Welcome to this month's installment of Dear Urbaneer, where our readers put our real estate knowledge to task with their questions. This month, a reader asks for Steve's guidance on purchasing an investment property in downtown Toronto based on his available capital.
I was recommended to you by one of your existing clients, who continues to find your knowledge insightful and your level of service excellent. I have been an investor in Montreal for several years. One of my children lives in Toronto, so I thought I might begin building an investment portfolio in your City. I am willing to spend upwards of $1million, with $200,000 in capital available as a down payment.
Would you have any property ideas I might consider?
Signed, Investment Savvy
Here's my reply.
Dear Investment Savvy,
Thank you again for reaching out to me to explore the Toronto real estate market. I enjoyed our conversation and your insights on Montreal and the property portfolio you built. Your systematic, rational approach to investment has served you very well! I applaud you.
You indicated a preference to purchase a property for $1,000,000 or less, with a $200,000 down payment. My calculations here are using a mortgage interest rate of 2.6%, paid monthly, with a 25 year amortization. Note, as interest rates change, your capacity to generate a return will change.
A couple of questions first, if I may:
1) Does the $200,000 down payment also have to cover the property closing costs? In Toronto, Ontario, both the provincial and city governments charge Buyers land transfer taxes which, on a $1,000,000 purchase are nearly $33,000. Here's a link to my site on the The Closing Costs For A Property Purchase In Toronto. If yes, you'll see in my financial assessments of property examples the margins just aren't there without additional capital.
2) Given their age and condition, many freehold properties in your preferred price range will require some initial investment for maintenance and repair. Are you willing to invest additional funds into a property purchase? I recognize the value in purchasing something in solid condition but most properties do require some upgrades. Here's a couple of my posts on Why So Many Downtown Houses Are Being Renovated - and - Exploring Toronto Property Values which offer guidance on navigating our century-old housing stock.
Freehold Income Properties
As I mentioned, one of the challenges in purchasing a freehold investment property in Toronto is the ongoing maintenance and repairs. Our housing stock tends to be over one hundred years old, so most buildings are going to have building components which range dramatically in age and condition. Given that house prices have increased substantially - particularly over the past five years - you'll pretty much need a dwelling which has two or three suites in it to carry the costs. The upside to buying a freehold property is that they have historically increased in value at a faster rate than condominiums (I wrote about this in High-Rise Versus Low-Rise: Exploring The Toronto Real Estate Gap - although interestingly, this year's stats show downtown condos escalated at a faster rate. I attribute this to affordability, and because the price of entry for a turn-key city dwelling hovers around $1mil, requiring a minimum 20% down, which narrows the available pool of Buyers). Ultimately the upside is a freehold property is more likely to hold its value as land (if anything, we're tearing down houses to build more condos) - which makes it the safer bet - but it does require one to reconcile there will be more operational headaches. This post is an essential read for any buyer of a freehold property, called Understanding The Six Essential Layers Of Property.
I completed a search of the central city for income properties (spanning The Beach west to High Park south of St. Clair) up to $1,000,000. There were only three that loosely aligned with my vision for investment, though I'd want more information - like a home inspection report, city zoning confirmation, and specific operating expenses - to be certain of this.
First, there are some fundamental risks when buying a Toronto freehold income property. Most dwellings are not legally retrofitted or zoned, which means 95% of the income properties being sold downtown are being sold as 'single family residences' with no retrofit warranty nor confirmation of legality. Because of our housing shortage, the City doesn't enforce legally retrofitting houses but if a neighbour complains you could find yourself having to comply or evict your tenants. It's a potential nightmare. Here's one of my past posts worth the read called Can I Have An Income Suite In My Residence?
Here's what I consider a bit of a horror show in the east end near Danforth and Woodbine on a busy arterial road - listed for $978,000 and 41 days on the market. The gross income is $51,666 and the annual expenses are about $13,238 (though note this is before accounting for annual maintenance and repair, advertising and promotions, and accounting for any vacancy). The rents are low relative to the city, which reflects the condition of the property and smaller size of the units --> Apt A $928, Bach $888, Rear Apt $1,253 & Apt 2 $1,236. To make this work financially - at best - you'd have to secure the property for under $850,000 (plus closing costs), put $200,000 down, of which you'd only generate a profit of $3000 a year after expenses. I'm not a fan of this, nor do I consider it an opportunity.
