Monthly Newsletter: October 2005

This month I have a few topics to discuss. The first is an interpretation of a story that ran this past week in the Star business section about the relative prices of real estate in Canada to other countries around the world. A few months ago, I chatted about how prices in Toronto relative to other North American cities are still quite low. This article examines this phenomenon in more detail at the national level and bears out some of the earlier conclusions we made. Secondly, I’d like to talk about cap rates, and what kind of expectations you ought to have with income properties in this market. Thirdly, I’d like to reprint a story on potential washing machine hazards that every landlord should be made aware of. Lastly, I’d like to plug a client of ours who offers custom audio-visual installation services. We find more and more that people who are paying top dollar for features in a property often desire a custom home theatre or interconnected sound throughout.

As we spoke about a couple of months ago, Toronto is indeed experiencing a renaissance. We are in demand and growing! The launch of the Ritz Carlton hotel and condo complex, the announcement of a new 48-storey office tower by Cadillac Fairview, and the buzz from the most successful film festival to date has the world talking about us. We are a hot topic and it has taken foreign interests to tell us that Toronto is a great place to live and invest. The escalation of Canadian real estate prices continues, however compared to many other countries, we seem to have room to grow. The attached chart from a recent Toronto Star article bears out this fact.

Price Movement

How resale house prices have changed in selected countries

Year-Over-Year % Change

Q1, ’04

Q1, ’05

97-’05

Australia

17.90%

0.40%

114.00%

Belgium

8.8

9.4

71

Britain

16.9

5.5

154

Canada

5.7

5.2

47

China

7.7

9.8

n/a

Denmark

6

11.3

58

France

14.7

15

87

Germany*

-0.8

-1.3

-0.2

Hong Kong

17.4

19

-43

Ireland

13.2

6.5

192

Italy

10.8

9.7

69

Japan

-6.4

-5.4

-28

Netherlands

5.5

1.9

76

New Zealand

23.3

12.5

66

Singapore

-1.5

2

n/a

South Africa

28.1

23.6

244

Spain

17.2

15.5

145

Sweden

7.7

10

84

Switzerland

1

3.4

12

United States

8.4

12.5

73

*Figures are year average increase, not from Q1 to Q1

SOURCE: The Toronto Star:Business, Sept. 27/05

Affordability continues to be at an all-time record. Allan Seychuck, RBC economist states: “‘For the most part, affordability improved in the second quarter across Canada. Rising house prices have raised concerns of a bubble, but there is scant evidence of one forming in the vast majority of Canadian markets.” The RBC Affordability Index, which measures the proportion of pre-tax household income needed to service the costs of owning home, stands at 25 per cent for a standard condo. The condo remains the most affordable housing type. A standard townhouse is the next most affordable at 28.7 per cent and had the largest improvement in affordability in the second quarter of 2005. A detached bungalow took up 36 per cent of median pre-tax income, while a standard two-storey home remains the least affordable with an index reading of 41.8 per cent.

RBC’s Affordability Index for a detached bungalow for Vancouver is 55.3 per cent, Toronto is at 42.1 per cent, Montreal is at 34.3 per cent, Calgary is at 32.8, Ottawa is at 32.1 per cent and Edmonton is at 27.6 per cent. Overall it appears that Canada as a whole and specifically Toronto is in great shape moving forward. We have a tolerant, multicultural society, our streets are safe, we are virtually immune to natural disasters and investors like a safe haven for their money. As the late Peter Ustinov once said “Toronto is like New York city run by the Swiss”

The next issue I’d like to address is diminishing investor returns over the past couple of years. One of the problems that we have been facing as a dedicated income property brokerage is that the bottom line returns have been decreasing as the demand and prices have been increasing.

Traditionally, we evaluate the investment value of a building by capitalizing its income. This “cap” rate is simply an expression of value based on the net income relative to the purchase price. If a building generates $50K of net income and has a sale price of $715K, then we take the net income divided by the price (in this case, 50 over 715), to arrive at a cap of 7. This is a good mathematical indicator since it doesn’t take into account borrowing costs or the amount that you put down on your investment. It allows us to compare many different types of investments based on their net income.

So what kind of cap rate should you be expecting for a multi-unit building in Toronto? Traditionally, strong income properties would fall in between 7.5 and 10. Nowadays, it is not uncommon to see caps as low as 5 – for example, net incomes of $50K on properties selling for a million dollars. Why are people paying these prices for such low overall rates of returns? I have three possible answers:

i. Investors are shifting their expectations. Prices are higher in general. Average costs in most neighbourhoods have gone up while rents have, by and large, stayed the same.

ii. There has been an increase in owner-occupiers who are either looking to get into an exclusive neighbourhood or are just looking to live less expensively each month

iii. Financing costs are lower so the associated carrying costs are lower thus improving net income

The next story comes courtesy of Paul Schuster, fire retrofit specialist. He relays a story about something he came across in the field that I think could be of benefit for all property owners, not just landlords:

“Recently I had the pleasure of working with an appliance repairman. We were looking at our clothes dryer which had stopped working. It was no longer drying the clothes. He pulled out the lint screen and proceeded to run water onto it. The water did not run through as you would expect, but pooled on the screen. He asked if we were in the habit of using fabric softener sheets. He explained that they tend to leave a residue on the lint screen preventing the proper venting of the heat and moisture during the normal drying cycle. Although we had always been diligent about cleaning the lint from this screen after each use we were not aware of this concern with a film building up. He then proceeded to clean this screen with soapy water and a small scrub brush. After this cleaning he then showed me how the water ran freely through the screen. This should be done every 6 months. He then described to me how this blockage of the screen had probably caused the heating element to overheat causing its premature failure. This situation could have also caused a dryer fire.”

Now that summer has come to end and the colder weather is around the corner, remember also to clean your air-conditioner filters, which by this time of the year are often plugged with dust and debris (unless, of course, you have been diligently cleaning them every few weeks). This will improve the efficiency of the unit next time you turn it on and it also prevents any potential damage to the overall system.

Lastly I’d like to mention an exciting new service that one of our client’s has launched. Last month I talked about high-end apartments and how there is always a strong upper-end rental market. It is quite common for income properties that have a great owner’s suite to sell quicker than traditional “rental grade” suites. There are many design and decorating features that gives a suite its “wow factor”, such as fireplaces, moldings, high end finishings like marble or granite, etc. One other very desirable feature is a home theatre or custom audio/visual installations. I’ve seen flush-mounted TVs in bathrooms, loudspeakers in kitchens and many other keen entertainment applications. Nowadays, with a wireless router, it’s possible to run your home’s entertainment centre through your computer. A client of ours, Geoff Benson, has just started a new custom AV sales & installation service with particular focus on wiring up rental suites. He can be reached at 416-816-3571.

That’s it for this month. Don’t forget to check out our “Sold Income Properties” list on our website under the sellers’ section and keep checking back to see our weekly feature properties. We’d also like to wish all our Jewish clientele and friends a healthy, happy and prosperous new year. Shana Tova!

P.A.

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