I helped a couple of enterprising millennials buy their first investment property in Toronto last week. They are a great example for other would-be, independent investors to learn from. I'll be presenting their story as a case study but before I do, I wanted to take a step back to look at what real estate investing in Toronto is not.
Since investment opportunities are locally specific and ever shifting, many of the age old or more general rules simply don't apply to Toronto investing today. The millennials I worked with were well aware of that. Are you? If you're entertaining the idea of an investment property, it may be helpful to break down a few of the more common assumptions before you begin.
In these scenarios, I'm considering the value of investing in a Toronto property in addition to your primary residence.
RENTAL PROPERTY: THE ONE PERCENT RULE
Have you heard of it? Its logic states that the gross monthly rent should be at least one percent of its final price. Say, a property that costs $100,000 should rent for at least $1,000 per month. If a property fits this description then it is worth buying. If it doesn't fit this description then it is not.
A detailed explanation of the 1% rule can be found at the blog Afford Anything. (Thanks Zoe C for pointing this blog out)
The 1 thing to keep in mind about the 1% rule? It doesn't apply to Toronto. Not in the slightest. You just won't find it here. Anymore. Period.
And yet, Toronto real estate is still well worth investing in. Just with a different financial gage. Here's another one you can't use...
RENTAL PROPERTY: CASH FLOW
If one of your goals in investing in real estate is cash flow, you can do one of two things:
- Stop looking in Toronto (or any major city for that matter) and go way, way out there.
- If by some stroke of incredible luck you've found one that does, buy it. Yesterday! One of the only slivers of the market where I can find this is in the smallest, cheapest, well located condos that can command a steep rent.
The notion that an investment property should cash flow is age old isn't it? It used to be the most basic litmus test that an investment property was worth buying.
You're best to put the aim of immediate cash flow from a rental to bed for good, or in 2008 where it belongs. (unless you're putting down a larger than usual downpayment or are an all cash buyer looking to park your money out of the bank)
RENTAL PROPERTY: THE MULTI UNIT HOUSE
There was a time when this was a great idea in Toronto and in certain areas, where you can purchase a property that isn't structurally impaired, and big enough to divide for under a million dollars, it still is. As a student, I was a tenant on the top floor of a large house on St. George near the university that had four lovely units in it. What a cash tap that house was and still is for its owners. And what a great place they were providing for people to live in too.
With most multi units fetching more than one million now, and mortgage rules being such that you cannot put less than 20% down for a property over one million, and land transfer tax on one million being $32,200 on top of the $200,000 you'll need to put down, you'll need to have at least $250,000 on hand to make that kind of a step into real estate investing.
Handy Land Transfer Tax Calculator Here.
Do you not happen to have $250,000 on hand along with the desire/ability to borrow hundreds of thousands more to invest in something that won't cash flow for another 25 years? The average multi unit property in Toronto is valued beyond reach for most independent investors now, unless part of it is a primary residence.
Should you fit that snack bracket however, you may want to consider it. It is often much less competitive than other areas of the market and a well located multi unit property still sells for less than the single family house next door. It is one of the ways to find relative value in Toronto real estate still. But you are a landlord to many, who not only have a relationship with you, but share a house with one another. They can get along with each other, or not. They can gang up on you the landlord, or not. There is a potential pain in the ass factor here that many shy away from. The others? They take the time to ensure great tenants, or hire a property manager!
BUY/SELL OR RENTAL : PRE-CONSTRUCTION
Likely the most common form of real estate investing in Toronto is the purchase of a pre-construction condo. The assumption here is that whomever is in first, pays the least. The assumption is that with rapid appreciation, by the end of construction, you could sell a brand new suite and profit from your foresight and chutzpah. Or perhaps you could rent it out, then sell it for even more later.
There are so many would-be investors who've been sold this bill of goods. There still are. For the lucky ones, it is usually a break even proposition. For the lucky ones.
Unless bought exceptionally well, in a development that finished on time and built what was promised, while having great terms for selling on assignment without getting dinged for the privilege by the developer, pre-construction is a gamble, not an investment.
The truth is, developers have already factored in appreciation into their pre-construction prices. The fact is, most condos today are sold for their sleek material choices and kitchen appliances, rather than any sort of spatial quality. Kitchens depreciate surprisingly quickly. To replace or fix that built-in Liebherr fridge will be expensive.
So unless you are on the inside with special terms, I would not recommend buying pre-construction. And even then, think twice and check the fine print.
