The Calculus of Investment Property
Let's say I want to buy a $500k condo in Toronto, and willing to put in $150k as downpayment (initial investment), resulting in a $350k mortgage. Let's further assume that the rental rate will be a conservative $2000/month.
So annually we talking this, conservatively:
Revenue: $24k (minor increase each year, and assume no vacancy. More than 2.5 months of vacancy and I would have an operating loss)
Let's say property tax will be $2k (minor increase each year)
Let's say condo fees $500/month = $6k (increasing each year)
Let's say operating costs for misc repairs etc is $1k
Let's say mortgage interest costs is 3% of $350k annual so roughly 10k (decreasing each year)
So right now net profit before tax is only about 5k. Let's say I'm at the highest marginal tax rate and after tax we have about 3k left.
So the net result is I dumped $150k to earn an annual operating profit of $3k in the best case. That's only 2% annual return (at least in the earlier years. Profit should increase as mortgage interest is reduced). If there are any vacancies, tenant issues, or if structural issues with the condo whereby everyone has to foot the bill, I would have an operating loss. Any of the e-banks earn better interest rates than this and it is guaranteed.
On top of the operating return I may or may not have capital appreciation. So let's say after 5 years, the value is now $600k (up from $500k). So on top of the 2% annual in operations, I would have $100k capital gain (50k taxable) and let's say again top tax bracket. So $30k net profit upon sale after 5 years.
So the operating profit is minimal and basically keeps up with inflation. Very possible loss if any vacancies or condo issues occur. We're really just gunning for the appreciation in capital. Stock investing easily beats the annual operating profit. In other words, investment properties in the current Toronto market is not actually very attractive if you consider the risks. There's also double land transfer tax and legal fees upon transfer of ownership. So the net amount you profit from capital sale is actually lower than $30k for an initial investment of $150k. Continued capital appreciation is not a sure thing. But increasing condo fees and mounting structural issues, and eventual vacancies are real and almost certain in the longer term.