In my last article I discussed how pre-construction real estate investors typically utilize one of 2 common strategies; either they buy and flip before or after closing, that is before or after actually taking possession of the property after it is actually built. Click here if you missed it.
There is however a third real estate investment strategy that many savvy real estate investors have used and continue to use for one simple reason. It works! In fact, it has been proven to work for well over a thousands of years!
Buying and holding real estate investment assets indefinitely, is not a “shiny new” strategy and it may not be viewed as the most “sexiest” of investment strategies out there today. However, like those “Buckley’s” cold medicine commercials say it best “It works”! In fact, if properly purchased and managed it works very well indeed.
Having utilized this strategy numerous times myself it will come as no surprise that I am a huge fan of it. However, with so many real estate investment options out there today which buy and hold strategy works best?
Let’s break it down!
The most common real estate investment vehicle of choice for both beginner and even many advanced investors today is either residential: 1) condominium units, whether they be high rise units or low rise town homes; or 2) freehold town homes, semi-detached and detached homes.
Many people mistakenly lump their personal homes as both a place they require for their housing needs, as well as, a real estate investment. Understandably so, given that most have been taught that most peoples homes are the biggest investments they will ever make. However, this “common wisdom” is flawed on so many levels, that go beyond the scope of this article.
Consequently, my analysis is strictly based on these real estate asset classes as “true” investment assets, which may not be applicable to someone looking to buy one of these assets as a principal residence for a variety of reasons that work best for their unique circumstances.
This week, in Part I of this article, I will give you my no B.S. take on condos as an investment.
Anyone attending my FREE No B.S. Real Estate Training class already knows the real macro reason for Toronto’s condo boom and why they have been, and continue to be, extremely popular investments for well over a decade now in the GTA. More specific reasons as to why condos continue to be popular with both investors and owner occupants include:
- Many condos are located in prime locations and offer great amenities and facilities such as indoor pools, gyms, concierge service and on site security. Although they may be significantly smaller than the freehold cousins, they enable buyers to buy in areas where they would not normally be able to afford their significantly more expensive freehold property cousins.
- Condo Property Management typically takes care of all common area maintenance such as snow removal, grass cutting, landscaping, elevators, roofs, pools, parking maintenance, etc.
- Building insurance costs are typically included in monthly maintenance fees, so at least a portion of owner/tenant insurance requirements are automatically taken care of.
- Condo units, especially high-rise condos, are typically mobility friendly with many containing multiple elevators making them a good option for the fast growing seniors demographic, including the baby boomers, as well as persons with disabilities who may have hard times going up and down stairs commonly found in freehold properties.
- Major future anticipated expenses and renovations costs are typically budgeted for with the vast majority being funded through a portion of the monthly maintenance fees paid by all unit holders. Say a determination is made that the roof will need to be replaced in 10 years’ time. Increasing maintenance fees to account for this anticipated repair costs over a ten year period may be the solution.
It is therefore no wonder that condo investments are typically perceived by novice investors as being less of a burden than their freehold counterparts. However, in reality this perception is very flawed and here’s why:
Cons – Many Restrictions, Many Rules, High Maintenance Costs:
- That perception of hands off property management comes at a very real premium cost! Unit monthly maintenance costs include owners proportionate share of of amounts paid to property management, security and other building personnel to run and take care of the entire condo complex.
- Unit owners also pay their proportionate share for the heating, air conditioning, garage/gym/pool maintenance, plumbing, lobby and other common area fixes and renovations through their monthly condo maintenance fees.
- Unit specific heating, hot water and air conditioning units may also be the direct responsibility of the respective unit owner in some condos as many condos’ maintenance fees do not cover some unit utilities. Some or all of the utilities may be extra and on top of monthly maintenance fees that unit owners must pay!
- Worse, unit owner are typically responsible for paying a prorated portion of all common area maintenance, REGARDLESS OF WHETHER THEY USE THEM OR NOT!
- Commercial contractors are typically engaged in performing necessary services and repairs, most of whom are higher priced than their residential counterparts. I should also note that practices of “kickbacks” are not uncommon in the property management industry, which may further results in contractors chosen who may either not be best for the job or not as cost effective as they should be. Guess who pays for all of this? Unit owners of course via their monthly maintenance fees.
- Parking and locker spaces may not be available and even if they are they can cost thousands of dollars extra!
- Want a BBQ or some potted plants on your balcony? Check with the condo bylaws and property manager as these may not be allowed! In some condos, even the unit owners choice of window covering colours may be restricted to ensure consistent décor throughout the building!
- Many restrictions placed on owners/investors such as what renovations or modifications allowed both inside and outside the property, when and how elevators to be used for personal reasons such as moving, contractors, and renovations; which contractors can or cannot be used, etc.
- Many restrictions placed on tenants/residents, such as what types and sizes of pets allowed, if allowed at all (note: unlike rental apartments and freehold homes, condo bylaws may trump Landlord Tenant Board rules as concerns pet allowance policies)
- Although building insurance is typically covered in maintenance costs, unit owner/tenant liability and contents insurance may not be. Say that as a result of a unit owner or tenant’s negligence, a flood occurs on a 10th floor unit that subsequently floods the 9 floors of units below. The tenant or unit owner or both may be liable for repairing damage caused not only to their unit but to all 9 neighbours units below as well if either or both are found to be negligent. Building insurance might not always fully protect unit owners and tenants!
