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Tight rental market helps spur condo plays

The industry estimates that one in three new condo units is bought by an investor

Special to The Globe and Mail

When Jacob Katsman decided to cash in on Toronto's current condominium boom, he aimed high -- penthouse high. Mr. Katzman organized a group of investors into a private company, Boardwalk Properties, and bought three penthouses at Toronto's huge CityPlace development.

The name reflects his investment goals. Boardwalk is the most expensive square in Monopoly, charging the highest rents to any player landing on it and commanding the highest sale value.

"It just seemed like a great opportunity," says Mr. Katsman, 33, chief executive officer of CCEWeb Corp., a software and network developer for the financial industry. "I think we can either sell them for about $1-million each or rent them for enough to provide positive cash flow. The location is great -- they overlook SkyDome. The design is unique. The prices were right."

That combination of rising prices and a tight rental market has seen private investors flood into condo markets in major Canadian cities -- especially Toronto and Vancouver. Developers and real estate agents estimate that one in three new condo units is purchased by an investor. Their goal is to either sell at a profit soon after closing or rent the unit and let time accrue equity -- and profits.

"I have been selling condos for 20 years and I know that unless you successfully market a project to investors, the property will be very slow to sell," says Mark Cohen, vice-president of sales and marketing for Concord Adex Developments Corp., developer of CityPlace. "When all is said and done, investors account for about 30 per cent of this project and I think that is typical."

William Binnie, owner of a Royal LePage Real Estate Services Inc. franchise in Vancouver, agrees. "I would say 30 per cent is reasonable in new buildings. It can be less in resales, though, because condo boards can limit the number of rental suites in their building. Still, the investor contingent here is a large one."

The factors fuelling condo investments are simple. First, stocks and mutual funds are not generating returns investors want to see. At the same time, mortgage rates are at historic lows -- in the 5- to 6-per-cent range. Rental vacancy rates are in the very low single-digit range and, at the same time, real estate prices are on an uphill curve.

All that means that condos bought with reasonable down payments -- 20 to 25 per cent -- can be purchased and rented at rates that deliver either a positive cash flow or the prospect of break-even in the near future.

At the same time, a rising market holds the prospect for capital gains.

"While condo investors could get burned in the short term, if the market takes a dip or interest rates rise, in the long term, the prospects are great," says Steve Krstinovski, an agent who specializes in condos with Royal LePage in Toronto. "Since 1995, condo prices in Toronto have gone up an average of 6.5 per cent a year."

Current favourable conditions should continue for the foreseeable future, says Charles (Chuck) Mady, president of Mady Development Corp. of Windsor, Ont. His company is currently a partner in the new Regency condo tower planned for Bay Street and Yorkville Avenue in Toronto.

"I am rather bullish about condos," he says. "If you look at recent bank reports, they say Toronto, especially, has the ability to absorb all the projects under way or planned."

The situation is not quite so bright in Vancouver, says Mr. Binnie. He finds that rental rates for condos are not quite as high as in Toronto and that most investors face a negative cash flow for the first few years. Still the prospect of being out of pocket in the short term has not deterred investors. He says he has clients that pick up two or three units at a time.

While economics rule out larger units as an investment, it works in favour of top-of-the-line penthouses, says Mr. Katsman. In fact, between the time he bought the first two units and the third, prices had risen by 20 per cent.

Granted, investing in penthouses demands big bucks. To date his group has put down $324,512 in cash for all three, with another $30,000 payment to go. When he gains occupancy of the first two this April, however, he plans to offer them for sale at around $1-million each. If he can successfully sell all three at that price range, his group will turn a profit of nearly $1-million.

Taxes and maintenance on each unit total $1,327.62. Rental rates are in the range of $3 to $3.50 a square foot, which means the units could rent for between $6,000 and $7,000 a month each, leaving between $4,600 and $5,600 a month for mortgages.

Tax planning can work in favour of real estate investors, explains Anne Jewett, an associate partner at Deloitte & Touche LLP in Toronto.

Any loss from rental activities, for example, can be deducted from other sources of income. Rental income can be reduced by depreciation, as long as that depreciation does not create a loss.

"Take a hypothetical case where rental income is $1,000 a month and expenses are $800. That leaves $200 a month in income. You can apply depreciation at 4 per cent a year on a straight-line basis up to the point where there is a loss. That means taxes on that $200 a month are deferred until the investor sells," she explains.

Upon sale, the depreciated portion is deducted from the total gain and taxed as straight income in that year, while the balance is taxed as capital gains at half the marginal rate paid by the investor.

While at first glance real estate might seem the perfect investment, agents, brokers and accountants all warn that anyone investing in condos must be aware of the downside.

Can the investor afford to carry the mortgage and expenses if the property proves difficult to sell? Is the investor prepared to weather any downturns in the condo market? What happens if mortgage rates rise?

"You have to look at the long term," says Mr. Cohen.

"While market conditions may change in the short term, real estate has always proved to be a sound investment over the long term and condos are an affordable way for many people to make those gains."

© The Globe and Mail

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