Improve Toronto Real Estate Returns: Secondary Suites, Laneway Suites, Garden Suites!
Watch to video to learn why secondary suites, laneway houses, and potential garden suites make sense for real estate investors and how much your Toronto investment real estate returns can improve if you take these on!
Demand for housing continues to go up in Toronto. We have tech companies opening offices in Toronto, Ottawa injecting $15M of funding into tech firms in Toronto, more people buying investment properties, and companies moving up the timetable for back to office and our supply really can’t keep up.
One way we’ve been increasing supply is to get land rezoned, convert existing buildings into condo friendly zoning, designing and building condos which multiples supply. But there’s still a lot of land that’s taken up by individual house owners. So a shifting focus for the city is to build up density on these properties while keeping those homes intact.
In this video, I’ll talk about why these densification opportunities such as secondary suites, laneway houses, and potential garden suites make sense for real estate investors and how much your real estate returns can improve if you take these on.
Since 2000, Toronto started allowing secondary suites in existing semis and detached homes that’s been built for at least 5 years. These are self contained legal units for another household to live together under one roof with a separate kitchen, bathroom, and entrance. Other cities in The GTA have much stricter zoning requirements for secondary suites, meaning it’s just not as easy to get these done.
In comparison, Toronto has opened up secondary suites to all houses because Toronto needs the extra supply unlike other cities that have plenty of land to grow. Initially, it was only allowed in semis and detached houses that’s been around for at least 5 years. Now the city made things more lenient by allowing new homes and townhouses too. If you build a basement apartment, how would you capital requirements and returns change?
Real Estate Investment Returns: Single Family Home
Let’s dive into an example with a starter freehold in Toronto – these are typically semis or smaller bungalows priced at around $900,000. From an investment standpoint, it’s already a pretty good investment. We’ve consistently seen much better appreciation compared to borrowing rates, plus you’ll also have rental income to pay for operating costs so yes, it’s a good investment.
This is also the easiest investment to get started with and since you don’t have to put in any work before you rent it out. In exchange, houses rented as a whole will get lower total rents, so rent yields aren’t as good meaning your holding power is weaker.
You can pay 20% down for investment properties so after closing costs you’re looking at around $210,000 of capital. A whole house rents for $3,200, minus expenses and a mortgage at 2% with 30 year amortization, you’re left with negative cash flows of $370 per month.
A side note here is that this is better than condos – the big difference is that houses have lower operating expenses without condos fees. if you compare rent yields, or cap rates, calculated by taking your net rent before mortgage expenses divided by your property’s price, we’re at 3.1% for this single family house vs condos which are now at 2.7%. So based on 5% annual appreciation plus rental income, this translates to a 5 year total return of $235K or an annualizes ROI of 16%.
Real Estate Investment Returns: Adding A Secondary Suite
Now let’s change up the situation and add in a secondary suite into the same property. We’ll put in a separate basement apartment. This takes more work on your part, more risk since you’re dealing with more unknowns and will cost you an extra $50,000 at least. This brings your total capital required to $260,000. Higher risk, higher reward and if you do it right, you property value will increase by more than you put in.
Based on experience your property will typically be appraised at around $1.025M after renovations, if you take out the extra $50,000 that you put in for renovations you gained $75,000. Next, let’s look at rents which increases because you have two units instead of one. Your upper unit goes can be rented for $2,550 and the basement apartment can be rented for $1,600 so now your cash flows are at positive $580.
This improves you holding power since you don’t need to put extra money into the property each month and when you look 5 years out, your total returns are at $401,000 with market appreciation, value add appreciation and rental income, which is a better annualized ROI of over 20%.
Real Estate Investment Returns: Adding A Laneway House Or Garden Suite
Now let’s take densification one step further. Your backyard has valuable space that can be made into livable units too, and that’s where laneway suites come in! In 2018, Toronto started allowing owners to build houses in the backyard if you have a laneway and starting this year, fire access requirements are now more lenient so it’s even easier for you to be able to build a laneway house.
What if you don’t have a house with a laneway? The city is working on that too and these are called Garden suites. It’s not yet approved but definitely in the works with a planned rollout as early as this summer. If you stay tuned to our channel, we’ll update you once we get more news about this!
A laneway house costs at least $270,000 to build, which can be funded with a construction loan for this. If you can access funds elsewhere, another alternative to simplify the process is to fund it upfront first, then refinance to take the cash out as soon as possible after the project is done.
So now with our house and secondary suite, let’s keep our calculations simpler and look at adding a laneway house without a construction loan. Our capital requirements will go up to $530,000. Once construction is done, you can conservatively rent the backyard house for $2,000 while expenses might go up by $500 per month, so your cash flows improve by $1,500.
Here’s a trickier part. Because laneway houses are so new, it’s harder to appraise these properties because of a lack of sales data. One way to appraise it is by looking at cap rates, but then you also run into what cap rate to use. A higher cap rate means a lower property value. From a bank standpoint, that’s most likely their stance so we’ll keep a higher cap rate of 4% to get the new market value, bringing the property’s price to $1.41M. This means you made $190,000 from value add and your total 5 year returns is $1.18M or an annual ROI of 24.5%.
Refinancing To Improve Real Estate Returns
Remember how we talked about refinancing the property after construction? Right now, even with better returns, we’re actually underleveraged and sitting on a lot of equity compared to the other scenarios.
So if we go back to refinance the property, we can pull a good chunk of equity and improve our leverage. In this example, if we increase our loan to 80% of the property’s new value, we can pull out over $400,000 which brings down our capital in this investment to $135,000.
Cash flows do drop but equity paydown goes up because we now have a bigger loan. At the end of the day, less capital in the investment is the biggest factor that brings up our ROI drastically. The 5 year returns in this case is closer to $1.14M or a massive 5 year annualized ROI of 54%.
How We Can Help!
Value add opportunities are often higher risk especially if you haven’t done this before. These numbers only work if you get the renovations done on time and on budget.
That’s where we can help. By working with our team, you leverage our real estate investing and renovations experience which reduces your risk while generating these higher returns. If you want to learn more about the different types of residential real estate investment opportunities there are in Toronto and what would be good for you, reach out to us so we can chat!
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