It's crucial to look at the total ROI on a condo investment, not just cash flow.
Well, the media is back at it. There were a series of articles published in the past week yet again trying to convince readers that the Toronto condo market is over-valued and that investors are starting to "bleed" when it comes to covering the costs of their condo investments. Which got me thinking...
Why is everyone just focused on cash flow?
Before I get started, I wrote a blog about cap rates last year that should make a good primer for calculating whether or not an investment makes sense. Today's blog takes the math one step deeper.
When you buy an investment property in Toronto, unless you put something like 30-35% down, you will not cover your carrying costs. I said it. I've said it before. And I'll say it again. You cannot cover your carrying costs on a Toronto investment condo with a customary 20% down payment. Should this worry you? Well, this has been the case in Toronto for years.
Has it gotten harder to cover your costs?
The short answer is, yes. Rents have risen significantly which is keeping the investment thesis intact, but with rising interest rates and even higher condo prices, it would be foolish to think that the condo investment thesis is better today than it was even just three years ago.
But is there still money to be made?
Let me run through a real-world example of what it's like to buy an investment condo in Toronto today, and what it was like say, 3 years ago. (I apologize in advance for the heavy math in this blog but without going this deep into the numbers, how do you know what you are investing in?)
Purchase a condo today:
Purchase price: $500,000 (which today is about the going rate for a new-ish, 1-bed/1-bath, 525 sq ft+ condo).
Condo fees: $350/mo
Down payment: $100,000 (20%)
Total mortgage: $400,000
Total monthly mortgage payment: $1,995 (3.49% amortized over 25 years)
Total carrying costs: $2,545/mo
Total rental income: $2100/mo
Net cash flow: -$445/mo
So this is the number the media has been focusing on. Negative $445/mo. Doesn't sound that great, eh?
Well, let's look at what those numbers looked like around 3 years ago, for a similar property at that time:
Purchase a condo in 2015:
Purchase price: $375,000 (which is probably what a comparable condo would have cost back in 2015, give or take).
Condo fees: $350/mo
Taxes: $2400/year (taxes haven't changed all that much, thankfully)
Down payment: $75,000 (20%)
Total mortgage: $300,000
Total monthly mortgage payment: $1,418 (2.99% amortized over 25 years, which was about the going rate back then)
Total carrying costs: $1,968/mo
Total rental income: $1600/mo (which is right around what an average 1-bedroom was renting for back in 2015)
Net cash flow: -$368/mo
So we would have been at negative $368/mo three years ago.
Even back in 2015 when Toronto condo prices were much lower, investors were still negative each month in their carrying costs. This isn't anything new.
But again, we need to stop looking at just cash flow. We need to be looking at total ROI.
I'm going to stick with the example from the condo for sale today here, and add a few new line items for us:
Mortgage balance at the end of 5-years: $345,057
Total equity build at end of 5-years: $54,943
Average equity build per month: $915.72
Total average net return per month: $470 (total equity build per month less the negative cash flow)
This is the true monthly return that investors (observant investors anyway) are looking at. They are getting an average real return of $470/mo, even though their cash flow each month is in the red.
What overall ROI does that translate into over 5 years?
Total ROI = (Total avg return per month * 60 months) divided by total investment
= $28,200 / $100,000
= 28.2% total return over 5 years
OR approximately 5.1% compounded annual return
This is the number that matters. 5.1% compounded annual return for a typical condo purchased today for $500k, with 20% down, and rented out for $2100/mo.
Most importantly - this does not factor in any appreciation in price. And who invests in a condo without the expectation that prices will rise over the next 5 years? Let's do a bit more math:
Assume a paltry 1% increase in condo prices per year, for each of the next five years:
Total value of the condo at the end of 5 years: $525,505
Total net return for investor over 5 years = (Total avg net return per month * 60 months) + appreciation = $28,200 + $25,505 = $53,705
Total ROI = Total net return divided by initial investment = 53.7%
OR approximately 9% compounded annual return.
And that's assuming a 1% increase in condo prices per year.
I'll save you the math but if you assume a 3% appreciation in each of the next 5 years, that compounded annual return jumps to 15.7%.
When you look at the actual math, and really study the ROI investors are potentially going to see with the total returns that are achieved through equity build and modest price appreciation, you can see why investors are still willing to put their money to work in the Toronto condo market. I didn't even factor in rent increases over the life of the investment, which again would boost those returns, but taking into account your typical increase in condo fees each year, I think it's a wash (so long as rent-control is in place limiting your ability to boost your profit even more each year).
So before you just accept media headlines at face value and think that the condo market in Toronto is doomed because all investors are "bleeding", take a step back and look at the numbers investors are really focused on. Because when you really do the math, there is still money being made, even if the media wants you to think otherwise.
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Your Toronto condo lover,
iPro Realty Ltd, Brokerage
Direct: 647-223-1679 (call/text)