Almost half of Toronto condo investors are committing to negative cash flow, according to a CIBC Economics study. One of the city’s most prominent mortgage brokers pointed out, this is a disaster in the making. If you can’t make the deal work at an all-time low for interest rates, when can you make it work? This got me thinking, what’s the likelihood of these investors making money from here, in a best case scenario? Let’s crunch some numbers. It’ll be like the real estate wealth expo, but for people that like math.
About The Investors
Since nearly half of condo investors are cash flow negative, they’re depending on the appreciation to payout. In order to do that, the rise in prices would have to at least cover their cost basis, before producing any profit. CIBC economics provided us with the data on a range of what these investors were paying. It looks like Calum is right, it’s going to be very difficult to make a profit on some of these deals.
Quite a few investors are benefiting from our record low interest rates, but a lot aren’t. The largest bracket of investors, 30.6% of them, are paying between 2.51% and 3.00% in interest. However, 32.3% of investors are paying over 6% – which is practically a biblical amount of interest. Even worse, 16.2% of those investors are paying over 9%. You don’t need a comprehensive risk model in order to assess how risky borrowing at this level is, you really just need to do some napkin math. (okay, maybe some tablecloth math).
About The Calculations
Today we’ll be looking at likely break even points for these investors, but we’ll have to make some estimates to fill the data gap. The price we’re going to be using is the Toronto Real Estate Board (TREB) benchmark condo. This is the price of a “typical” condo on December 2017, which was $490,500. We’ll also factor in the cost of commission at 5%, but we won’t be adding other fees that would also reduce profitability.
Since the interest rate is a bracket, we’ll use the middle of the bracket except for the lowest number, which we’ll use the lowest 5 year fixed we’ve seen (2%). Closing costs for sellers is also a thing, so it’s a good idea to include those when running your own numbers. These are highly variable, so we’ll also exclude these as well. However, you should find a *good* Realtor or mortgage broker to walk your through these numbers. Especially if you’re getting ready to pull the trigger and buy an investment.
Oh yeah, and despite the numbers I’ve presented to the banking industry… more than once, let’s give Realtors the benefit of the doubt. We’ll assume Keynesian economics trumps credit consumption and real estate cycles. In this fictional market, prices only act how how they have been since 2005, as far back as TREB usually provides data for. 😉
One Year Later, You Need Prices To Rise Over 7% To Break Even
Quite a few investors think they can buy a condo for a year, and make a profit. If you’re paying 2% interest, you would need prices to rise 7.03%. At 2.75%, you need a 7.66% increase. 4.5% would need a 9.13% increase. After that, you’re getting into double digit gains required. 7.5% interest, would require an increase of 11.66%. 9%, would require a massive 12.92% increase. If you’re a real estate professional from a non-Canadian market, you’re probably cringing. Let’s see how this compares to our positive biased, historic price increases.
Charting it against historic 12 month returns, we see this is really hard to do – even at the lowest interest rate. At 2%, only 34% of 1 year periods would have gone past breakeven. At 2.75%, that drops to 27%. If you’re paying any more, the ratio drops to less than 1 in 5. Basically, if Toronto’s real estate market was restricted to acting how it has over the past 12 years, you would break even just over a third of the time.
Five Years Later, You Need Prices To Rise Up To 42%
Looking at investors that plan to hold for a 5 year mortgage term, the return required is a huge range. At 2%, you would need a 13.24% increase, which isn’t all that bad. However, at 9% you would need to see a 42.55% return. That’s a really wide gap, but here’s the breakdown of everything between.