Who wouldn’t like an investment with an 18 per cent annualized rate of return?
That’s the pitch for some investment condo projects being sold across Canada. Emails from realtors, developer ads in free condo magazines, and even spots on the radio are bombarding the public with promises of huge profits, such as doubling your money in three years.
It might be possible to get rich quick by investing in a condo, especially if you’re leveraging yourself 20-to-1. And anyone who’s bought stocks, bonds or mutual funds in recent years knows how difficult it is to see gains that size, especially in the wake of the 2008 global stock market meltdown.
But focusing solely on the potential upside ignores the cardinal dynamic of investing in anything from equities to real estate: risk versus return. If an investment has a potential return that is high, then it necessarily carries a lot of risk. My two cents on the condo-as-investment idea?
Spend at least as much time understanding the risks before signing on the dotted lines.
The ad below, for example, promotes an annual return on investment of 18.8 per cent and a return on investment on your deposit of 74.3 per cent. Attend an information seminar and you’ll also get a free forecast of real estate market returns.
Here’s another advertisement that suggests a 91 per cent return on your investment, if you buy a pre-construction condo and flip it before it closes. The idea here is that you agree to buy the unit before the building has been built in the hopes that in the years it takes to complete and register the building, the price of that unit will have increased.
To follow that logic, heck, why stop at one? Why not buy five investment condo units to rent out and become a millionaire in eight and a half years?
It’s worth noting that many families have created wealth through owning property. And across Canada, there are still many projects that will likely turn out to be good real estate investments over the long run. That being said, any investment decision, be it stocks, bonds, mutual funds, or condos, needs to made with an appreciation of not only what could go right but also what could go wrong.
When dealing with investment funds, there are industry regulations in place for what can, and cannot, be communicated. For example, according to National Instrument 81-102, which governs the investment funds area of securities markets in Canada, any sales communication for a fund that contains performance data must also have certain disclosures.
Ads have to disclose the existence of commissions and other fees. They also must clearly indicate that returns are not guaranteed and past performance may not be repeated.
The rules governing advertisements for real estate investing either seem to be less developed, or not enforced.
For example, people may know that when you are selling your existing home the buying and selling agent will split the once-traditional 5 per cent commission. That 5 per cent has been ground down a bit over the last decade as people are bargaining harder on rates, so maybe the two agents each gross 2 per cent.
With a condo pre-construction sale, however, there is only a selling agent. The developer may offer a 6 per cent commission (gross) to this agent. They may receive that in three equal instalments of 2 per cent, conditional on milestones of the development, but suffice it to say, that’s three times what they would earn for a regular sale.
The spread-out payments also create a stable income, which is great for anyone in sales. Make no mistake, the incentive to push pre-construction condos is very high. And that’s important information for prospective buyers.
Speaking of pre-construction condos, this video with realtor David Fleming adamantly argues that it’s almost impossible to make money flipping a pre-construction sale in Toronto in 2014. If you’re contemplating a similar investment, it’s worth watching. Remember, you need to at least be aware of what can go wrong.
Since some investors put little down when they buy an investment condo, they can find that the income from the condo doesn’t cover the expenses of owning the unit. They are slightly cash flow negative from the start, in the hopes of making money by quickly selling that condo for a capital gain.
The longer your horizon, the more confidence you can have that housing prices will be higher, but no market can be reliably predicted over the short term. If the market is flat or down, you may end up with a capital loss in addition to the monthly losses you were eating.
There is also the risk of a gap between tenants. If you are thinking of buying a condo as an investment, as yourself: How many months could you carry a property without a renter? For now, vacancy rates may be low in certain areas, but what if that changes between the time you agree to buy and the time the unit is ready for rental, which could be years?
What if condo prices stagnate, or fall?
I’m not suggesting you should panic. I’m suggesting that you inform yourself of the risks and the possible downsides of buying a condo as an investment.
When making any kind of investment, here are some general rules of thumb to consider:
- Borrowing to invest magnifies potential gains as well as potential losses.
- The potential of higher returns necessarily comes with higher risk (but higher risk may or not come with higher returns).
- All markets move in cycles, and they cannot be reliably predicted.
- The longer people have been enthusiastic about a certain asset class or strategy that has been performing well, the less likely the enthusiasm is to continue.