… and it gets worse:
- Typically the only qualifications a candidate is required possess to be elected to the board of a condo complex is that they must be a resident with a heartbeat! That’s all! Many do not possess any previous management or property management experience whatsoever. Yet, these are the people who are entrusted and are responsible for making all the important and sometimes hard decisions for the entire building! It is no wonder that incompetence, egos, politics and overall bad decisions instead of good and prudent stewardship run rampant on many condo boards.
- Worse, unit owners are typically responsible for their proportionate portion of all building liabilities. Roof needs changing? Building has foundation issues or is sinking? Windows need replacing? If condo reserve fund is not sufficiently funded via monthly maintenance fees or these repairs were not budgeted for it is the UNIT OWNERS WHO PAY EXTRA via special assessments, which can possibly be applicable for many, many years! Those wishing to sell a condo unit with special assessments attached may find it harder to do so and even then at an impaired unit value!
… and from a real estate investment stand point it gets downright UGLY! Here’s why:
- Condo units are typically much smaller than freehold units and priced by square foot and this is the reason why they appear to be much more affordable than freehold properties, where in reality on a square foot cost basis they rarely are! In fact, on a square footage basis, several GTA condos sell for 3, 4, and even 5+ times the cost to build a freehold unit in the same vicinity!
- Indeed, given their small size, tenants consisting of 4+ family members may not even consider condo units as viable options for their housing needs. However, it is family units that typically make for more stable and dependable tenants.
- As previously indicated, the monthly condo maintenance fees typically include a certain amount that is paid into the reserve fund for future anticipated expenses. However, these are sunk costs, meaning that when an owner sells the unit they do not get any of that money back for which they paid into the reserve fund.
- It should come as no surprise that poorly funded reserve fund may have a negative impact on respective condo property values, since this would most surely result in significantly higher maintenance costs down the road. Conversely, yet interestingly, an adequately funded or even an over funded reserve may not result in higher property values since these are typically determined by the market and comparable condo unit values in the immediate area.
- In addition to the many common condo by-laws, rules and regulations, some of which were indicated above, further restrictions may exist regarding the allowable frequency to rent your units, with some condos restricting rental activity altogether. Say your condo building has a rule that says you can only rent to 1 tenant only in any 12 month period. You rent the unit to a great tenant who 2 months later gets an awesome job offer in Vancouver and decides to move out after giving you 60 days’ notice. Think you can rent the unit again? Think again! The condo rules may prevent you from doing so, until the full 12 month period has lapsed. In the meantime, I can assure you that the required mortgage, maintenance and utility payments won’t be paying themselves!
- Most importantly, you should be asking yourself this question, when considering condos over freehold units. What appreciates in value – buildings or the land on which the buildings stand on? As a Chartered Accountant, I can tell you that buildings depreciate, that is they decrease, in value whereas land increases in value. Condo units consist mainly of building space, an intrinsic depreciating asset, rather than land. In fact, most high rise condo unit owners have extremely little proportionate ownership in the land on which their building is situated, yet are all liable for all expenses and any other costs incurred by the entire complex!
- As buildings get older, they require much more maintenance, which costs unit owners much more in maintenance costs. This is not just hypothetical. If you were too look at the vast majority of 30 to 60 year old condo units today, you will mostly find that their real estate values have practically gone absolutely nowhere over the past 30 years, with astronomically high maintenance fees that only continue to increase annually.
To hit this point home, here is a real life, long term condo investment example to consider:
Recently, in June 2015, a fully renovated 26th floor south facing 1 bedroom/1 bath condo unit, approximately 850 square feet in size and with a whopping $468 in monthly maintenance fees, located in the north part of Toronto sold for a mere $219,000! Great deal you may think. Think again! Any investor looking for long term appreciation here need not apply. Interestingly, the same unit would have most likely sold for nearly the same amount 20 YEARS AGO!
High monthly unit maintenance costs also negatively affect cash flow on condo investment units. In fact, those investors looking at putting down only a 20% down payments will find it very hard to find a cash flowing condo property, regardless of whether the unit is older or brand spanking new, in a decent area of Toronto today. Indeed, they may even find themselves paying for the privilege of owning such a property by being out of pocket on a monthly basis since the rent they receive from their tenants may not be sufficient to cover all their monthly expenses.
Yet oddly enough, there continues to be a general perception among the general public that condos as a long term real estate investments are great options. I am sure many builders and real estate agents may have you believing this, but I can assure you I am not one of them!
Don’t believe the hype! Sure the tenants would pay off the mortgage over a 25-30 period, which would result in some cash flow. But the property will have, in all likelihood, performed absolutely miserably when taking inflation and overall average area real estate appreciation into consideration. I find that real estate in general is an inflation adjusted asset, WITH THE EXCEPTION OF CONDOS, which are typically a depreciating rather than appreciating assets.
Consequently, with very few exceptions and despite all the myths out there, historically over the long term GTA condos have had some of the worst long term real estate investments returns out there, when compared to many other real estate investment options available today. I must confess that as bad as those long term condo investment returns may seem they may still be better than many other non-real estate investments out there. After all, everything is relative! 🙂
Can this change in the future into a high rise GTA condo market similar to say Manhattan in New York where multi-million dollar condo units are common? Possibly, but are you willing to take that bet?
I personally am not willing to take that chance, especially since other, cash flow positive and similarly priced real estate investment options are available today that offer much better returns with less risk than the Toronto condo market.
Should you wish to learn more about these other opportunities feel free to call or message me at (416)617-2559 or email me at Felix@Cloud9Life.ca. I am always happy to share my very own real estate investment secrets with all my friends! 🙂