This triplex - located in transitioning 'Little India' which is not without its charm - intrigues me. I'm not definite that it was purpose built as a duplex (it's feasible) as Land Registry states it's a duplex, presumably with the (illegal) basement suite being added later. It dates from 1958 which was an era when houses were built with longevity in mind - albeit utilitarian - so I'm anticipating the basement has decent heights and the house is solid concrete block and brick. Incidentally, I happen to be transforming one of these purpose-built duplexes myself in Riverdale which I'm writing about in The Tales From Tennis Crescent. The income statement lists the Gross Income at $40,800, with a net income of $36,412. Listed at $999,000 for 41 days, this numbers don't work at the list price. From my assessment, this is one of the opportunities where you'd want to immediately invest upwards of a 100k to elevate the one vacant suite and any failing building components (those windows look old) which require attention. Right now the monthly rents are listed at $850 for the lower, $1250 for the main and $1300 for the upper, but these could be easily be $300 a month more with improvements while reducing your maintenance and repair. However, the numbers don't align to make financial sense. Right now you'd only just break even with a purchase price of $850,000 (plus closing costs). However - for me - at the right price I consider this a contender for size, condition and opportunity. I tend to prefer houses sixty years old or newer, unless they've been substantially rebuilt.
This multi-unit house in hip Roncesvalles Village is on a busier street next to a mid-rise and opposite a new condominium under construction. Sold for $781,500 in August 2016, it was renovated by the current seller and has been subsequently listed 3 times, anywhere from $1,099,000 to its current price of $998,000. Having sat on the market for awhile now, I'm guessing it looks better in the photos than in person. Also, the listing realtor hasn't posted any rents (proposed or otherwise) on the listing so it lacks critical specifics. I'm ball parking the monthly rents would be around $1600 for the 2 bed, $1400 for the one bed and $1200 for the lower level - with expenses of around $10,000 per annum. That would net about $40k per year, meaning a $950,000 purchase price (plus closing costs) would see you just making ends meet. I want to be upfront and say I don't have enough information to offer an objective opinion about the property but I will say most investors are drawn to dwellings which have been upgraded and require less work. If this was done with sufficient care and attention to detail. There's a 200k spread between its original purchase price and current list price, and with buying and selling costs accounting for about 75k of this - plus carrying it for 10 months at about 25k - to total 100k), a prudent buyer would explore how much of the 100k balance was spent on the property versus potential profit.
With regards to the condominium market, my recommendation for both investors and end users is to try purchase the unique when possible, as it's more likely to protect your value if your unit has special qualities, whether it's being more loft-like, has outdoor space, or a view. I also encourage my Buyers to choose a location where there are fewer condominiums situated in village-neighbourhood settings, as you have less competition and values are supported with fewer product. After all, if you own a unit on the 9th floor of a 50 storey building in Cityplace (for example), then your value is not only predicated on the most desperate of 300 other unit owners having a similar layout in your own complex, but also all of those owners in the surrounding buildings of a similar vintage. Here's my post called Five Points to Ponder Before Buying a Condominium.
I ran the numbers on four reputable condominiums I like in downtown Toronto - ranging from Dundas/Ossington, Bloor/Bathurst, and near the St. Lawrence Market - all vibrant neighbourhoods - listed from $750,000 to $925,000. I favoured these 2 bed for their unique qualities - which included generous square footage on multi-levels, a wraparound balcony with cityviews, an expansive terrace with barbecue, and high ceilings with top notch finishes - but the numbers simply don't work. Market values for condos shot up this year, evaporating potential returns on investment. Although these suites would rent anywhere from $3000 and $3600 per month, given their high taxes and common fees (totaling about $950 to $1100 a month), with 20% down you'd be running a negative sum of around $700 up per month with 20% down.
- 55 Halton Street - 33 Lombard Street - 783 Bathurst Street - and - 112 George Street, Toronto -
I analyzed these four 2-bedroom condos in reputable buildings situated in the central core - near Yonge/Bloor, Yorkville, Yonge Carlton + Yonge Wellesley (near hospital row) - offered for sale between $635,000 and $719,000. These are a bit more standard in their quality and configuration (I favour a split bedroom floor plan) - though they're in calibre buildings which rent well. They rent for sums ranging between $2500 and $2900 per month, with property taxes and common fees varying from $800 to $1050 per month. Even if you place $200,000 down on these purchases, the shortfall between income and expense run around $200 to $300 per month. And this doesn't take into account the risk of increasing common fees and property taxes, which are a given.
