AMA .- Investing in Toronto Rental Market
Alexandra asks: “I’m considering investing in the Toronto market that has an extremely low rental vacancy rate. Since the demand is so high and Toronto is a growing city, do you think this is a good idea?”
Alexandra, this is a great question.
It is true that vacancy in Toronto is extremely low. The city continues to add about 125,000 population each year, and there are about 35,000 units of new construction added to the market each year. Clearly there is a gap between demand and supply for housing overall. If you break down the vacancy by type of property, you can see even more granularity. For example, Bachelor apartments have the highest vacancy at 1.6%. This data comes from the Canada Mortgage Housing Corporation. This is Canada’s quasi government back mortgage insurer.
One bedroom apartments have a 1.3% vacancy rate, two bedrooms have a 1.1% vacancy rate, and 3 bedrooms are 0.9% vacancy rate.
Rental rates increased an average of 4.9% from 2017 to 2018.
The shortage of housing in Toronto isn’t new. That’s been happening for years. So the real question is “Why is the vacancy rate so low?” If the opportunity is so amazing, why do we not have more people flocking into the market to invest in rental properties? It doesn’t make sense that the vacancy rate remain so low for such a long time.
In my opinion, there are four factors that contribute to making rentals in the Toronto market a mediocre investment.
- Properties are very expensive to purchase. We’ve seen sale price increases over the past several years in the double digits. When the purchase price increases much faster than the rent, it’s hard to make the numbers work. You won’t see the market support an 18% increase in rents, whereas in 2016, market prices increased an average of 18 across the entire Toronto market. That’s a huge shift. You end up tying up too much equity in a property for the rent that you can collect.
- Toronto has instituted rent controls which limit the amount of annual rent increase that a landlord can demand from tenants.
- Constructing new dwellings in Toronto attracts very high development fees to the city to pay for the increased load on infrastructure, whether we’re talking about water, sewer, electric, roads, public transit and so on. When you have to write a cheque to the city for $84,000 to build a new single family home, and you have a choice to sell that home in the open market where you have no cap on the sale price, versus putting it into the rental market where your rent increases are capped, it’s an easy choice.
- The landlord tenant laws in Ontario are heavily skewed in favour of the tenant.
Toronto is a wonderful city. It’s clean, safe by World or American standards, multi-cultural, and there is an abundance of commercial and employment opportunities. But it’s increasingly one of the most traffic congested cities in North America. They haven’t been able to build enough road infrastructure to keep up with the population growth.
Some investors have bought into the market, accepted the fact that there is very small cash flow, and in many cases negative cash flow. They’ve justified the investment by saying that they make it up in appreciation. For investors, it has worked out. But you don’t control what the market will do in the future. For that reason, it’s a risky strategy and one that I don’t recommend.
I personally favour markets where the rent to purchase ratio is much better.