BUY/SELL : FLIPPING OUT
There seems to be no end of eager flippers pouncing on properties to then release them back on the market a year later for much more money. Perhaps you've considered putting your design savvy to good use and do it yourself. The challenge with this approach is...
You usually have to overpay to acquire a derelict or fixer-upper property, precisely because there are so many people with teams waiting for their next flip opportunity. They are in high demand. While I think we're slowly seeing a winding down of this trend (enough people have lost their shirts doing it to never want to do it again), HGTV has still created a surplus of people who think it is an easy way to make quick money.
The truth is, it's hard for anyone without cheap labour to make a flip function financially. So long as the cost of lot size and location are the overwhelming contributors to the valuation of any property, what you add to it is a relatively small margin. So, if you're flipping, you've entered a small margin game, whether it's fair or not. Unless you manage to purchase really well, in a neighbourhood with a long line of people who'll pay a premium to live in a finished property, and you've done your homework to know what people attracted to that neighbourhood are after in a house, your profit margin comes from doing things as cheaply as you can possibly get away with. I don't know anyone who, in the end, finds that kind of work satisfying.
With property appreciation so rapid recently, many flippers in Toronto have done alright. But the truth is, their profit usually has had more to do with appreciation during their ownership than their renovation.
BUY/SELL : NEW BUILDS
Rare opportunities show up for a Toronto lot to be developed from the ground up. These often pose a greater opportunity than flips mainly because of the inherent efficiencies of building new rather than working around old. Even more, the size of the building can be dramatically altered, depending on zoning. Adding interior square footage to a property can seriously impact its value for the better.
Often the biggest financial hurdle with new builds is the end tax. The 13% holy shit tax you get to pay for improving the property from the ground up in order to sell. Unless you plan to make your new build your own residence or you manage to sell it before it is complete, you will owe the government 13%.
While there are HST rebates to the buyer which are then passed along to the developer, here are the new build tax rules and why they make developing in Toronto especially hard. New home buyers in Ontario are charged 13% HST on their purchase, which consists of a 5% federal tax and 8% provincial tax. The new house HST rebate in Ontario kicks back 75% of the Ontario portion of the HST, up to a new home purchase amount of (get this) $400,000. This means the largest rebate possible even for a million dollar home is $24k provincially and $6k federally for a total of $30k.
The builder/developer then adds the HST rebate difference into their price in order to cover their left over portion of the tax expense. Assuming they can without making the list price balloon too high. It can be hard to price a new build listing competitively next to the neighbouring resale that doesn't have a tax to factor into its price.
WHAT ARE YOU DOING THIS FOR?
We can be quick to jump to a type of property we'd love to own. Be it a big old Victorian house, a boxy warehouse building, a storefront, a cottage, a loft, that sliver of a lot no one has done anything with yet. But I wonder, have you thought as much about what you would be investing for? What are you looking to get out of it? This is more likely to determine your investment property type than anything else. It is something worth getting clear on.
- Are you investing to also benefit your lifestyle in the short term? Perhaps an investment in another locale that you could go in on with friends, or even rent out for the short term when not there is a good idea? You can likely purchase it for less than you can anything in Toronto, and you can enjoy it too.
- Are you looking to bank on the rapid appreciation in Toronto combined with a vehicle for your design skills? Perhaps a fixer upper or new build in a great location could be just the thing, assuming you're set up with a team, ready to take on an extra project with a tight timeline in the near future, have a reserve of cash on hand, and are prepared to enter a few bid wars along the way?
- Are you looking for just a simple straight up appreciation vehicle to cash out of within a decade? Ideally here, your space is well located already, is finished in such a way that it can last without you having to do too much to it, and purchased in such a way that you did not over pay.
Are you buying it for cash flow in retirement? This is where a small investment in Toronto now can pay big dividends later. It can be rented out now, letting time work its magic while the mortgage plays itself out. Then, when you're no longer working and own it mortgage free, cashflow magically appears thanks to your tenant, month after month. For the rest of your life. Ahhhhhh.
- A bit of everything? If you aren't clear on what you're doing this for, then chances are you won't go through with it. Your ambivalence may not stop you until it's time to sign on the dotted line, but it will appear at some point to stop you if you don't address it. Time to look within to find your why, while turning off MLS. I mean it... Turn it off... Now! :-)
Next post will be about what successful investing in Toronto real estate could be! Because it really can be something.
If you've read this far, thank you. I'd love to learn more about you. Do you have any real estate questions you'd love answered? Fire away! I'd love to hear from you.