Toronto Condo Apartment Return % Examples

Many people assume someone who owns 3 individual condo apartments in Toronto is getting a free lunch, but the truth is, owning apartments has pros and cons, risks and rewards, just like any other investment. Its difficult to explain how the returns of real estate investing actually work over a conversation at a cocktail party. This post will show real life examples of the returns of 3 individual 1 bedroom apartment condos in Toronto for 2016. I hope this post gives the layperson more knowledge about the actual results of owning condos on Toronto. The rates of return might not be as high as you’d expect!

Below is a table listing the income and expenses of 3 apartments in Toronto. Each of these apartments are located in downtown Toronto. Condo 1 was purchased 10 years ago, Condo 2 was purchased 8 years ago, and Condo 3 was purchased 6 years ago. Condo 1 and Condo 2 are proper 1 bedroom apartments where the bedroom is a separate room from the kitchen and living area. Condo 3 is a bachelor apartment where the living space is contained in a single room with only a separate bathroom. Each building has 24 hour concierge, Condo 1 and Condo 2 have modest rooftop terraces, whereas Condo 3 has extensive amenities including indoor and outdoor pools, a large fitness center, and meeting space. Condo 1 and Condo 2 are rented unfurnished to long term tenants. Condo 3 is rented furnished with term leases. Each unit includes utilities, and Condo 3 also includes unlimited internet. The rent is $1,600 per month for each unit.

Condo 1 Condo 2 Condo 3
Rent $19,200 $19,200 $19,200
Insurance -$195 -$168 -$150
Property Taxes -$2,288 -$2,119 -$1,954
Interest Expense -$4,138 -$5,642 -$6,062
Condo Fees -$5,644 -$3,834 -$3,823
Legal Fees -$1,933
Maintenance -$407 -$433
Utilities -$1,981
Profit $6,935 $5,097 $4,797

The additional insurance expense listed is required because although each building has insurance to protect damage caused by common elements, there are gaps in the policies so individual units need to also have insurance for damage caused by the resident or elements exclusive to the unit, such as if there is a flood caused by the resident of the unit causing damage to the building, this risk is covered in the unit specific policy. Also, damage to articles of the resident are also covered under the unit specific policy regardless of fault.

Interest expenses are associated with the mortgages held on each unit. At the time each unit was purchased, a 20% down-payment was invested, and the balance of funding was provided by mortgages.

Condo 2 suffered legal expenses in 2016 because of an error made by the property manager who was subsequently terminated by the condo board. The legal expenses were associated with adjudicating the dispute resulting from the error by management. This impacted the returns of Condo 2 for this particular year.

Maintenance expenses are related to tasks such as appliance repair. The utilities expense on Condo 3 is the cost of providing internet to the resident.

The total annual income provided after expenses for all three units is $16,829 or $1,402 per month.

What is the rate of return these condos produce?  This can be determined by dividing the income of each property by an estimate of their market value. I estimate Condo 1 to be worth $450,000, Condo 2 to be worth $425,000, and Condo 3 to be worth $325,000. The estimated rates of return are provided in the table below.

Condo 1 Condo 2 Condo 3
Value $450,000 $425,000 $325,000
Mortgage $250,000 $225,000 $200,000
Loan to Value 44.44% 47.06% 38.46%
% Return Equity 3.47% 2.55% 3.84%
% Return Cash 2.46% 2.53% 3.34%

As the table illustrates, each property has a bit of financial leverage. Its been a number of years since these condos have been owned as described above, so a portion of the mortgage debt has been paid down, and the properties have appreciated in value, so they carry more equity with a lower leverage rate than when they were each initially purchased.

Readers might be surprised to see the low rates of return. Higher cash yields can be obtained in many other liquid investments such as many blue chip stocks, and some bonds. I’m not going to argue that real estate (in particular condos in Toronto) is the best investment. Many investments are good ones, and from time to time certain asset classes will outperform others. There are many factors to consider when investing in stocks, bonds, and real estate, and its impossible for the individual investor to know which one will be the best. Individual investors can only assume that the market price has accounted for all the relevant factors. I think its more important for the individual investor to maintain a diversified portfolio rather than attempt to dramatically outperform the market. The individual who wants to create wealth should focus their energy on business activities where a financial investment is limited and operational success is far more important. With those thoughts in mind, a low rate of return in the short term should not cause an investor to sell their real estate today.

