RelativeRealty | Toronto, Ontario

Does Toronto Real Estate Make Investment Sense Right Now?

Covid and ultra low interest rates seemed to throw investment rules on their head while creating excessive growth and volatility in areas such as tech stocks, crypto currencies, and yes Canadian Real Estate. While crypto and tech stocks have pared a good portion of gains in recent months, the average sale price for a GTA home was up 32% year/year from Feb 2021 to Feb 2022. Expectantly, Canadian Real Estate’s appreciation is going to be stickier and more stable than other investments, but the average price has pulled back since its February highs. The average price in the GTA is down 6% from February to April and year/year sales are down over 30% and 41% in March and April.    

What changed? 

Yes. Interest rates increased. The Bank of Canada finally decided it could no longer ignore the fact that inflation is coming in well above its target and has stopped their bond buying program, and increased the benchmark interest rate by 0.75% to 1% with an additional 1.5% increase still expected over the next 18 months or so. 

What also happened is that cap rates for GTA real estate hit extreme lows. As prices skyrocketed the past 18 months, rents have just recently recovered near pre-pandemic levels. 

What this means is that investors can put their money in a 3-5 year GIC and  make 4%/year, or buy a Toronto condo and make less than 2% based on February’s Rent vs Buy Analysis.    

In recent years, GTA real estate investors have been willing to overlook low cap rates in exchange for high price appreciation, and they have benefited greatly from doing so. However as cap rates bottom out and interest rates increase, should they continue to do so? Take a look at the following cap rates from February’s analysis.

Leslieville Condo 1.8%  

Danforth Detached 1.85% 

Scarborough Bungalow with Basement Apartment 2.98%

To get February cap rates to match current GIC returns rents would need to increase 30-70% or prices would have to drop by over 30%-75%, or some combination of the two. 

What’s to expect because of this:  

Higher Rents: We are already seeing rents trend higher and I believe this will continue as rental demand in Toronto experiences increased pressure from high immigration targets. One and Two bedrooms apartment rents rose over 17% from a much less competitive Q1 2021. As mortgage rates increase, more would be Buyers will also turn to the rental market putting further pressure on rent.  

Less Investors: With investors making up close to 25% of Buyers in recent years don’t be surprised to see this number drop. Investors finally have some incentive to lend their money instead of invest, and many will choose that risk free route or seek markets with better cap rates. Much like stock market investors, we can expect investors to have more cash flow discipline as the cost to borrow increases. While end users may also pull back on their Buying plans, this is more likely to be shorter term and demand should remain if employment and wages remain strong and rents increase.  

Lower Prices: A higher MOI leads to more balanced conditions and downward pressure on prices. A 1.6 MOI is still very much in the Sellers favour, and Sellers are less likely to list if they don’t expect to get their desired price. However, if supply increases and negative demand pressures continue we should see prices correct more than the 6% seen so far.  

Affordability Constraints: The government has introduced programs that will ease some affordability constraints such as first time home buyer TFSA or the non housing policy likely to have the biggest stimulus impact on housing being affordable daycare. However, rising prices have made it increasingly difficult for first time buyers to come up with a down payment and rising rates will reduce purchasing power and may cause buyers to look at more affordable options.  

It’s not all negative. Canada is a safe and desirable place to live. If the government executes on the high immigration targets, strong demand for housing will continue. Unemployment rates and wage growth have been very positive. And while everyone is expecting rates to rise in the short term, many expect them to have to reverse course shortly after.

While investors are taking a beat or two, end user Buyers should keep an eye for good opportunities, while the market is less competitive. If rents increase as expected more Buyers will eventually be drawn back into the market in due time. Don’t purchase if forecasted interest rates are not manageable. While nobody knows how inflationary pressures will play out, there will be a breaking point for how high the BOC can push interest rates. Given how much more indebted Canadians are then in the past, small interest rate hikes will have much larger impacts than they did in the past.