I wanted to verify my hypothesis, so I went back to see how Toronto real estate reacted as interest rates changed over time, and the results are super interesting. In my simplified analysis, I split the data into three segments: Toronto detached homes, Toronto semis, and Toronto condos. 

Detached homes in Toronto are the most expensive, and these homes are typically owned by end-users rather than investors.

Semis are cheaper and attract a good balance of end users and investors. Just so you know, semis attract a bigger relative investor pool because the entry price is cheaper and rent yields tend to be better than condos but even better than detached homes. What we find is that for the same sized home in the same neighbourhood with similar rents, semis tend to be cheaper to buy than detached homes. So what you end up with is that your rent yields are better, which is better from an investment holding power and returns standpoint. 

Finally, we have our condos, and we know these are very popular with investors because they are the easiest pieces of Toronto real estate to get into; they have the lowest price and they make a more passive investment. 

When there are more end-user homes like detached properties, lower monthly payments mean better buying power just like what we talked about, so these homes tend to shoot up more quickly. We also see that semis do just as well as detached homes when they have more investors in the mix. On the other hand, condos, which have a major chunk of investors, don’t do as well.

So let’s try to make sense of this and the big difference here is that the cash flow position plays a big role for investment properties when our economy is in a downturn. When things turn south, consumer goods and services tend to drop in price, and this affects rent as well. What we also notice is that luxury goods and services tend to drop more during these times, which is why condo rents usually see bigger drops. Based on the last downturn, interest rates dropped by 1.5% and condo rents came down by 20%. So the net effect is that cash flows actually got worse for the condo investor, which is why there’s less room for condo prices to come up.

But if this is happening to condos, how come it didn’t seem to have an impact on semis, which also have a big investor pool? Well, semis are different from condos because their cash flows are different. To begin with, we’re looking at stronger positive cash flows instead of negative cash flows.

Then, freehold rentals are less luxurious, I would say, so rents actually don’t get as affected in a downturn. So, instead of dropping 20% like condos in the last 2 years, freehold rentals dropped closer to 10% in rents. When you combine a smaller drop in rents with improved mortgage rates, the cash flows for semis actually look better when rates drop. So, this gives more room for freehold investments to go up in price.