As a young professional living in Toronto, I often am asked the question, “when do you plan on buying a home?” The average price of detached homes in Toronto increased by 20.7 percent in one year. The inventory of unsold condo is decade low with only 6.8 months of supply. The demand for Toronto's residential real estate only seems rising. My best friend purchased his first condo and my wife keeps nagging me to purchase a condo as the price rises. Yet despite such compelling forces, my answer is always, “not anytime soon.” Why? Because I believe it makes more sense to continue investing in stocks for the time being. Here are my reasons for my strong conviction.
Reason 1: Unattractive Valuations (Long Payback Period)
As discussed in my article, Understanding Payback Period, payback period is an important concept for value investors and I generally require my investments to have a payback period of less than 10 years. Unfortunately, the payback periods of condos sold in Downtown Toronto are generally around 20-30 years.
For example, for a 500-599 ft^2 1 bedroom property at ICE Condominiums in Harbor Front, rent is currently listed at $1, 750 while the purchase price is listed at $435, 000.
Let me calculate the payback period of this investment. Since the condo purchase involves taxes, I will first add provincial land transfer tax, Toronto land transfer tax, lawyer fees to the initial investment minus the instant rebate (since this would be my first real estate purchase). The income gained from this investment would be rent minus maintenance fees. Keep in mind that expenses could be greater if the room requires renovations, re-painting, etc.
According to my calculation, this investment in particular has a payback period of 26 years, assuming the rent and maintenance fee stays the same.
As shown in another article, 5 stocks to add to your watch list in 2017, I can easily find equity investments that have a payback period of less than 10 years. In other words, I find value stocks more attractive than condos as an investment vehicle.
Reason 2: Expected Increase of Mortgage Rate
Since Trump won the election, Canadian mortgage rates have been increasing. You can read the details in the Globe and Mail article here. The article tells us that Canadian mortgage rate is determined mainly based on the yield of 5-year Canadian bond, which is correlated with the yield of 5-year US government bond. Because one of Trump’s policy is to increase the government spending and tax cut, there has been a concern among the market whether the U.S. government can pay back its bond or not. Such concern has given upside pressure to the yield of the 5-year US government bond, ultimately resulting in the increase of Canadian mortgage rate.
Reasons 3: Canadian economy's dependency on real estate
The Canadian economy heavily relies on the real estate market for its economic growth today. In 2015, real estate was the largest component of Canada's GDP (about 13%).
In a sense, the slow-down of Canadian real estate will equal the slow-down of the Canadian economy as a whole. As I work in Canada, the state of the economy largely affects my salary, bonus and future job prospects. By living and working in Canada, I am already exposed to the risk of the real estate market; I see no reason to increase my exposure by investing in a condo.
As a value investor, I find value stocks more attractive than the condos in Toronto as an investment vehicle at the moment. Some might laugh at me for missing some of the growth in the near future; however, I believe such patience will pay off in the long-term.