Why high mortgage rates are slowing Toronto's condo market

As interest rates have soared, the Toronto real estate market is experiencing a phenomenon not seen in recent years – a glut of inventory for sale, particularly in the condo market. The reason? The economics of carrying a secondary investment property in the city no longer make sense.

Condo investors are being battered by heavy borrowing costs, following the steepest ramp-up in rates seen in 40 years; the Bank of Canada increased its rate a historic 10 times between March 2022 and July of this year, bringing the benchmark cost of borrowing to 5%. That’s a sharp contrast to the pandemic-era rate environment, when properties could be financed for below 2%. 

That means investors with variable mortgage rates have seen their borrowing obligations balloon in the past year and a half – and even though rents are soaring, that hasn’t been enough to offset those carrying costs.

It’s evident unit holders are selling with new urgency. The latest Q3 condo report from the Toronto Regional Real Estate Board (TRREB) shows the number of active condo listings has surged by nearly 40% on an annual basis, with 6,506 units now sitting on the market. The number of units newly listed between July and September also rose by 28.8%, with a whopping 13,226 properties brought to market. 

That newly-listed product well outpaced the 4,415 sales that occurred during that time frame, which has considerably softened the market. The sales-to-new-listings ratio – which is used to gauge the level of competition for real estate  – came in at 33.3% for the quarter, officially minting a buyers’ market. Again, that’s a dramatic turnaround from the pre-rate-hike era;  the same data set from Q1 2022 (which captures the months prior to the BoC’s first rate hike) reveals a sizzling sellers’ market, with a ratio of 64.6%.

Scott Ingram, a Toronto-based realtor at Century 21 Regal Realty Inc., says today’s spike in listings is similar to the market’s early-pandemic slump in the fall of 2020 – but different factors are at play.

“Then it was not being able to find tenants, or Airbnb visitors, and due to falling rent rates,” he says. “Now the rental market has stabilized but it's the negative cash flow (or deeper negative cash flow) that has investors sweating.”

The cash flow challenge

The fact is, condo units in Toronto typically have never offset their costs through rental income; their saving grace has been strong market appreciation and a longer-term investment horizon. Despite the poor cash flow and cap rate offered by the market, consistent price growth has historically offered enough ROI to persuade investors to wade in.

But price growth – which was especially rampant between 2021 and 2022 – has substantially chilled in recent months. TRREB reports the average unit resale price has dropped more than $100,000 between the market peak of $808,566 in March 2022, to $707,056 this September.

Also read: High mortgage rates spooked GTA home buyers in September

Patrick McKinnon, realtor at One Group Realty, says that even when rates were at record lows – in the 1.8 - 2% range – condos weren’t easily cash flowing, but the investment could make sense with a large enough down payment. But today, the ratio of what a condo could get in rent compared to its cost is “pretty tough.”

“Those who are investing in condos right now are putting a significant amount more cash down, and they are a lot more careful and are taking a lot longer to pull the trigger,” he says. “And some are still hesitant, because the options aren’t really there.”

The good investments, he says, show the promise of appreciation over the next 10 years, and preferably have a cap rate of over 5% – but that’s a pretty tall order these days. “There’s a pretty significant backlog of investors who are waiting and looking or, in some cases, are being very active as we speak. But we’ve not really been jumping on anything that’s under 5%, and even then, it’s still not cash flowing with a 5% cap rate, if you put 20% down.”

To make the numbers work today, he says, buyers should prepare to make at least a 30 - 40% down payment – and even then, finding a truly suitable investment unit is like “a needle in a haystack.” 

“That’s something to take into consideration; right now for condos, it’s nearly impossible, I’ve not found one, where it makes sense from a perspective where the building is healthy, or the maintenance fees are stable – and [a cap rate] 6%, I’ve not found that.”

The reality, McKinnon adds, is that investors with financial flexibility are more likely to park their cash elsewhere these days.

“Some are coming to us and they have all this cash flow because they also have a business. And they say, ‘Ok, I’ve got capital, give me the guidance to where I should look for condos.’ After I give them the information, they go, ‘My business just gave me all this cash; why don’t I just put it back into my business, then, because the condo doesn’t seem to be worthwhile.’”

Preconstruction offers opportunities, but risks persist

That’s not to say a savvy investor can’t find an advantageous way into the market. McKinnon adds that unit assignments( where investors purchase pre-construction units and flip them for a higher price before the deal closes) can provide some payoff – if buyers can stomach the risk.

“There might be an angle, where an investor can find something that will actually get them close to cash flowing,” he says, but points to unknown variables such as development charges, maintenance fees, and property taxes.

“If you’re going to go that way, that’s probably one of the easier ways to push up that cap rate,” he says. “But it’s still risky.” 

And lately, the pre-construction market hasn’t been fruitful for many; the Condo Investment Report from CIBC and Urbanation found only 48% of condo investors of newly-built units in the GTA were cash-flow positive in 2022, a trend expected to worsen in the coming years as more pre-construction condos are completed. Cash flow declined from a positive monthly average of $63 in 2020 to a negative position of -$233 two years later, according to the report, and worsened to -$400 for newly-completed condos in the first quarter of 2023.

“While the rental market recovered and rents reached new highs in 2022, that growth was more than offset by rising mortgage costs as interest rates soared, resulting in the average investor of newly completed condos experiencing negative cash flow for the first time,” states the report, which was authored by Urbanation President Shaun Hildebrand and CIBC economist Benjamin Tal.

“While some of this monthly net loss can be offset by principal repayment, it is unclear how many investors use borrowed down payments that would add to their monthly financial obligations. The concern here is that this change in cash flow could represent a tipping point that causes investors to shorten their holding time and think twice about further investing.” 

The latest numbers from the  Building Industry and Land Development Association on newly-constructed condo sales indicate October activity was down 20% year over year, sitting nearly 50% below the 10-year average with 1,304 total transactions. New condo benchmark prices, meanwhile, are down 11% to $1,023 million. 

Triplexes can offer stability in uncertain rate environment

Another option for investors with means, McKinnon says, are triplexes, which tend to have stable maintenance fees and multiple units, meaning greater cash flow potential. “If their budget is closer to a million dollars, well let’s focus and see if we can’t find a triplex; it might not be beautiful, and it might not be in Trinity Bellwoods or the Annex, but it will help you cash flow. And then on top of that, you can hold onto this forever, the maintenance fees aren’t just going to increase without your control. There’s going to be plenty of work to be done in the course of 20 years, but they can hold onto that for the rest of their life if they want, and they can do what they need, when they need it.”

Also read: 

• Condo mortgage calculator
• Investment properties in Canada
• Investment property mortgage rates
• Home affordability improved in October as home prices chill
• Bank of Canada council split on latest rate hold