Is there ever a bad time to invest in a rental property?

Record low interest rates coupled with an overly extended bull market for Canadian residential real estate has some investors questioning the validity of investing in a rental property.

Current economic indicators support these fears: mortgage rates scheduled to rise, a global economy not yet out of the recessionary trenches, residential real estate prices in Canada that have clearly outpaced increases in general earnings over the last decade.

From 1992 to 2011 the average sale price for a home in Toronto increased from $214,971 to $465,412

This all paints a compelling picture supporting the hesitation some investors have when dealing with rental properties. But is this hesitation legitimate? Is there ever really a good or bad time to get into the real estate rental market? The answer is yes, and also no; it all depends on your current financial situation.

If the Toronto residential market is used as a barometer we can see that residential real estate has treated us quite well over the past 20 years. During the period from 1992 to 2011 the average sale price for a home in Toronto increased from $214,971 to $465,412 according to the Toronto Real Estate Board (TREB).

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Acquisition Vs. Ownership

We walk onto a car lot, and the first vehicle to which we gravitate is the most attractive, the most powerful, the biggest, or the most luxurious.  We set out to buy new household appliances, and the ones that catch our eye are the shiniest, the biggest, or the ones with the most gadgets.  The same draw applies to our purchase of new shoes, new cell phones, new computers, and so on.  It is understandable, then, that most home buyers look first at the most attractive home, with the amenities that appeal to us, rather than the practical, logical choice.

Neuroscientist Antonio Damasio suggests that we, indeed, are living an illusion of conscious choice, since our subconscious directs our actions first, and the emotions stem from our subconscious.  In other words, for the most part, we make emotional decisions and then, perhaps, choose to justify them with a logical argument.

But emotional choice when buying a home may be the wrong approach, in spite of the urge to justify it by saying to ourselves, “I am going to be living here for many years, so I want something that I thoroughly enjoy.”

Yes, it is true that if we don’t like something, we will find fault with it regardless of its practical value.  Think of taxes!  Without them we would be denied many of our social pleasures, but there are very few of us that look for ways to pay more tax.

Emotion is often equated with irrationality.  Unfairly, I might add.  Logic can be irrational, too.  The most secure home is the eight-by-eight isolation cell in a prison, with guaranteed meals, no repairs, and a perpetual  “roof over your head.”  No one rationally would choose such accommodations.

Home buying requires a balance of emotion and logic.  One should look at buying a home much like operating or purchasing a business, balancing the need for something a person enjoys with something that is economically viable.  You may love large spiral staircases, but if you are approaching elder years, consider that, in a few years, those beautiful stairs may be a curse, as you attempt to climb the expanse dozens of times each day.  Features that appeal to you now may be your nemesis later.

Most prospective homeowners see only the aesthetics, even though they know that they should focus more on practicality.

An energy-efficient home may save thousands of dollars in heating and cooling costs each year, but large, airy windows, a huge basement, hardwood floors, and an expansive yard (with no natural vegetation to block summer heat or winter winds) offers more beauty. A large great room design is “sexy,” but the din of four kids playing in the same room in which you are trying to watch a show, work on the computer, or prepare a meal, may be stressful.  Deep, luxurious carpet tugs at the emotions, but may be hard (and expensive) to clean, or difficult to maintain with tons of traffic.  A sizeable home with a huge lot in a desirable community may say, “I’ve arrived,” but may also shout “big property tax bill.”

The litany of concerns about making emotional decisions should not deter you, however, from using your emotions to make a buying decision.  Although many of us spend more waking hours at work than in our home, we want those precious hours at home to be enjoyable.  Being able to say, “I am living in the most efficient house on the block” is of little comfort if the aesthetics are so Spartan that we would rather be at work!

Home buying requires many of the skills that a successful entrepreneur employs.  He/she looks at the balance between capital cost and long-term operating costs when purchasing for the business.  The capable businessperson evaluates the benefits of short-term versus long-term.  Yet, unlike the calculations of a pure capitalist, a homebuyer must also be ready – even eager – to say, “Perhaps I really don’t need this feature,”  or, “this item is not practical, but I deserve to treat myself well, and, since I want it, I’m going to let my heart, rather than my head make the choice!”

Toronto Housing Value Great for Buyers and Sellers

Value has little to do with price. Media reports that “Toronto’s house values have skyrocketed” could as easily be seen as a positive indication of the significance of the city as an indication that price has risen.

While the media consistently ranks Toronto, Vancouver, Calgary and Edmonton among Canada’s most pricey housing markets, it fails to add the corollary that those markets lead the way in price because they are the areas that have the most to offer in terms of home ownership, convenience and lifestyle.

While no reporter or commentator would suggest that a Lada could be compared favourably to a Lexus in any other category other than purchase price, the most popular criticisms of Toronto’s real estate market versus other locations across Canada involve little more than a comparison of that price difference.

