Introduction
When rents and interest rates were more predictable, it was a lot easier to figure out what prices would make great investments. But in the past six months, everyone seems to have a different view of where rents and interest rates are going, and that’s what’s causing much bigger swings in prices from deal to deal.
Now, more recently, things are starting to stabilize, which means the range is slowly going to narrow again. So in this video, let’s try to figure out where things might settle once things stabilize.
Canada Interest Rates
The typical Toronto investor isn’t looking for huge cash flows. They invest in Toronto because they are looking to grow generational wealth, provide the kids with a separate home once they grow up, and generally reap the long-term appreciation.
Still, holding power is key and might even be more important these days now that we’re reminded of how things can get shaken up. As a result, freeholds are becoming increasingly popular as investments because they generally cash flow positive, with a couple hundred dollars per month to help out in case of emergency.
In a normal market where rents and interest rates are more stable, it’s easy to work out what the purchase price needs to be to give you a couple hundred dollars of cash flow, and because of this, it’s a lot easier to predict how much homes might sell for.
Nowadays, assumptions are all over the place. If an investor is using lower rents from a few months back and thinks interest rates will go up another 1.5%, then the price they’re willing to pay would be pretty different compared to someone else using today’s rents and variable rates.
Yes, variable rates are still rising, and we might still have 1.5% to go. But inflation is stabilizing, we’re probably in for a recession which is going to slow down rate hikes, and if you look at bond yields, they went up and back down and haven’t casually broken the ceiling from June. Essentially, the market is telling us that the amount of future rate hikes that has been priced in has not changed, and because five-year fixed rates are based on five-year bond yields, we are also nearing a peak here, which means that using the current five-year fixed rate for calculations is relatively safe.
Toronto Rents
Next, rents You hear about rent rising, but what we’re finding is that investors don’t actually realize how much rents have risen and how they are equally significant as changing interest rates! A multiplex that could’ve been rented out for $4000 per month a year ago can be rented for $5000 this year, and this is part of what it takes to soften the landing for investment properties.
I wanted to touch on where rentals might be headed. We are still seeing strong demand for rental properties, primarily from new immigrants, and that’s what’s going to keep it strong. But with inflation looking to peak in the coming months, this is also going to slow down rent growth next year.
So, to be conservative, we can stick with today’s rent for our calculations. Now take a look at this example. Based on today’s rents, the upper 4 beds can rent for $3400 and the lower 1 bed can rent for $1600 per month. Operating expenses are around $750, so that takes our operating income to $4250. If we need $200 of positive cash flow, our mortgage payment needs to be a max of $4,050.
Toronto Investment Property Floor Price & Cap Rate
With a 20% down payment and a 5-year fixed rate of 5.25%, the likely floor price would be $920,000. Just as a comparison, if someone was using $4000 in rents instead of $5000, the floor price gets taken down to $690,000. So, accurate market rents make a huge difference.
This $920,000 floor price is very specific to a property with an NOI of $4250, so a better way to figure out whether a property is hitting the average floor price would be to look at the NOI as a percentage of the property price, aka our favourite cap rate metric.
The sample property we just talked about has a 5.5% cap rate, which is probably the average cap rate when the dust settles if you have similar assumptions for interest rates and rents. Obviously, if you have different views, your cap rate would be different… We are actually very interested in the why, so feel free to comment and let us know what cap rate you might be looking for and why.
How We Can Help
Like I mentioned earlier, selling prices are all over the place right now because assumptions are also all over the place. Which means this is the time where you have the best chance to get deals well over a 5.5% cap rate before things get more clear and the range narrows again.
And if you want to find out what the best deals look like in Toronto these days, we are happy to chat. We’re a real estate sales brokerage that focuses on investing in freeholds in core Toronto, and we search the market every day.
When you work with us, we take the time to understand your needs, teach you the ropes, and help you buy the best investment property for you. But that’s not all. Our team also provides renovation guidance, leasing and property management if you need it. So, just connect with us if you want to learn more about our services!
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