Has Investing In A House Lost Its Luster?

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First they taxed the foreigners. Then interest rates were jacked up. Finally the Canadian federal government dropped the B-20 bomb. Even with these big three events, housing has continued to be the most sought after commodity in Toronto and Vancouver. Yes, I did say commodity, because over the years it has been treated as such, especially in cities like Toronto, where over 121,000 residents own multiple properties. That’s a lot of people and the list has grown from just a mere 24,000 residents in year 2000. If you look at how many condo units were built in total over a decade in the 2000’s, it’s clear that almost a decade’s worth of housing supply was bought by investors. Housing has easily been the way to leverage to riches for people who jumped in during the early 2000’s, but has the party finally run out?

CREA Puts On A Brave Face

Have you read the news lately? All reports coming from popular news outlets like the Toronto Star and Global News points to a bright start for 2018 in the housing market. Prices are up and sales are up! That’s all we’ve ever heard since the beginning of the millennium. Even the latest news reports coming out report robust December sales numbers.

Though the early start in January has seen remarkably slower sales numbers for detached homes in Toronto. No doubt there will be many excuses from realtors complaining of extreme cold weather turning off buyers, and the severe lack of inventory that is available for buyers to choose from. It’s certainly a save face moment for the cartel to ensure business continues to boom.

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The low inventory statistics can always be played both ways regardless of what marketing scheme the organization wants to spin. High demand and low inventory could lead to higher prices. Low inventory can also lead to lower sales because there is less inventory to choose from. But when you get lower inventory and lower prices, certainly that’s a cause for concern.

Not Entitled To Gains Anymore

Once upon a time it was thought that home prices could never fall. The foreigners were buying up every property that stretched from Hamilton, to Oshawa and all the way to Barrie in the GTA. Vancouver was already overrun by foreigners and there were no more affordable places to live. Now the tone is different. Buyers from last year are now realizing that prices don’t always go up. And in the case of those that bought in Whitby, a suburb in the GTA, they were in for a rude awakening.

What was thought of as a sure fire investment and a prudent financial decision, has now become a regret. Not only has the cost of new homes been slash by $90,000 by new home builders, but new buyers are actually receiving their homes at the same time as last years buyers because of delays. Can you feel any more ripped off?

Unfortunately, buying a house isn’t like buying an overpriced shirt at the mall that just went on sale. There are no refunds. Only regrets. The party was great when prices were constantly going up, but that entitlement to capital gains through buying a home is no longer a sure thing. The softening of prices are making investors think twice before putting a large amount of money on a property that may remain stagnant in value or may even fall in price.

Paying Someone Else To Live There

Back in the day investing in real estate was a good way to get predictable income that would actually cover the cost of owning the property. More recently with the increase in the interest rate and over a decade of skyrocketing prices, the argument for real estate as a viable investment has decreased. It’s very common in cities like Toronto and Vancouver to actually have negative cash flow while renting out a condo unit. Take the following example:

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A one and den condo unit in downtown Toronto can cost upwards of $600,000 to own. With a 20% down payment of $120,000, an investor would still be on the hook for monthly payments of $2,346 to cover the mortgage. Additionally the owner would be responsible for the $459 monthly maintenance fee that the unit carries. Add to that the potential property taxes of around $300 a month and the owner could be looking at a carrying cost of $3,105. That’s a pretty big monthly bill for an investor to carry, but how much can an investor expect to get back per month in rent?

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Although a few floors lower, a similar type unit that is a one bedroom and one den condo can be rented for only $2,200. Even if the unit was a bit higher up it wouldn’t garner an extra $900 in rent if similar units are going for this price in the same building.

As an investor trying to make money, that would actually equate to a negative cash flow of $905 a month to invest in the condo. Who ever heard of paying out each month as a good investment? That sounds quite absurd doesn’t it? Many investors will talk up the fact that someone else is paying off the mortgage, but is that even true? Of the $2,200 being collected how much is actually going towards the principal?

If you look at a the $2,346 monthly payment, roughly $1,250 of that is actually interest to the bank. When you add up all the other fixed expenses, the condo owner is actually paying $2,009 per month to someone else. In reality, the renter is only contributing $191 to repaying the principal. Of the $1,100 principal that is being paid back, the condo owner is actually forking out $900 of it. That means the home owner is essentially subsidizing the tenant to live in their condo! Who’s paying for who now?

Now many will point towards the capital gains that the owner will reap from selling the condo a few years later. But even 3 years later the condo owner would have invested a fair amount of money.

  • The initial down payment of $120,000
  • Spent $16,524 on maintenance
  • Paid $10,800 in property taxes
  • Given the bank $45,000 in interest.

Even if the place sold at $650,000 after three years the $60,000 gain would really only be $34,000 after 4% commissions were taken out. Considering the home owner put an additional $32,400 into the condo over three years, the total amount invested would be near $180,000. An 18% gain on a 5:1 leveraged investment over 3 years isn’t a good investment at all. That’s only a mere 5.7% annual gain and without leverage would be closer to only 1.2%. Buying the bank stock that’s collecting the interest for the mortgage would probably be a better investment and carry lesser risk.

Rising Rates

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Remember that the Bank of Canada is starting to raise interest rates. This can only mean that owning real estate as an investment is going to get much more expensive. The days of condo flipping and renting out to tenants for a profit could be coming to an abrupt end. That means that it’s more necessary than ever to consider diversifying a portfolio that might only contain real estate.

Just remember that real estate investment can be very rewarding, but can also be dangerous. Since real estate is the only investment in town that allows for extreme leverage, it’s important to keep your debt ratios in order and not get close too close to the 80% loan-to-value ratio. Getting called on margin from falling real estate prices can be more damaging than buying stocks on margin. Just tread carefully.

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