one way or another in the short to medium term.

GTA Suburbs

Let’s look at the GTA suburb market first because it’s an easier market to dissect, with the market mainly dominated by end user buyers. When it comes to holding power, there’s one less variable of rental income that comes into play when analysing the market. As a whole, the GTA suburbs have seen the best run since the start of the pandemic. People didn’t need to live in the core and wanted to take advantage of low interest rates to buy their first house and flocked to the suburbs.

As a result, real estate prices in the suburbs jumped 43% between February 2020 to September 2021, which is insane.
When it comes to carrying costs for end user home owners, their biggest cost is their mortgage payment, which can vary depending on real estate prices and mortgage rates.

So let’s see how holding power has changed in one of the GTA suburbs, Oshawa. In February of 2020, average detached homes were $625,000, mortgage rates were at 2.5%, which means home owners would pay $2,000 each month in mortgage payments.

Then the pandemic happened and interest rates dropped to 1.6%. At this point in October of last year, Oshawa’s average prices rose around 10%. Lower rates cancelled out with higher prices, and so the monthly mortgage was still at $2,000 and there was no change to holding power.

Obviously things didn’t stop there. Oshawa property prices continue to go up, and right now it’s at $930,000. That’s almost a 50% increase since COVID started! This takes the monthly mortgage payments from $2,000 to $2,600, and forking out an extra $600 each month is definitely a lot harder to carry a home compared to before.

We’re in another wave up again because we’re hearing talks about rate hikes again, so we have another wave of home buyers, possibly the last, who still want to take advantage of lower interest rates to get into a home. With the momentum we’re seeing combined with the lack of inventory, it’s very possible to see another big leap here because end users tend to act emotionally and overshoot in prices.

If real estate prices go up by another 10%, mortgage payments will be close to $2,900, which is almost 50% more than what buyers were paying pre-pandemic. Realistically, that’s really stretching finances way too thin for the typical suburban end user buyer. When that happens, we might start to see holding power start to let go, which might lead to our first big pullback in suburb prices until mortgage payments normalise back to where they were before the latest jump.

Then we have a recovering economy, which may take buyer demand in the suburbs lower as it becomes less attractive to live further away from the core. The second part of a recovery economy is interest rate hikes, which will put more stress on the already thin holding power. Higher rates bump up mortgage payments and might be the catalyst for the second round of pullbacks in suburban prices. As a reference, each 25bps increase in rates will mean that property prices need to come down by 3% in order for mortgage payments to remain at the same levels.

Toronto Condos

Let’s move onto Toronto condos, which are the complete opposite of the suburbs. Instead of being driven by end users, Toronto condos are dominated by investors. So instead of just looking at mortgage payments, it’d be more accurate to look at the net cash flow situation, which takes into account rents, prices, and interest rates.

When you do this, you can see that before the pandemic, an average Toronto condo was around $725,000 and it could be rented out for $2,700. After operating expenses and your mortgage payment, you would have to take $300 out of pocket each month to hang onto your condo, and that was something that condo investors were fine with.

Then the pandemic caused condos in Toronto to sit empty. No rent means cash flows went from  -$300 to -$3,000. The end result was that landlords had to drop rents by 20%, and some others were forced to sell, and so condo prices also dropped by 15% at their lowest point last year. 

The upside is that rents have recovered 5% over the summer because of more rental demand from students coming back for school, immigration opening up again and some workers heading back to work and there’s more expected upside potential for rental recovery. Because of this rosier forecast, condo prices also recovered, and right now, condos are sitting close to the prices seen before COVID started.

At the moment, rents are still lower than the peak at $2,400 for the average condo, but interest rates are also lower at 1.6% instead of 2.5%, so the two cancel out for the most part and cash flows are sitting at -$400 per month, which is mostly manageable for investors. 

Another important factor that’s different is that investors are less emotional with their buying, especially after what we went through with condos during COVID. Relative to the suburbs, we expect less overshooting of prices in Toronto condos, and price movements will follow closely with rent growth.

If rents go up by 10%, then condo prices can go up by a similar 10% and cash flows will stay more or less the same at -$400 per month. When condo rents recover completely, going up 15%, then condos will comfortably go up by a similar 15% and cash flows will also stay somewhat the same.

The second thing to monitor in the Toronto condo market would be interest rate movements, which will limit condo price growth when they do go up. This doesn’t necessarily mean condo prices will go down, because rents are still climbing upwards when things recover. However, when rates start to hike, condo price growth will start to climb slower than rent growth. Remember, a 25bps increase means property prices need to come down by 3% for mortgage payments to remain the same. As an example, if mortgage rates go up by 25 bps and rents go up by 10%, then property prices might only go up by 7%.

