From Globe and Mail:
Bond yields worldwide jumped in recent weeks as
the Federal Reserve hinted its bond-buying program could soon begin to wind
down. The Canadian bond market has not been immune to this force, with 5-year
government bond yields up from 1.33 per cent five weeks ago to 1.84 per cent
last week.
Ten-year
yields are up 80 basis points over the same short time span. (A basis point is
1/100th of a percentage point.) Posted mortgage rates in Canada have moved
higher in lock-step, with the cheapest five-year fixed mortgage rate up 65
basis points over the same period, putting it back above 3 per cent.
This puts significant pressure
on Toronto condo investors. Yet a recent blog post on Urbanation, a website
that tracks Toronto’s condo market, touted the invest-to-rent option –
presumably because the previously popular invest-to-flip option is no longer
profitable – noting that the average rent for a Toronto condo is now $1,856,
handsomely up 10 per cent from two years ago.
Note
that rents did not really go up by 10% over the past two years.
In reality rents went up just over 7% over the period of two years.
Based on the average condo sale
price of about $330,000, this appears to be a healthy rental yield of 6.7 per
cent – on the surface, it’s a tidy sum compared to the low-risk option of
parking money in a “return-free” savings account at a chartered bank. What the
report failed to mention, however, were the carrying costs.
So, here are the sober math facts of the net rental yield. Interestingly, banks do not charge a
premium for an investment-property mortgage (under a puzzling assumption that
there is no added default risk to investment properties versus owner-occupied
purchases) so the posted rates apply to an investor.
Based on
a 3.05 per cent mortgage rate, a five-year fixed mortgage with 20 per cent
down-payment and 25-year amortization period requires a payment of $1,265 per
month or $15,187 a year on an average condo, a 7-per-cent increase from just
one month ago. Monthly maintenance, including utilities, will set the investor
back conservatively $4,000 per year on a one-bedroom downtown condo. Take
another $2,600 per month off for real estate and income taxes.
All that is left is $535 per year, for a net rental
yield of 0.16 per cent. And a repair or a paint job could wipe out that profit
in a flash.
The
question becomes, why would an investor take on the risk of owning a condo for
virtually no annual return?
The
answer: They are not. Even before rates began to spike in May, Toronto condo
sales were flagging, with sales down a whopping 55 per cent in the first
quarter of 2013 versus a year ago. Diminished affordability was no doubt a
contributor to the sales slump as the market felt the pinch from the new
regulations requiring a shortened amortization period – the equivalent of a
100-basis-point increase in the five-year mortgage rate.
However, potential buyers are also worried about a price
correction. Price gains in the condo market were a skimpy 1.2 per cent in May,
which is a far cry from the 10-per-cent-plus returns investors had come to
expect before the federal government’s mortgage crackdown. Double-digit returns
made condo purchases worth the risk; 1 per cent annual returns, not so much.