- 110 Charles Street East - 80 Cumberland Street - 21 Carlton Street - and - 22 Wellesley Street East, Toronto -
It wasn't until I ran the numbers for these four 1-bed condos (one also has a den) with no parking - listed from $429,000 to $459,000 - near the Distillery District, St Lawrence Market, Jarvis/Wellesley and Yonge/Dundas - that the numbers work - with a $200,000 down payment (almost 50% of a purchase!). These units rent for between $1800 and $2000 per month, with the common fees and taxes ranging from $480 to $580 per month. Your return is between $150 and $400 a month - which is a dismal return of one percent per annum.
- 33 Mill Street - 1 Market Street - 281 Mutual Street - and - 210 Victoria Street, Toronto
Based on these examples, it seems quite a high risk to sink $200,000 into a condominium that - under the proposed Rent Control Legislation - will only give you a one percent return assuming there are no increases in expenses. The skyrocketing prices in downtown Toronto have reached a threshold that it doesn't make financial sense, especially when the Provincial and Federal Governments are implementing housing measures to cool the market, putting the brakes on property value escalations which once secured a favourable return. Whereas investors were snapping up properties - not for their income stream - but for the future escalation in value (which served as a viable strategy up until recently), even that certainty is now at risk. Wouldn't you agree? Here's an article in The Globe And Mail from March 22nd, 2017 which told the story "Speculators Super-heating The Toronto Real Estate Market."
What About Buying A Condominium Pre-Construction?
A lot of investors in the past have purchased from developers pre-construction with the aim of flipping the Agreement of Purchase and Sale prior to registration (known as 'assigning the unit') - or even closing on the trade and selling it after the condominium has been legally registered with an existing tenancy under lease. First, there are a number of risks associated with this, which I wrote about in On Buying A Toronto Condominium Pre-Construction. Also, be forewarned, the Government is on guard now to begin looking at practices that may be contributing to tax avoidance and excessive speculation in the housing market, such as "paper flipping" — a practice that includes entering into a contractual agreement to buy a residential unit and assigning it to another person prior to closing. That's briefly addressed in this Globe and Mail article called 'We Know We Have A Problem': Ontario Lays Out Sweeping Measures To Curb High Rents, Home Prices
Did I Miss The Opportunity To Invest In Toronto Real Estate?
Although the increase in prices this year appear to be making investing in Toronto real estate challenging, there are always opportunities that present themselves. However, it requires a combination of being patient waiting for the right property and then being fully prepared to act on securing it when it does get listed for sale. Here's two income property sales that demonstrate what I consider solid buys, recently purchased by my investor clients. These posts have additional informative links to other posts on Investing in Toronto.
An Alternate Strategy If You Have Deep Pockets
For those whom are willing to brave converting a single family residence into a property with one or more income producing units, here's my article on what to look for, in How To Strategically Purchase An Income Producing Property. As far as I'm concerned, this might be the best strategy for an investor to garner a return on their capital, although it's not for the faint of heart. It also requires time, a familiarity with renovating and/or upgrading property, and additional investment capital to convert a dwelling into multiple units (and potential permit fees and development charges from the city).
It looks like Toronto real estate prices need to drop in order to generate even a modicum of return. Expect the driving forces of this transitioning market to see a withdrawal of investors actively buying, but instead sleuthing for better opportunities. Curious to know where I believe the Toronto real estate market is headed? Here's my Summer 2017 Forecast Part One and Part Two which offers my point of view on our transitioning housing market.
Are you seeking prudent guidance on building a long term real estate investment portfolio - from realtors who aren't afraid to tell you to wait while becoming educated and informed? Or perhaps it's time to explore divesting some of your property assets? At urbaneer, my team and I are here to help with all of your housing needs, without pressure or hassle.
~ Steven and the Urbaneer team
Steven Fudge, Sales Representative
& The Innovative Urbaneer Team
Bosley Real Estate Ltd., Brokerage - (416) 322-8000
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