May 28, 2020 | Falling Rents: Good for Tenants Bad for Levered Landlords

In December 2017, the Bank of International Settlements (BIS) reported that Canada’s highest population areas were home to the most over-valued realty prices, relative to rents and income, of anywhere in the world.

According to a recent CIBC and Urbanation study, 48% of all newly completed condominiums in the greater Toronto area since 2017 were purchased for the purpose of renting out. Still, nearly half in 2019 were negative carry—not making enough rent to cover their holding costs.  Thirty percent of those studied were paying an interest rate greater than 6%, and one in six were paying a rate of more than 9%.

Now a perfect storm of rent-depressing factors is hitting many of the most expensive urban areas in 2020 as fewer short-renters are travelling, immigration pauses, post-secondary schools move online for the fall, new work-at-home employees seek space out of city centers, and millions look to lower expenses by consolidating with extended family and other roommates.

In just April, the Greater Toronto Area (GTA) saw a 91% increase in new listings of furnished condos from a year earlier.  In early May, the median monthly rent for a condo leased in the GTA was $2,200, down 4.3% from the same period a year ago while the number of signed leases fell 42.5% (source: Urbanation).

Capital Economics projects that rents are likely to decline by at least 5 to 10 percent in Toronto and Vancouver this year.  An additional 60,000 new condo units are presently under construction in Toronto, and 20,000 more are expected to be completed annually over the next two years.

This is a bad time to be a highly leveraged owner of Canadian real estate. As John Pasalis, president of brokerage Realosophy Realty, notes many people “overextended themselves” to buy multiple properties in recent years.  See Pandemic puts downward pressure on residential real estate:

These were investors who, a year ago, couldn’t care less if they were cash-flow negative [by] $500, $600, $700 a month on their condo investment, because in their mind that was going up 10 per cent a year, so it didn’t really matter,” Mr. Pasalis said. “Well, in a recession, you can’t be cash-flow negative on two or three or four rental properties. That’s going to destroy you.”

In turn, some investors could be forced to liquidate their units, which could weigh on resale prices, Mr. Brown of Capital Economics said.

“With property investors basing their price expectations on the assumption that rents would instead keep rising strongly, this represents a big risk to house prices,” he wrote.

Danielle Park May 28th, 2020

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