Per CREA, the benchmark home price for Greater Toronto has increased from $836,800 in January 2020 to $1,045,800 in May 2021. This CTV News article illustrates how rent prices have dropped significantly during this period due to the COVID-19 pandemic and are starting to pick up in some areas but not all. This got us curious - how many homes which were both bought and leased during this period were still cash flow positive? For reference, a cash flow positive property is where the rent price being received exceeds the cash costs of ownership (mortgage payment, property taxes, condo fees, etc.). If a property is cash flow positive, the owner is pocketing some extra cash on rental income after covering these costs.
We analyzed every sale and lease record from TREBB in 2020 and 2021, to see whether each individual property would be cash flow positive or cash flow negative. We know that home prices have become detached from incomes, and our findings from this analysis show that home prices have also become detached from rent prices.
Data, assumptions, and approach:
Data relating to the GTA is provided by the Toronto Regional Real Estate Board (TRREB) and may include some sales outside of the formal GTA boundaries. When looking at TRREB data, we are only considering the most common types of residential properties (detached, semi-detached, row homes, condo apartments, and condo townhouses).
We created a list of every address (excluding any unit number) and bedroom count, where there was at least one sale and at least one lease transaction in the given year. We calculated an approximate ownership cost for each item in this list and compared this to the average rent price for that address/bedroom count combination. Approximate ownership costs were calculated as the sum of:
1) Mortgage payment on average close price (assuming 20% down payment, 25 years amortization, 2.00% mortgage rate)
2) Condo fees (if applicable)
3) Property taxes
Some charts:
This chart shows that the cash cost of ownership is higher than the corresponding rent prices at the vast majority of properties across all property types. Remember that we are not taking any averages here - this is based on the review of every individual address/bedroom combination in the GTA.
This chart shows that those who bought and leased in 2020 and 2021 are generally experiencing large net cash outflows. On an annualized basis, this ranges from $4,150 for row homes to $11,000 for detached homes.
Conclusion:
It appears that buyers have become comfortable with having a negative cash flow property. One reason for this is because they expect future price appreciation to exceed their net cash outflows. We started this article by pointing out how home prices increased by over $200,000 in under two years, which would more than make up for the net cash costs. Also, buyers could still be building equity as long as rent prices cover mortgage interest and other costs apart from the principal portion of payments. Based on those two arguments, buyers can justify why they are willing to buy a property that will be cashflow negative. So should we be concerned with the findings of this analysis? Absolutely.
The issue is that one key reason for buying a cash flow negative property is the expectation that price appreciation will be ongoing and outpace cash outflows. Once this stops or becomes less likely, the investment becomes far less attractive. Many industry experts called a top in March 2021 and we have seen prices decline slightly in May and June. If prices are no longer appreciating as expected, the soundness of the investment then falls to whether rent prices can cover monthly expenses and a portion of principal payments. However, if only a small portion of principal payments are being covered by rental income, it no longer makes financial sense to keep your cash in this property as opposed to stocks or other assets where you can generate a higher return. With home prices so detached from local incomes and rent prices, there seems to be less and less fundamentals supporting current home prices. What happens when a market so heavily influenced by investors is no longer a lucrative investment?
After reading this article:
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