Are condos a wise investment?
MONEY 401 | They can be, but you must know the lay of the land
ELLEN ROSEMAN
Aug. 6, 2006. 08:43 AM
Is it a good time to invest in a condo apartment in Toronto? And if so, what are smart buying tips for a condo investor?
Industry insiders say you have to do your homework. It's a tough time to buy since prices are rising, but rents are stable or going down.
Rents for condo apartments in Toronto have been relatively flat since 2003, says Jason Mercer, a senior market analyst with Canada Mortgage and Housing Corp.
During the same period, the prices have gone up steadily in both the new and resale market.
"On average, the income-generating ability of condominium apartments has declined, making other asset classes more appealing for investors," says a CMHC condominium survey last fall.
There are warning signs for the Toronto real estate market, which had its best year ever in sales of existing homes last year.
"This year, we're seeing a bit of a plateau," says Mercer, who predicts that annual sales will fall by about one per cent.
Meanwhile, there's a surge of new condo construction in Toronto. About 38,000 rental apartments are coming on stream and will be registered this year and in 2007.
Still, Toronto is not seeing the same speculative activity as it did a decade ago. Investor-held rental condo apartments are now 18 to 19 per cent of the total market, compared to more than 30 per cent in the mid-1990s.
The vacancy rate for rental condo apartments was just 0.9 per cent last year — compared to an overall 3.7 per cent vacancy rate for all rental units in Toronto.
Given what could be a difficult time for condo investors, what should you be looking to buy?
Boycott big, says Brad Lamb, broker-president of Brad J. Lamb Realty Inc.
"Investors should buy the smallest units in the building, anywhere from 350 to 600 square feet," says Lamb.
"Tenants aren't rich and powerful. They can afford to rent the lowest common denominator."
Lamb is a top condo broker, known for his eye-catching billboards across the city. His website says he sold more than 1,300 condo units last year for $400 million.
He has a few rules for investors, starting with the size of the down payment.
"You should always put 25 per cent down. If less than that, you're speculating," he says.
How much income do you expect the rental unit to generate each year? That's gross income, not net income.
Multiply the gross income by 11. That will give you the maximum price to pay.
"The factor I use used to be 10, but that doesn't work any more," he says.
Suppose you figure a condo will generate $1,400 a month or $16,800 a year. Multiply by 11 and you get a top purchase price of $184,800.
You should aim to earn a 10 per cent return on your invested capital, he says.
Suppose you buy a $180,000 condo unit and put down 25 per cent, or $45,000 (your invested capital). Your goal is to clear $4,500 a year (your net income after expenses).
Condos that meet these criteria are not the easiest thing to find in Toronto, he says.
"You have to hook up with the right real estate brokers. If you're a loyal client, they'll get you into properties before the public do. It's much like getting into a hot night club."
Lori Franze is a real estate agent with Coldwell Banker, selling units at the new Pinnacle towers on Yonge St. (near the Air Canada Centre). Here's her advice:
Put enough into the down payment to cover mortgage principal, interest, taxes and condo fees, including potential increases in condo fees.
Invest in mid-priced condos. Don't buy more expensive units, which won't cover their costs in rent.
Anything under 700 square feet performs best. Remember you'll always be competing against the lowest-priced condos, with units for sale or lease.
Do your research on rents in the neighbourhood, vacancy rates and the time it takes to find a tenant for similar units. There's nothing worse than buying a place that will sit vacant for months.
Be prepared to do your own property management or consider the costs incurred to hire someone. It may be worthwhile to hire a real estate agent to rent out your condo unit.
"Realtors not only bring expertise in preparing the lease documents to best protect the owner, but also bring a higher quality of tenants," Franze says.
Donald Bentley, president-elect of the Toronto Real Estate Board, works with Royal LePage in the Leaside area of Toronto.
"Look for condos that appeal to the widest group of people possible," he says.
This means easy access to public transit, shopping, parks and other amenities.
If you're buying a unit in a new building, check the quality of construction done by the developer in the past.
"You want to make sure the developer finishes things to the highest standard, so the building doesn't get run down in a short period of time."
And if you're looking at an existing building, check the percentage of units that are owner-occupied.
More owner-occupied units means more care, maintenance, decorum and pride of ownership, Bentley says.
He advises buying in buildings that have a higher percentage of larger units, such as two bedrooms or one bedroom with den.
"If more of the building is occupied by people who can afford higher rents, it will weather better than a building full of small units, appealing to a relatively transient group who are using it as a stepping stone."
Does the condo unit have a parking spot with a separate deed? This means you can sell it if you don't need it.
"Liquidity is an important factor," Bentley says. "Being able to divide and sell separately does have some merit.
"We have a parking spot on sale now for $38,000. But the purchaser has to own a unit in the building."
Don Campbell teaches courses in real estate. He has advice for condo buyers in a new book, 97 Tips for Canadian Real Estate Investors (Wiley, $26.99).
Rules change from one condo corporation to another. Do the condo bylaws allow rentals in the building? If so, how many are allowed and how many are currently in the building?
"Many novice investors have been caught buying properties in buildings where the rental allotment was already filled, so they had to keep their property vacant or resell it," he says.
Some rules are quirky. Tenants may not be allowed to park their bicycles on the balcony or set up a home-based business.
Read the bylaws so you know what you're responsible for and what you can and can't do as an owner.
Check the reserve fund study that shows the current condition of the common areas, the schedule to replace them and the cost of doing so over the years. This is done by an outside company.
Is the condominium board doing what the study says it should be for maintenance and building a reserve fund?
The condo board does not have to do everything the study suggests, but if it's not building adequate reserves to cover obvious future major expenses, you can expect to receive a hefty bill in the future.
"If the reserve fund study isn't complete (perhaps it's in the process), you need to talk to your lawyer about an addition to your contract," he says.
Include something like this: "Seller warrants there are no special assessments required, contemplated or unpaid."
There's a helpful worksheet for condo investors in Campbell's book. You can also consult CMHC's Condominium Buyers' Guide, a free publication available at its website,
http://www.cmhc.ca
. Next week, we wrap up this series on condos with a look at the feasibility of buying and renting to family members.