Real value is derived from price measured against benefit. Commercial value, and, in particular, real estate value is based on market dynamics and competitive pricing, and has little relationship to personal value.

Often slammed sarcastically as “the centre of the universe” by other Canadian communities, Toronto, in fact, has earned the reputation as the centre of the Canadian universe. That reputation derives from the immense benefits that Toronto offers to its residents, and to newcomers.

One of the contributors to rising home prices is rising demand, fueled, in large part, by the influx of people from across Canada, and the in-migration (and immigration) of people from other nations. While Canada holds front-runner status among western democratic nations for ratios of immigrants, Toronto is a real Canadian leader in attracting people from all corners of the country and globe. Do those people yearn to live here because it is an average city, or because it draws people like a magnet with its diversity of opportunity – employment, economic, social, educational, athletic and cultural?

As a westerner, I am proud of my rural, pioneer-like roots, and of the opportunities within my own region of the country. Our housing prices are among the lowest in Canada. Yet, if I am asked for an honest opinion, as to the value of housing here versus Toronto (not price), I must confess that there is no fair comparison.

In recent years, Toronto and southern Ontario have experienced an economic challenge that has seen their relative strength of influence across Canada diminish. Economic strength in Alberta and British Columbia has impacted on the Ontario position in Canada. Yet, Toronto still offers the best long-term potential, with its location among a host of influential cities, communities and regions. So, relative to Canada`s western cities, Toronto`s real estate market has waned. But, when considering the advantages of home ownership in this city, the prospects of newcomers to the city and upward mobility of locals, and the variety of housing stock available, this market still has great value, in spite of increasing prices.

In fact, Torontonians should take pride in its rankings as a city with a “skyrocketing value of housing.” So long as value means worth, rather than solely being based on price, Toronto should encourage the national media to promote the city as a valuable place in which to live.

Frontage Costs for Sewers Add to House Costs

In many municipalities across Canada, the cost of extending sewer/water services from a main line to a new, subdivided or unserviced lot is the responsibility of the landowner or developer. Particularly, in rural communities where businesses wish to construct a facility that is not able to be served by the existing water line, those businesses often pay the full cost of new water services infrastructure, minus any provincial or federal government contributions.

In 1999, Toronto reconsidered its policies on reimbursement for extension of water services to unserviced lots, in order to bring it in line with the practices of nearby communities. This change in policy is often unnoticed by homebuyers, until the developer levies the charge against the cost that he has incurred, or the city seeks to recover a portion of those costs. The costs can be quite significant!

Sewer line costs are calculated on the basis of the length of the line, or a per-meter basis. In recent years, those costs have increased by more than 280%. Where a prospective buyer of a new home is considering a new development community, it is imperative that he inquires about all costs, including any one-time or ongoing levies.
While the city of Toronto reimburses new water services clients a portion of the construction costs, those fees are less than 50% of the actual construction costs.

One of the ways to mitigate the buyer’s frontage costs is to look for homes on lots that run lengthwise into the property, rather than across the property face. Vertical construction such as this will reduce the lot width demand, and, in turn, reduce water services charges. Even where the developer has absorbed the costs of infrastructure into the purchase price, the narrower lot should result in a lower cost for a lot of the same square footage but wider frontage.

Perhaps the most effective way to ensure that you are not absorbing more than your share of the cost of development for your home site subdivision is to use the services of a realtor. The experience of a professional realtor, much like the expertise of a lawyer or doctor, is the best return on investment that you can make, when making the largest purchase of your life.

Moving Towards 2010 – Here’s Hope to Strides Made in ’09

This time of year always presents a time for a bit of reflection. It is the close of one year, the start of the next – a new beginning.

January 2009 certainly saw most of the world in an uncertain situation. The United States elected a new president who represented a change that the world – not only the U.S. – was needing. Now President Obama, was full of passion, enthusiasm though had his two feet on the ground when he spoke of the hard road ahead. When he spoke of the necessary changes that needed to be made, he wasn’t delusional, he knew what he was in for – and he was hopeful. He moved forward, confident in his choices and confident in his hope.

We in Canada, fortunately did not suffer the collapse of a housing market or banking system. Fortunately, for us, our systems were and are in place in and have done us good. We have been fortunate to have experienced a strong and healthy real estate market despite the slight fluctuations in our economy. And as we move into 2010, we move with the confidence that we will be able to sustain our economic growth here in Canada.

Of course, we can never know for certain but certainly we – hope.

I wanted to share with you a piece on hope by Vaclav Havel. You may know him as a writer, dramatist and a politician. Or you may just know him as the last president of Czechoslovakia and the first president of the Czech Republic. He reminds us that hope is not the same thing as optimism, that it is not so much about something turning out well, as it is about something that makes sense, regardless of how it turns out.

