Why Toronto Real Estate Investing Needs To Be A Long Term Investment (Don't Flip!)

Introduction

We’ve been hearing slightly less news about Toronto real estate in the past couple of weeks, and that might be because the August data came out pretty mixed. But even though things didn’t change as much last month, we’re currently down 16% from the peak, and that’s not a small number at all and we anticipate more bumps ahead in the short term because the Bank of Canada doesn’t seem to be done with rate hikes just yet.

And so, this is our warning video. If you’re thinking of making a quick buck over a short period of time, don’t do it with real estate. I know we’re a real estate sales brokerage, but we honestly don’t think this is a good idea and so, here’s a video all about why short term investing with real estate isn’t a good idea.

Toronto Real Estate Short-Term Performance

Toronto freehold prices have dropped 21% to 27% from the peak so far, and right now, 416 semis is currently the leading loser. Some people might feel like this is just the beginning, but if we’re talking about a house that was priced at $1.5M back in March, it could be worth close to $1.1M now, and that’s a $400,000 drop.

And when we dive into the August TRREB data, we are starting to see some signs of price support. Once 416 detached homes fell back to January 2020 levels in July, buying action came back in which led to a 9% price increase for August, so now it’s hovering around Q2 2021 levels. On the other hand, 416 semis didn’t fall as much in July as everything else, so now they’re playing catch up with a bigger price drop last month. The rest of the properties more or less stayed put, and so we’re seeing supports close to prices seen in the first half of 2021.

Basically, buying action picked up a bit and listings remain low and that’s what’s been propping up prices lately. But we just saw another big rate hike in September, and it’s not over yet and these rate hikes will start to weaken holding power. If this translates to more sellers soon, and buyers getting a lower mortgage ceiling because of these higher rates, it’s possible to see prices to fall even more in the short term.

Short Term Real Estate Investing Risks

Day traders prefer a volatile market and we sometimes see this mindset get transferred to real estate. But the numbers don’t really work. Here’s the thing: Real estate has high transaction costs, which is one big difference compared to other asset classes like stocks.

In Toronto, you’re looking at around 3.5-4% that goes to land transfer tax and closing fees when you buy. Then when you sell, you’ll have to pay buyer and seller agent fees, which is around 5–6% of your selling price after HST. So, if you buy a house for $1,000,000, and make 10% or $100,000 from flipping it, you end up barely breaking even after fees and taxes. You also need a lot more money to invest in real estate, and it’s a lot more active work compared to investing in stocks, so it’s hard to make a short term horizon worth it.

Now instead of gaining 10%, let’s see what happens if the market takes a downturn and erases 10%, which is more than likely these days. In this case, you end up losing $185,000 which is almost all of your initial capital – this is a huge likely risk that we’d rather you not take.

Long-Term Real Estate Investment Returns

Now we on our team real estate investors and we do it because the numbers make a lot of sense as a long term investment. Take a look at these numbers. Net rent yields are around 5% in Toronto these days; average appreciation is 7%; and so total returns are around 12% per year before leverage. Of course, appreciation isn’t guaranteed, but based on fundamentals, with limited land to build on in Toronto and our government’s aggressive immigration goals, we’d say it’s a pretty safe assumption that prices will continue to go up over time.

The other thing I wanted to bring up is the fact that you get two buckets of returns when you are a long-term real estate investor: rental income and appreciation, and these often move in opposite directions. So what we have here is more stable, better risk-adjusted returns compared to other asset classes.

Now if we go back to the fees and taxes that made short term real estate investing not really make sense, they still exist for a long-term investments. However, they do get diluted over time. So if we distribute them over ten years, then we’re looking at a much more reasonable one percent per year and the better risk adjusted returns that you can get with real estate justifies this higher cost.

Also keep in mind that if you’re using a mortgage to fund your investment, your rate of return can improve more. Take a look at this chart that compares returns if you were to buy with cash versus buying with a mortgage over a ten-year horizon and you can see that you end up much better off using borrowed money.

Just remember that leverage works both ways; you can be much better off with borrowed money when you make money, and you can be much worse off when you lose money and that’s why you need to have strong holding power so that you can ride through the bumps and reap the long-term benefits.

How We Can Help

If we go back to opportunities right now, I’d say the biggest benefit for buyers these days is that the ball is now in their court. What you see as the list price might not be what you’d actually be paying, and it’s very possible to bargain for more discounts with less competition. You can also take more time to think it through when putting in offers, add conditions if necessary, and generally relax more during the buying process.

But given that we will probably see more downward pressure, you might still think you should wait for a clear bottom-which isn’t a wrong decision. Just note that at that point, more people will want to get into the market and the buyer experience won’t be the same anymore. Prices will also be on an uptrend by then, and you will feel more pressure to act quickly and possibly end up buying at a price that is higher than what you can bargain for today.

So if you’re thinking about buying real estate soon and you want to understand more about what’s happening in Toronto real estate and where the best deals are, we’re happy to chat. We’re a real estate sales brokerage that focuses on investing in freeholds in core Toronto, so we can help you see things more clearly and match you up with the best investment property for you. After we help you buy it, 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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