Are There Opportunities For Real Estate Investors?
Toronto’s real estate market has significantly cooled off since April with both sales and prices coming off the spring market peak. The low rise (semi-detached, detached and townhomes) market is normalizing and returning back to earth. The condo market is on fire with July’s Toronto Real Estate Board Market Watching showing 20% appreciation from July 2016. Two things that have or will have a major impact on the real estate market:
Mortgage Qualification Changes to Buyers with 20% Downpayment
The banks’ regulators, OSFI, is however looking at bringing more changes to mortgage qualifications which would impact the majority of potential homebuyers, yes more changes to a cooling real estate market. The proposed new changes, if they come into effect, will mandate uninsured mortgage applicants are stress tested. Let me explain…
Currently for homebuyers with less than 20% downpayment regardless of the mortgage term they choose (5 year fixed, 5 year variable, etc…) have to qualify at the mortgage qualifying rate. Eg. 5 year fixed 2.69% but homebuyer has to qualify at 4.84% which is today’s mortgage qualifying rate (MQR). For homebuyers with 20% downpayment or more qualify at the contract rate. Eg. 5 year fixed 2.69%, qualify at 2.69%.
The new proposal will mandate homebuyers with 20% downpayment or more qualify at contract rate + 2%. Eg. 5 year fixed 2.69%, qualify at 4.69%!
There are issues with this proposal:
- Penalizes homebuyers with “skin in the game” who have 20% or more equity into a home
- Purchase power of potential homebuyers will be reduced by approximately 20%:
- $75,000 income earner qualifies for a maximum mortgage amount of $390,816 based on 2.69% amortized over 30 years
- $75,000 income earner would qualify for a maximum mortgage amount of $306,601 on 4.69% amortized over 30 years, which is a 22% reduction
- This is a federal policy that’s aimed to cool off Toronto’s and Vancouver’s real estate markets however it will hurt all other regions and cities in Canada
- More people will be pushed into renting as opposed to buying and the last time I checked there is a rental supply issue in the Toronto area
- Loss of government revenues due to reduced sales: less land transfer taxes
The opportunities for real estate investors from this potential proposal is:
- Increased rental demand: good news for landlords
- Push demand to less costly (more affordable housing) which is the condo market
Ontario’s Fair Housing Plan
Back at the end of April, the provincial government announced a 16 point plan. The 2 big components of the announcement were:
- 15% Non Resident Speculation Tax
- Rental increase cap across the board whether built before or after November 1991
Similar to Vancouver’s foreign buyer tax announcement, Toronto’s (low rise) market is experiencing a pause and coming off unsustainable 25+% increase in prices which is a good thing. Buyers are sitting on the sidelines to figure out the impact of these changes but will probably return in 12-18 months similar to what happened in Vancouver. This Fall’s market will be telling. As for the rental increase cap, some developers have scrapped plans to build purpose built rentals (the rental market needs more supply not less) and now will be selling the units as condos to individual buyers. Here is what I see as opportunities for real estate investors:
- Less supply of rental housing will push rents up and above inflation rate. Currently, we are experiencing bidding wars on Toronto condos for rent
- Tenants will stay put longer in their existing rental condos since rents are capped at a maximum of 2.5% increase, the would be available condos for rent will experience fierce competition from prospective tenants pushing rents higher above inflation or the 2.5% allowable increase
- Tenants in 2 bedroom condos will stay for a much longer period as affordability deteriorates (higher mortgage rates and tougher qualification standards) and lack of 2 bedrooms for rent on the marketplace. Stability of rent and lack of vacancy is good for the real estate investor however the inability to reset rents to market rates for a longer period of time may impact cash flow as condo fees and property taxes increase. TIP: Completing a 5 year cash flow projection is important part of your due diligence. Contact me to complete the real estate investor 5 year cash flow plan
- Smaller condos (Junior and 1 bedrooms) are back in style. Since tenants profile in this space tends to be younger, as life changes occur such as getting into a relationship or having children, these tenants will tend to stay for a shorter period of time relative the 2 bedroom tenants. This would allow the real estate investor to reset rents back up to market level
- Low rise market has come off the peak in April 2017 and condos have experienced a very strong appreciation closing the gap between the 2 niche markets. If you are an owner of a condo, this might be the time to liquidate the condo or refinance it to invest into a duplex or triplex. Diversifying your real estate investment (low & high rise) is a sound financial approach
Headlines in the media can be confusing since they are designed to be sensational. Yes sales have come down, yes low rise prices have come down from April’s peak, however well priced properties are moving fast and the condo real estate market has been on fire. I am firm believer when a door closes, another opens up. Example, higher interest rates indicates the economy is doing well; jobs create, consumer spending and confidence is up which is great news. This also means there are more people with good paying jobs looking for condos or properties to rent or buy. Understanding the market and analyzing the data to look for opportunities for real estate investors is key. There is more to the story than the headlines.