The % return on equity row describes the rate of return based on the equity invested = profit / (value – mortgage). The % return on cash row describes the rate of return based on the market value of the property = profit / value. The difference between the two rates is the impact of leverage. If the rate of return on the apartment is higher than the interest rate paid, then its profitable to borrow, otherwise, its better to invest without borrowing, or to mortgage the property but use the cash generated to invest in some other higher rate of return. Its also important to note that without the one-time legal expense associated with Condo 2 in the current year, the % rate of return on equity would have been 3.52%.

How does the rate of return on these properties compare to publicly traded REITs?  An investor could probably obtain similar rates of return by investing in REITs, without the hassle and risk of managing individual assets. The leverage rates of residential REITs compared to the current leverage of these three apartments is similar. Some REITs have higher leverage, some have lower. The other benefit of owning a REIT, besides the passive nature and less work, is the benefit of liquidity and diversification. Shares of a liquid REIT can be sold at any time with very low transaction costs, whereas individual properties are expensive to sell if a broker is used.

From a tax perspective, the individual properties are probably a better investment. The expense categories that CRA allows for real estate investments are pretty broad, and can include transportation and administrative expenses. The individual property investor can also make CCA deductions to reduce any other current year’s tax owed, but this comes with the caveat that if/when the properties are sold this CCA is clawed back in the form of capital gains tax. With REITs, the distributions are mostly taxed at the holder’s marginal rate in the year they are received. REIT distributions are not dividends, but are considered passive income to CRA. If its possible, try and hold REITs and bonds inside registered accounts (RSPs, TFSAs, RESPs, RDSPs, etc) and hold dividend paying stocks in non-registered accounts since the tax rate on eligible dividends is relatively low.

Another element that should be considered when analyzing the rate of return of condos in Toronto is the potential for their value to appreciate. This is one of the main drivers behind many real estate investments, the idea that the property will become more valuable over time, regardless of the annual yield %. This has certainly been the case in Toronto throughout its history, but who knows what the future will bring. If we consider urbanization will continue, major cities around the world will to grow and the added population will continue putting pressure on real estate prices. With leverage, the returns from appreciating real estate prices are magnified.

Home Capital Buyout Rumours

So who’d want to buy Home Capital Group and why? Before considering who, let’s first consider why. What would the buyer of Home Capital get and how might this transaction be structured?  First, could a big bank wring value from HCG?  Probably not, the big banks such as BNS, RY, CM, TD, BMO can source better quality mortgages on their own terms without needing a portfolio of mortgages from HCG. What about competitors such as EQB and FN? They have a similar business model, and they could probably clean up HCG’s mortgage book and further leverage relationships in the mortgage channel?  The problem with this logic is EQB and FN are about the same size as HCG, and if the quality of HCG’s mortgage portfolio is less than expected, it would drag down the buyer, possibly also causing a larger bankruptcy. Its pretty risky for EQB and FN to buy HCG, and there is limited upside. A better strategy for EQB and FN, and its the one that EQB has taken, is to play defense and arrange for liquidity to get by the near term GIC redemptions.

What about a larger firm such as Brookfield?  I guess its possible, but not likely. This would be a departure for Brookfield, but it does have some logic. If Brookfield could fund $10 to $15 billion in the short term, it could satisfy GIC redemptions and put the mortgages into a MIC, even offering this MIC to the secondary market (as a private equity or public listing). It would take some time to do the re-organization, but Brookfield has the capacity for this and could certainly find financial partners. Once the MIC was setup, it could be re-capitalized further diversified. This type of strategy would preserve the HCG mortgage and deposit brokerage relationships.

All of this is armchair speculation. I think the most likely next step now is to find further information from the OSC on their claims and settlement process.  Also, I think investors need to know more details on the quality of the HCG mortgage book, is it indeed full of holes or could it stand up on its own?

 

OSC should be blamed for Home Capital destruction

Terence Corcoran: Home Capital Group didn’t just fall from the edge of a cliff – it was pushed

By now most Canadians have likely seen the Home Capital Group Inc. stock graph, a Rocky Mountain plunge that began April 19 at $22 before hitting bottom a few days later at $6, wiping more than $1 billion off the value of one of Canada’s most successful non-bank mortgage lending enterprises.

Home Capital is Desperate

Home Capital Group announced it has secured a $2 billion line of credit that will carry an interest rate of 10% and a 2.5% standby fee. They also announced their HISA deposits have fallen y more than $500 million in the past few weeks to $1.4 billion.

Home Capital Announces Non-Binding Agreement in Principle with Major Institutional Investor for

April 26, 2017 /CNW/ – Home Capital Group Inc. (“The Company” TSX: HCG) announces that its subsidiary, Home Trust, has reached a non-binding agreement in principle with a major institutional investor for a credit line in the amount of $2 billion. It is expected that a firm commitment will be agreed to later today.

