Domestic condo investors are the ones actually holding the reins

It’s domestic condo investors, not foreign investors, who are shaping the GTA market according to a new report by Urbanation’s Shaun Hildebrand and CIBC economist Benjamin Tal.  

In “A Window into the World of Investors,” the authors assert that “never before has the role of these investors been so great in generating demand for and influencing future supply of condo units.” Last year, the condo market accounted for a record-high 80% of all new home sales in the GTA, which makes the segment hugely influential on the market as a whole.

The paper isn’t intended to prognosticate, but to offer data compiled using sales and rent information for more than 4,000 condo pre-sale transactions that closed last year, and aligning it with matching purchase price and mortgage information obtained from Teranet. “By doing so, we hope to enhance the understanding of the drivers behind the important and vibrant GTA market,” it says.

You’ll often hear that investors who become landlords are in a negative cash flow position each month, with their rental income failing to cover their mortgage and interest costs, plus maintenance fees.

According to the report, just over 20% of condo investors didn’t need a mortgage to purchase their properties, slightly lower than the share of non-investors in the same position (which they chalk up to downsizers with equity); those who did tended to provide the minimum 20% required, and 44% of those who took a mortgage were in fact in a negative cash flow position; excluding the principal payment, that fell to 27%.

Among those with positive cash flow, the average monthly net income was just over $360. It doesn’t seem like a sound way to make a fortune, until you get to the part about average resale price per square foot in newly registered buildings — which they discovered was 51% higher than the average pre-sale price, with the average length of time between the two about five years.

That’s a 155% return in five years based on about a $75,000 investment; the annualized ROI was, they found, 31% in their example based on average rent of about $2,000. For a little perspective, a 10-year Government of Canada bond yields maybe 1.5%, a five-year GIC maybe 2.5%.

Whether those investors hang onto their investments in spite of the negative cash flow has an impact on housing availability, with the authors figuring that if all the investors that took possession last year who now face negative cash flow of more than $500 sold their units, it would amount to about 9% of new supply, or 3.4% when the resale market is included.

They also gained more subjective information from discussions with successful condo investment brokers, who reported that international buyers account for less than 10% of their clients; most agents had been working with investors who represented 80% or more of their clientele for at least seven years.

Local immigrants, they said, represented a “significant share” of investors. Many are repeat buyers who have multiple units and use condo investment as part of their retirement strategy or to help their children get into the market. Most reported that many of their clients hoped to put down 20% in presale and rent the unit upon completion to cover their holding costs and pay down principal, with some putting down more to achieve neutral cash flow and others willing to use losses to mitigate taxes.

Investors, they found, were less concerned with appreciation during the construction phase and were confident interest rates would stay down while prices and rents stayed up. Only a severe recession or a substantial rate hike (like 200-300 basis points) was likely to change their behaviour.

They pinpointed higher incidence of investors failing to meet closing requirements as a potential risk in the market, but said the percentage was still small. In looking at units pre-sold in the last year and scheduled for completion in 2021, they found that a softening in investment activity could come from rents failing to rise by the 17% over the course of construction that would cover their carrying costs; a rate increase of 100 basis points would require a 28% increase, and 200 basis points 39%.

When they assumed a 100 basis point increase, they calculated that an average annual rental increase of 7% would be required to cover costs, but even if it was unachievable and the condo investment market softened, any effect would be substantially mitigated by end-user demand.

For end-users, the significant influence of investment buyers can be frustrating, but demand is so high in both camps in the GTA that the overall market picture seems unlikely to change significantly any time soon.

The condo market has caught up to the rest of the market in the last couple of years and no longer represents a way in for many cash-strapped buyers. Condo investment still represents an opportunity to build substantial wealth in the long-term and Toronto buyers aren’t likely to see prices come down any time soon.