Cap Rates and Condos

I had a condo buyer email me recently and tell me they were looking to buy a resale condo with a 6-7% cap rate. This would be a somewhat rare but  achievable cap rate if you were buying a multi-unit freehold property in the core of Toronto, however, for a condo, this kind of cap rate is unheard of. Cap rates for condos downtown would be something more like 3%.

Cap rate, or capitalization rate, is basically a measure of return on an investment property you would get if you bought the property with all cash (no debt/no mortgage). It is calculated by dividing the annual income a property generates AFTER expenses by the purchase price of the property. So if a property that costs $300,000 generates $2000/month after expenses, then the cap rate would be 8%.

What are cap rates like for Toronto condos? Take for example the listing that I have at 16 Yonge Street right now. The numbers break down like this

• Asking Price $329,900
• Current tenant pays $1575/month
• Expenses: Maintenance fee $327/month, taxes approximately $167/month, insurance approximately $20/month = $514/month

So if you do the math it works out to ($1575 – $514)*12 / $329,900 = 3.8% cap rate. This is actually a very good cap rate as the rent:price ratio for this unit is quite high compared to most downtown condos, and the maintenance fees and taxes are relatively low. To achieve a cap rate of 6%, the rent would have to be increased to about $2200/month if the expenses stayed the same. Finding a condo that you can buy for $329,900 that will rent out for $2200/month is basically impossible in Toronto.

So why are cap rates typically much lower for condos than for multi-unit properties (i.e. duplexes and triplexes in the core of Toronto)? One simple reason is that with condos, there is almost zero maintenance a landlord has to do. You can very realistically own a rental condo for 5-7 years and spend literally nothing on maintenance and repairs. Try doing that with a freehold property! Low cap rates is one trade off for the relative convenience and simplicity of condo ownership.

But the fundamental reason behind the low cap rates is that condo investment in Toronto is driven by an expectation that prices will increase (appreciation) versus a desire for cash-flow (income). Prices have kept appreciating over the last 15 years in Toronto and thus cap rates have pretty much always been quite low for condos. If prices start to decrease, or rents go up faster than prices, cap rates will start to rise.

Questions or comments about investing in resale condos? Please contact me.