How rising interest rates have rocked real estate investors

While real estate has traditionally been a reliable source of income for Canadians, rising interest rates and other ownership costs should make more would-be investors in condos and other residential properties think twice, according to one BC-based advisor.

“Whether it was new construction purchases that people bought into two or three years ago, or new agreements to buy, the rising cost of credit has really played a big factor,” says Matt Morrish, financial advisor at BlueShore Financial. 

The cracks are showing in some of the hottest property markets. According to research from the Canadian Imperial Bank of Commerce and Urbanation, only 48% of leveraged condo investors who bought pre-construction units to rent out in the GTA were cash-flow positive in 2022.  

For the first time ever, more than half of that group were losing money on their rental properties – and the proponents of the research expect the trend to continue.

A rising-rate shock for real estate investors

While many were understandably quick to buy properties when interest rates were near zero, Morrish says those opportunistic buyers are in a very different position today. Not only has the Bank of Canada’s aggressive rate hiking ratcheted up financing costs, but record levels of inflation have also impacted countless Canadians’ cashflow position.

“I think at the time, you could have been prudent and thought ‘Interest rates are the lowest they’ve ever been, and they may go up to 3% or 4% when my property closes or at renewal,’” Morrish says. 

“Is it reasonable to expect that it could reach 5% or 6% in such a short period of time? I can’t say for sure, but these are risks that are possible, and people really have to be aware of it themselves,” he says.

With property prices still significantly elevated – the average selling price for Toronto condos in Q1 2023 was just over $750,000, while selling prices for Vancouver condos averaged roughly $730,000 – he says borrowing costs are also quite lofty.

Factor in maintenance costs, property taxes, and other costs of ownership, and the average individual landlord in the GTA or Greater Vancouver Area today will find even higher rental rates are not enough to push them into cashflow-positive territory.

“Take for example a house being financed with a million-dollar mortgage,” Morrish says. “That million-dollar mortgage is carrying a monthly mortgage payment of about $6,300, and the expected rental from the property is just $5,000. So even before factoring in taxes and maintenance, that’s a $1,300 monthly deficit.” 

An ‘invincible’ asset? Not quite

From his vantage point, many people – particularly those in the Vancouver area and extending around the Lower Mainland – still can’t shake the notion of property as an invincible asset that can only increase in value. 

But reality is slowly setting in as more people struggle with mortgage payments, disruptions in rental income, and the challenges of selling in a prohibitive credit environment, among other challenges. 

“There are people who just love property; that’s their investment preference. So they may come to us with their minds already made up,” Morrish says. “But even for those clients, we make sure to discuss alternative options.”

During the heady months of rate hiking in 2022, he recalls numerous meetings where he’d walk clients through the math of being a landlord. Once they’d worked through the expected rental income and debt costs, he says many clients would quickly reconsider. Still, he says others feel so strongly about the prospects of future capital appreciation from property assets that they insist on moving forward. 

“We mostly deal with clients who say ‘I know I’m going to run into a cashflow deficit, but I believe so strongly that this property will appreciate in value, so it’s worth it,” he says. “I’d still emphasize that like any investment, capital appreciation isn’t guaranteed. … There are risks involved.” 

In the near term, the higher borrowing costs and other expenses of ownership may make residential real estate less attractive as a source of income. Clients who want to invest in a residential property or condo, Morrish says, should not only consider their ability to pay for those expenses, but also examine the role it would play in their portfolio.

“There are a slew of different investment options available to achieve a regular income stream or capital appreciation, and those things take a lot less maintenance,” he adds. “We often talk to people, and they may get a little bug in their ear about some type of investment. It might be right for your neighbour down the block, but is it right for you and your investment objective?”