Here’s hope to the choices made in ’09, that they will serve us well in 2010. That Canada – as the rest of the world – can continue to build/rebuild economically and strengthen this global village we are all a part of.

Hope – by Vaclav Havel

Hope is a state of mind, not of the world….Either we have hope or we don’t; it is a dimension of the soul, and it’s not essentially dependent on some particular observation of the world or estimate of the situation.

Hope is not prognostication. It is an orientation of the spirit, and orientation of the heart; it transcends the world that is immediately experienced, and is anchored somewhere beyond its horizon.

Hope, in this deep and powerful sense, is not the same as joy that things are going well, or willingness to invest in enterprises that are obviously heading for success, but rather an ability to work for something because it is good, not just because it stands a chance to succeed. The more propitious the situation in which we demonstrate hope, the deeper the hope is.

Hope is definitely not the same thing as optimism. It is not the conviction that something will turn out well, but the certainty that something makes sense, regardless of how it turns out.

Vaclav Havel, writer, dramatist, politician
Last President of Czechoslovakia
First President of the Czech Republic
Cancer Survivor

Young Buyers Drive Condo Boom

December 1, 2009
By CBC News

With a record 20,000 new condo units set to come online in 2010, the recession appears to have bypassed that part of the Toronto real estate market.

The worldwide economic slowdown took a bite out of stocks and real estate values almost everywhere in the world.

But with a record 20,000 new condo units set to come online in 2010, the recession appears to have bypassed that part of the Toronto real estate market.

Love them or hate them, Toronto is fast becoming the city of condos.

The condo building boom that began several years ago is showing resilience, as low interest rates and a steady stream of eager new buyers are sustaining a market that looks affordable by international standards, some experts said.

Condo consultant Barry Lyon said 2010 is poised to be a record year for Toronto condos.

“We have become the largest condominium market in North America in terms of new production,” he said. “Bigger than New York.”

This week, CBC Radio reporter Jamie Strashin’s Condo City series chronicles Toronto’s condo building boom. Find out why the market is so hot on CBC Radio One ? 99.1 FM in Toronto.

There are a number of factors, said Jasmine Cracknell, a research assistant with N. Barry Lyon Consultants Ltd., who tracks the city’s condo market.

Despite price gains and a wave of new units coming onto the market, condos remain an affordable option for domestic first-time home buyers, she said. And foreign buyers invest because the prices seem very competitive internationally, she added.

“When we have people from out of town, they cannot believe the price,” she said. “When you think of New York, [prices] are $2,000 a square foot [but Toronto] is closer to $500 in the downtown.”

She dismisses the notion that Toronto’s market might be overbuilt, because the way building projects are financed in Canada precludes that from happening.

Canadian regulations outlaw lax lending rules such as zero downpayments and 40-year mortgage amortizations that helped inflate the U.S. market.

In addition, condo developments in the city need to be 70 per cent sold before banks will finance their construction. Which means shovels don’t hit the ground unless there is genuine demand for the units and they can afford them, she said.
Young buyers drive demand

“People are living in these buildings, even if they do become rental housing, ” she said. “It’s not like they are vacant.”

Whatever the cause, the condo trend shows no signs of slowing. According to the most recent data, October’s seasonally adjusted annual rate of housing starts increased by 14.8 per cent in Ontario. The CMHC attributed the jump to more activity in the multiple-starts segment, which includes condos.

Data from the Canadian Real Estate Association shows further evidence of a booming market. The agency does not break out the data for condos alone, but residential housing in Toronto was pointing straight up for the year up to October.

‘People are living in these buildings ? it’s not like they are vacant’? Condo consultant Jasmine Cracknell

The total value of housing sales nearly doubled to $3.5 billion in October 2009 compared to the same period a year ago. Unit sales were up 64 per cent and the average price in the city was $423,507, an increase of 20 per cent on the year.

Much of those gains are coming from condos, as buyers like Michael Petrucco buy in.

He has just moved to a condo in Leslieville with his girlfriend. After living in suburbs for years, he opted to move downtown and cut down on a punishing commute.

“Not having to commute from Thornhill makes my life easier, I’m home earlier,” he said.

And he’s not alone in that desire, Lyon said.

In contrast with the 1980s, when the Toronto condo market was just getting off the ground, it’s young professionals such as Petrucco driving the market this time, Lyon said.

Back then, retirees made up about 80 per cent of the city’s original condo buyers.

“Now it’s a high proportion of singles, and some couples,” Lyon said. “Not many of the people who formed the original condo market in Toronto, the empty nesters.”

Indeed, Cracknell notes that the ratio has flipped ? a full 80 per cent of condo buyers today are young, first-time buyers.

