Why Is There A Rebound In Toronto Real Estate In 2023?
You may have heard or even experienced that even with today’s high interest rates, offer dates, bidding wars, and selling for a few hundred thousand more than ask are now once again happening in today’s market.
Over the past few months, buying demand has been picking up, inventory hasn’t come up at the same levels, and so this buildup of demand has been creating higher selling prices that don’t really make sense to real estate investors anymore.
So what exactly is going on? Where are we going to go from this point on? Where do numbers still make sense for Toronto real estate investors?
Starter Freehold Price Trends
Take a look at this chart that shows starter freehold price trends in Toronto over time. We did see prices shoot up in Q1 of 2022 right before rate hikes and then drop back down equally quickly over the summer of 2022 by 25%.
But ever since Q4, demand has been picking up, and more recently, this has led to prices rebounding to not exactly peak levels but definitely higher than where they ended in 2021.
Toronto Real Estate Investor Mindset
As real estate investors, we look at fundamentals. Numbers might still work with cap rates at 5.5% once you factor in appreciation at a conservative 3% per year as well.
But now that cap rates are dipping down to close to 5%, we’re likely to be cash flow negative at current interest rates; it gets harder to justify buying investment properties with a 5% cap rate considering the risk-free government bonds are at 5%.
Toronto End User Mindset
But obviously, we are seeing the demand pick up in Toronto, and here’s the thing: end-user buyers are the ones outbidding investors and continuing to drive prices higher, and that’s because the mindset is pretty different.
We’ve heard many stories of renters who have been forced to move and simply don’t want to rent anymore. and the argument to move looks better these days since the purchase price is actually more affordable nowadays because of the price drop.
Families separate, families are created; there are many reasons why people need to buy a home, and for the past few months, there just wasn’t enough inventory to go around.
Another thing is that, towards the end of last year, 5-year bond yields started to come down and people were locking in fixed rates at 4.5%. Now that the rate hold is close to expiring and bond yields are coming up again, that’s another reason why we’ve been seeing more buying action lately. And then it also looks like cash buyers are also picking up, and they obviously don’t get impacted by higher rates.
So all of this is causing the end-user buyer pool to grow, but inventory is still subdued, and that’s what’s been causing the unexpected price gains lately.
This wasn’t as obvious in the December and January data since there was limited activity in general, but we do see a lot more of this reflected in the February data.
Eventually, we suspect that as more news outlets pick up on this, we’re probably going to see even more upward price movement in the short term until hopefully a bigger influx of spring inventory comes onto the market. Once that happens, we do expect prices to stabilise with a better balance of supply and demand plus pent-up demand getting flushed out.
What Does This Mean For Toronto Real Estate Investors?
So, what does it mean for us as real estate investors? It has been harder for us to find properties where the numbers can work, but we still stand by the fundamentals.
We still insist on slightly positive cash flows for security, but also keep in mind that maximising total returns should be the ultimate goal for an investor. Basically, you’ll have to accept that the cap rate vs. risk-free rate cap will be compressed, but this isn’t a permanent thing and will have the potential to improve once rents go up or rates come down, so chasing maximum cash flows shouldn’t be the top goal.
I mean, you can get much higher cap rates outside of core Toronto, but that’s usually because appreciation is simply not the same. And if you look at total returns, Toronto still makes more sense, especially when you also factor in a better tenant pool overall in Toronto.
But if you have a similar mindset about choosing Toronto, you would have to be a lot more selective with what to invest in. The key is really to go to markets where end users don’t, and that’s always going to be properties that need renovations.
Just put yourself in the shoes of an end-user buyer.
If you’re going from renting to buying, then you typically don’t have a lot of capital, and you might end up having no choice but to buy a house that is all done up because they actually require less capital compared to one that needs renovations since you can’t get a mortgage for the renos.
If you’re moving upsizing, then it’ll be harder to figure out living arrangements while you’re renovating, and that’s why most also opt for renovated homes.
Even if you’re an end user that’s not in those categories, you might still not want to deal on renovations, and all of these reasons are why investment properties that need big renovations make the most sense to us these days.
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