Airbnb in Lisbon

Airbnb faces a patchwork of regulations in the many jurisdictions where it operates.  Some places are very restrictive, but some places are welcoming the innovative platform. Lisbon has emerged as a city that welcomes Airbnb and has created a regulatory environment that creates a transparent playing field for hosts and guests while also encouraging the tourism economy.

Airbnb Finds Love in Lisbon After Berlin Shies Away

On his way to work, Lisbon Mayor Fernando Medina likes to count the dwindling number of empty buildings. Thanks to a tourism and real estate boom, many are being converted into trendy apartments that cater to the growing number of visitors to the city.

REI & CAR REIT Bombshell!

There is a lot of potential M&A that could be done in the Canadian REIT sector for companies to realize greater diversification and scale. There is also a rule in Canadian REIT laws that allows for a REIT to own up to 20% of its assets in shares of other REITs. RioCan & Canadian Apartment Properties are two of the largest REITs in Canada and both are based in midtown Toronto.  They operate in different REIT sectors.  RioCan is mostly focused on retail, while CAP is exclusively focused on multi-unit residential. With the liquidity for the traditional plazas that RioCan has historically been targeting drying up, and opportunities for growth in core urban markets remaining strong, RioCan has been developing its urban portfolio. This is particularly true in Toronto, Calgary, and Ottawa with announcements being made recently.

RioCan has a few large projects coming down the pipe including the Well in Toronto and a mixed use development at its head office at Yonge & Eglington in Toronto. But RioCan doesn’t have much expertise in residential management in house, and with a powerful balance sheet (and flush with cash from the upcoming sale of its US portfolio), it has now been confirmed by an analyst at RBC that RioCan owns more than $300 million worth of CAP units, making RioCan Canadian Apartment Properties largest shareholder.

Could this mean an eventual merger between the two large REITs?  As a unitholder in both companies, I think this would be a great idea. It would provide the combined entity with more scale and diversification.  RioCan has a market cap of $9 billion and CAP has a market cap of $4 billion. The combined entity would have a better chance of collecting minority investment from some of Canada’s pension funds because of its combined size. The combined entity would also be able to fund larger development projects in Toronto without pushing up against various legal REIT tax caps.

Based on the estimates from RBC, RioCan is getting close to owning 10% of CAP REIT. Anything over 10% and they would have to formally disclose their position and report any additional purchases of CAP REIT shares. I think its less likely they will do this. I think its more likely that they make an offer for the remaining shares, but at the current valuation of CAP (distribution yield of only 4%) RioCan shareholders will be paying a high price.

Sleuthing by RBC’s Neil Downey reveals CAP REIT’s surprise shareholder

According to Neil Downey, a managing director and real estate analyst at RBC Capital markets, the evidence is beyond a reasonable doubt. What’s less clear is the motives behind the news that one real estate investment trust is the largest shareholder in another real estate investment trust.

RioCan Redeveloping Malls

Across North American over the past several decades, large regional shopping malls were build in suburbs where land was once cheap.  Today, there is a growing crisis with those traditional shopping malls. Part of the problem is many shopping malls were built with a single purpose: retail. But today, we understand that urban environments work best with mixed-use formats. The idea follows the work of Jane Jacobs.  With less intensification in certain suburban locations, many malls are facing capacity problems.  Especially with traditional anchor tenants facing financial challenges that are calling to question the long-term viability of their retail format. In other locations, greater urban density of cities are reaching the suburbs of regional malls, and making the land much more valuable.

In both of these cases, it makes sense for shopping mall developers to consider re-development that increases the density of the real estate while at the same time diversifying the shopping malls use. Typically, a shopping mall is surrounded by large parking areas. and bordered by arterial roads and highways. The first choice to consider is whether pads can be added to the outskirts of the parking space bordering on the surrounding roadways. This only makes sense if the zoning can only be retail and the retail environment can absorb more competition and greater parking capacity is available.  Another option is adding residential and office and other use space to the core shopping mall.

There is a huge shift taking place in the shopping mall sector of retail real estate.  Companies such as RioCan seem to be taking the right initiatives to improve the situation as outlined by the story below.

RioCan unveils Silver City redevelopment plan

RioCan REIT is proposing to build a number of residential towers at the Silver City Gloucester retail complex. The country’s largest real estate investment trust has filed plans with the city for the first phase of a “multi-building residential development” at the property south of Ogilvie Road and north of Regional Road 174 near the Blair transitway stop.