Many are eschewing ever renting and opting to live with parents before buying condos in their early twenties. Even in the last five years, the appeal of the downtown condo has changed, Petrucco said.

“You didn’t have the same infrastructure, you didn’t have the grocery store or movies,” Petrucco said.

Real estate fees could be slashed – Yourhome.ca

Real estate fees could be slashed – Yourhome.ca.

Housing Boom Has Legs: CIBC Economist

Interest rates are not going to rise any time soon, says a leading housing market expert, but it’s incumbent upon homebuyers to ensure they can carry their mortgage even if rates rise 200 basis points.

Speaking before the Canadian Mortgage Conference and Expo in Toronto, hosted by The Canadian Association of Accredited Mortgage Professionals (CAAMP), CIBC senior economist Benjamin Tal made the case that rates will probably not rise until late 2010, which means the hot housing market in Canada, will likely continue well into next year.

“I don’t see the Bank of Canada raising interest rates well ahead of the U.S. because of the implications for the Canadian dollar. Can you imagine a situation where the BoC would raise interest rates, while the U.S. is neutral? The dollar would end up going to the sky. That’s exactly what the bank of Canada doesn’t want to see,” Tal told Advisor.ca.

“Therefore, we won’t see the switch the market is projecting; it very possible we won’t see a rise in rates until late in 2010 or early 2011. It will be longer than what the market is expecting. The situation in the U.S. clearly does not justify higher interest rates, not now and not anytime soon.”

U.S. time bombs averted

Eventually rates will rise. Tal argued the worst of the recession is over in the U.S., and discounted concerns over “four time bombs” related to U.S. debt, which market bears say will create another financial crises. Those four bombs are resets on Alt-A mortgages and Option Adjustable Rate Mortgages (Option ARMs), as well as concerns in commercial real estate and credit card defaults.

A large portion of the subprime mortgage crisis was caused by resets on teaser rate mortgages which renewed at higher rates that homeowners couldn’t afford. Many of these mortgages were sliced and diced and securitized in the debt markets, which caused a global systemic crash.

Similar concerns exist on Alt-A mortgages, which were sold at low teaser rates with a reset after the first five years. Tal points out most of the resets are coming due now, so the mortgages are resetting at the now historically low rates.

Option ARMs are little more problematic. These mortgages allow homeowners to pay interest only on their home purchase for set period. Eventually these mortgages reset and the homeowner must start making principle payments.

“Only 47% of the Option ARMs were securitized, which does not create the nasty side effects that subprime had. The huge portion that is not secured, which are on the balance sheets of banks, can be played with over time. It’s not really a mark-to-market shock. Not to mention that 50% of these mortgage contracts are for 20 years, not for five years.”

Tal adds, “The same goes for commercial real estate, which is mostly held by small banks. Already more than 127 banks have gone under in the U.S. this year, and I expect 300 to 500 to become insolvent over the next 12 months. Compare that to 10,000 banks in The Depression, and it’s not as serious a macroeconomic story.”

The primary factor that caused the subprime crisis — inflated home debt — seems to have dulled the impact of credit card bubble, Tal says.

“People turned to their houses as an ATM, you put debt on the house, instead of the card. We haven’t see a bubble in the credit card market and even if you allow for 11% unemployment, were talking about $90 billion [losses] in the U.S. credit card market, which is roughly what the banks are expecting.”

Not a bubble yet

There is growing concern that the low rates and the fast rise of home prices in Canada is causing a bubble, but Tal says this speculation is premature.

Tal says a combination of low rates and high consumer confidence, backed by a strong financial lending system, support much of the optimism in home buying.

“In Canada, consumer confidence is only 10% below the highs of 2007. In the U.S., it’s 50% below,” he says. “We have confidence and low external interest rates.”

His biggest concern is that homebuyers may have overleveraged their most recent purchase, and may not be able to afford the inevitable 200 to 300 basis point increase, which would mark a return to a “normalized” rate regime.

“I challenge the [mortgage lending] industry to come up with research to make sure we know what types of mortgages are in the pipeline,” Tal says. “We need to know how many people taking variable rate mortgages at 2.5%, who cannot afford financing a mortgage at 4.0 or 4.5%. If it’s a marginal number, then we’re not creating a bubble — we’re basically seeing monetary policy that is working.

“We have to make sure if you take a mortgage now, you have to be able to finance it 200 basis points higher after 2010. If you can’t, then you should probably buy a smaller house or don’t buy a house at all — that the prudent thing to do.”

Tal says he believes most lenders are running this basic risk analysis on prospective borrowers.

“I think everybody knows these interest rates will not last, even consumers understand this. That could be a reason why people are buying right now, this is a window of opportunity that will close in the not to distant future. I believe this will probably not close as quickly as people expect,” he says.

Filed by Mark Noble, mark.noble@advisor.rogers.com