So, compared to the suburbs, Toronto condos will actually see fewer violent price swings and less downside risk. Instead, we expect slower, more calculated price increases which might be suppressed by upcoming rate hikes. 

Toronto Freeholds

Finally, let’s see where the freehold market in Toronto might be headed, with demand being more of a mixed bag of end users and investors. Having said that, end user markets in Toronto have very few investors because rent yields don’t make sense in those areas. At the same time, you also don’t see a lot of end users in investment heavy areas because they’re less family-oriented. So assuming that most of us watching are investors, I’ll laser focus in on the investor freehold market in Toronto.

In terms of cash flows pre-pandemic, you can get starter freeholds at around $850,000. If you split it into two separate units, the upper getting $3,000 and the lower getting $1,600, you can get a combined monthly rent of $4,600. After operating expenses and your mortgage payment at 2.5%, Toronto freeholds were positive cash flowing at an amazing +$1,000 per month.

We saw the suburbs first surge at this point in October of last year, but Toronto freehold prices were more or less unchanged. Freehold rents in Toronto were down 10%, and this was offset by lower interest rates, so cash flows didn’t change much. They are still close to +$1,000 per month.

Then, we all know everything went up in Q1 followed by a lull in Q2 and Q3, so now prices are “just up” by +15%, which isn’t nearly as crazy as what we saw in the suburbs over the past two years. This takes starter freehold prices up to $1M, and therefore, cash flows are now sitting at a lower +$450 per month.

Cash flows are compressing, but holding power is still fine in the freehold market! I talk to many new investors and sometimes investors tell me they don’t care for cash flows. It’s true that you should look at the complete picture, including appreciation, but if you’re looking at Toronto condos vs. houses, you’ll find that they have similar long-term appreciation, but houses have better cash flows, which means houses have better total returns. What’s more is that cash flows become a safety buffer in case things turn south. Choosing markets with better cash flows will ultimately mean stronger holding power and a more stable real estate market.

Right now, the supply for Toronto freeholds is tight and demand is strong, so we do expect another wave up on the freehold side as well. Giving our safety buffer, if rents and interest rates don’t change, prices can still go up by another 15% before cash flows turn negative for investors.

Another thing to remember is that when it comes to investments, there’s less attachment to a home. If the price becomes attractive enough and cash flows become less attractive, long-term investors might end up cashing out earlier than expected and reentering when things normalize. So if that happens, we might see a better balance of supply and demand.

Finally, unlike the suburbs where rents haven’t changed much, Toronto’s freehold rents are still down around 10%, which means more upside potential for cash flows. If rents bounce back by 10%, then Toronto freehold prices can go up another 15% and maintain the same cash flows. If you add in a 25 bps rate hike to the mix, Toronto freehold can still go up 12% while keeping the same cash flows.

Our Toronto Real Estate Market Forecast 2021 - 2022

As you can see, holding power will be a very prominent theme moving forward and will likely be a key driver of real estate prices. What this means is that markets that have the weakest holding power, which in my opinion is the suburb end user market, will likely be the first market to peak. After that, real estate prices in the suburbs might make their first adjustment downwards. Even after the adjustment, they will still be more vulnerable than other markets and might make further price adjustments once interest rates start to hike. 

Toronto condos have more going for them, with more expected rent increases and the least growth out of the three markets, which gives it more room for price increases. But because condo investors are already cash flowing negative, prices will likely get tamed by interest rate hikes.

Out of the three markets, it’s clear that Toronto freeholds have the lowest risk from a holding power perspective with a positive cash flow buffer. There are also other good things going for this market. Rents still have room to go up, which can further bump up property prices. In the long run, a lack of land for houses in Toronto also means this market is fundamentally stronger than the rest when new housing supply gets built in the suburbs or with more condos.

Toronto freeholds have the best historical returns, the most stable market, are most likely to reap the best appreciation moving forward, and, of course, they are our favourite choice. But if you can’t afford it and wonder if you should wait to see how things pan out in the condo market, just remember it’s really hard to time the market and catch the lows because they don’t last long. 

Chances are you’ll be able to snag a couple of percent off, but that’s a big “maybe” because we don’t expect condo prices to fall much. So instead of timing the market, it’s always best to just start investing in real estate when you’re ready. This way, you’ll be able to start collecting rental income immediately instead of waiting for an indefinite time, and you’ll most likely be better off this way.

How We Can Help

We’re big believers in investing in freehold houses in Toronto and if you want to chat more about this, we’re ready for you! We can look at your requirements and preferences and then match you up with the best investment property that fits your needs. After we help you buy it, our team also provides renovation guidance, leasing and property management if you need it. Just connect with us if you want to learn more about our services!

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