Rental investors bought half of GTA condos last year, but rents fall short, CIBC report says

Nearly half of all new condos sales that were finalized last year in the Greater Toronto Area were for rental purposes, but income from them could be falling short of ownership costs, according to a new study by CIBC.

Rental investors accounted for 48 per cent of new condo closings in 2017— with the majority of them buying the property through a mortgage at 77 per cent, according to the CIBC Capital Markets and Urbanation report released Friday.

But more than 44 per cent of mortgage holders were cash flow negative — meaning the owners were spending more to maintain the condos every month than they were getting in rental income.

CIBC economist Benjamin Tal said in the report that rental income fell short of mortgage payments, including the principal and interest on the loan and condo maintenance fees.

However, buying and holding on to condos may reap benefits down the road, given fast-rising property prices in recent years.

Rising prices

Last year, the average resale price of a condo rose by 26 per cent, while rents grew by nine per cent, according to CIBC.

Despite rental income not being enough to cover monthly costs, Tal said investors still saw "exceptional returns."

"Based on a 20 per cent investment [down payment] of approximately $75,000, that equalled a 155 per cent return on investment before closing costs," he said.

The report notes that investors who were taking in more rent than they were paying in expenses for their new condos were getting an average net income of more than $360 a month.

'Safe haven'

Condos accounted for a record-high 80 per cent of all new-home sales in the GTA in 2017, and some investment brokers told the economists that buyers were looking for more than rising equity. 

'Some investors have been willing to make larger down payments to achieve neutral cash flow, while others use losses to limit their overall tax burden," said Tal.

"In general investors aren't concerned with achieving exceptionally strong price appreciation, particularly foreign buyers who view Toronto as a safe haven."

Brokers said investors were generally confident that interest rates will remain low, while rents and condo prices would continue to rise.

"Most [real estate] agents expressed that it was difficult to foresee a scenario in which investors would flee the market, and that only a severe recession and or a sudden 200-300 basis-point rate hike would cause a substantive change in behaviour among investors."

But data from the Toronto Real Estate Board this week showed condo sales dropped nearly 33 per cent in March from a year ago as tighter mortgage rules introduced by Ottawa this year and higher borrowing costs hit potential homebuyers. 

Toronto real estate broker Andrew Ipekian told CBC that people became a little more cautious after the new rules and measures came into place, but there's still pent-up demand in the market.

"All the condos being built — a lot of them under construction at the moment — are still not keeping up with demand," he said.

"That's why you are seeing so many people over bidding or going over the asking price, selling in a number of days, primarily because there is not a lot of choice out there."

Rising rates

The "changing economics" of holding condos as an investment, while supply in the market increases within the next three years could pose a challenge to investors, Tal said.

"We estimate that for new units in development that were pre-sold over the past year and are tentatively scheduled for completion in 2021, in order for carrying costs to be covered with a 20 per cent down payment, rent would need to rise by 17 per cent over the next four years if there was no change in mortgage rates," he said in the report.

If interest rates did rise by one percentage point, rents would need to increase by an average of about seven per cent a year, he added.

The Bank of Canada has hiked interest rates three times since the middle of last year, raising the key lending rate by a total of three-quarters of a percentage point to 1.25 per cent. 

Markets are predicting a more than 68 per cent chance that the central bank will raise interest rates again by July.

"While not out of the question given last year's [rental] rise and the expected growth in rental demand, it might be difficult to achieve [the seven per cent rent increase] and potentially could lead to some softening in investment activity," Tal wrote.