Big-city real estate investment, and especially condo investment, has a bit of a bad rap. But it’s completely undeserved. I’d like to clear the air. We’re going to walk through the numbers and cut through the jargon to show you exactly what you’re getting in a condo investment.
First, there are only three ways to make money in condo investing:
Buy at one price. Sell higher. Rinse, repeat.
Find a tenant. Collect rent. Deduct expenses.
This is the difference between the market value of the unit, and the amount owed in financing (if the unit is mortgaged). Equity gain doesn’t involve any offloading or selling of the asset. It’s the ongoing difference between what you have and what you owe.
The next thing you need to understand is that condos are the most unique investment on the planet. No hyperbole. The reason so many brilliant financial minds are unwilling to invest in real estate is that they approach condo investments the same way they approach other investments, and this is a fatal error.
The only similarity to stocks that condo investments have is that they both can make money through sale proceeds. But condos offer many more opportunities than stocks, and so analyzing condos through a stock model misses a huge part of the picture. The best part about condos? Somebody will pay you to use it until you sell it.
Condos, unlike stocks, provide you the proceeds of your return on investment while not requiring to unload the income-producing asset. To realize your ROI on a stock, you’d have to sell it. Condos allow you to reap the monthly returns indefinitely.
With an annual profit of $12,120, it would take you 23 years to pay off what you invested into the property. And that’s not even considering the property’s appreciation! Think about it. In 23 years, your renter(s) will have paid you back your initial investment while continuing to provide you with rental profits, and you'll own a significantly more expensive property. At an average growth of 4% per year, in 23 years the condo you paid $280,000 for will be worth about $690,000.
Worst Case Scenario
What if the market crashes, or the property value drops unexpectedly?
Historically, the worst real estate devaluation crisis in Toronto happened in 1989. New dual-income households had much more spending power, speculative investment increased dramatically, and low unemployment rates meant more people were searching for homes. In the four years prior, housing values increased by more than 100%. Property values between 1989 and 1996 saw a 23% correction in property values, adjusted for infaltion.
Go back as far as modern-day record keeping and you will see that there is not a single 15-year period in history where real estate values, adjusted for inflation, have not yielded a positive gain.
Still, the leadup to the 1989 crash was clearly a “bubble” situation. Normally, markets ebb and flow with the economy, unemployment rates, etc. This is normal. But bubbles are characterized by large, sudden spikes in value that are not justified by these market conditions. In the five years leading up to the crash, property values appreciated by more than 100% - close to 20% annually.
But let’s add the “bubble” factor to our numbers. For the naysayers.
Let’s assume Toronto’s market devalues by 23%.
A 23% decline over 7 years means that our $280,000 investment will be worth $215,600 in 2021.
If this was a stock, then you would have lost $64,400.
But this is not the case with a condo holding.
We're getting paid on our investment with each passing month, profiting $12,120 annually.
We've still made $84,840 in rental profit.
Instead of a $64,400 loss, in actuality it's a $20,440 gain or 0.73% return on your investment. That’s better than a savings account - and the loss isn’t actualized. It’s temporary. Eventually, the properties recover their value and begin to appreciate again.
We're still paying $1,302 in mortgage which makes our monthly profit of $1,010 a loss of $292 per month. In 7 years that works out to an additional $24,528 over the 7-year crash of our condo.
The key is not to panic and not to actualize this loss. And why would you? Most of your costs are still being paid.
During the 5-year term for the mortgage described above here's how it breaks down:
Regardless of what the market value does, the principal repayment amount ($25,768.91) is part of your equity building. Think of it as a contribution to a mutual fund in the amount of $429 a month. That's the monthly portion that is 100% equity. This amount should also be considered when we discuss our monthly loss of $292.
So here's how our math breaks down:
This is the most important distinguishing feature between a condo investment and any other type of investment product: regardless of temporary drops in paper value, investments made in proper rental markets will always have someone else pay your investment off until the asset recuperates its value… even in the worst market situation possible.
In the case of our 1989 example, in 7 years of a repeated worst-case-scenario market, with financing in place, we would have built $25,768.91 worth of equity, which we did not pay for. There is even $1,650 left over as rental profit per year, which works out to $8,250 at the end of our mortgage term.
Fast-forward to now: the Toronto “bubble” is, in fact, not a bubble at all. Market data show this. Property values have increased by 16.2% in total in the last four years. That's a growth of just over 4% per year. This is not unsustainable. It’s actually a pretty modest growth pattern - especially considering the GTA’s population growth. It also closely follows Canada’s GDP - an important indicator of our economic health. StatsCan published December 1st a 2.3% third-quarter (annualized) increase, within two percentage points of the housing market increase.
Still, I’m with the skeptics: you should know your worst-case scenario. And now we do. Condo investments are the only asset you will ever find that will provide you with income, regardless of how low its paper value gets.
The only thing you have to do is make sure you're buying the right one.