There’s amazing content that follows this, though if you’re a classic TL;DR skimmer, here’s the point of this piece: using real estate as an investment really speeds up your savings, and will get you into your own home, eventually, a lot quicker. Buying your 2nd place first is the winning strategy for 2022 and beyond.
Unless you’ve been living under a rock or stuck in a basement in Toronto over the past year (or longer), you’ve likely heard about the runaway train that is Toronto housing prices. You’ve been seeing headlines since forever about how it’s unaffordable, or worse - unachievable - to become a property owner in Toronto. Disclosure: I’m a Realtor. I’m also very much a realist. (Note - If you’re going to read this as though there’s a bias, I prefer if you would consider reading this though my realist position.)
More than half of young potential buyers in Toronto have given up on ever owning a home, survey finds - thestar.com
We hear about it and read about it so often, that we’ve now taken this position as reality, and most of us are quitting before even attempting.
Unachievable. Are you kidding me? We’re letting headlines and naysayers tell us what we can and can’t achieve now? C’mon guys, we’re better than that.
I’m a dad. Never - and I do mean never - will my kids ever hear me utter these words. It’s so limiting and so defeating.
I was a first-time home buyer 25 years ago. My immigrant parents were first time home buyers in their late 20s. It wasn’t easy for them, it wasn’t easy for me either. Though I will admit, it’s a lot harder today IF you were trying to do what we did: buying your first place and calling it home. I will concede, it is definitely more difficult for you all today.
Why is it more difficult today? You can look at many things here, though the simplest and most accurate reason is that home prices have increased more than the pace of salaries. That’s it.
There are plenty of reasons why it’s happened this way - most of them come down to straight supply and demand issues. Economics 101, baby. Tie that in with government policy that seems to consistently backfire, a steady stream of population patterns that bring in people that just want to make Toronto home, and you have the foundation you need to mostly account for the price hikes in Toronto and surrounding areas.
So, yes, if you still look at things through the eyes of someone born in the 70s and 80s, things are pricier today. Maybe it’s time for you to stop looking at real estate as if the world is still stuck in those decades and consider a different strategy?
HOME OWNERSHIP IS ACHIEVABLE FOR FIRST-TIMERS
Let’s clean the slate. Let’s start fresh. We’re living in the now, not in the past. Home ownership is absolutely still achievable. I absolutely know this to be true. And it’s important that you do, too. You know the expression “if you think you can or think you can’t, you’re right!” Same applies here. It’s harder than it was, granted. This is exactly what we help people do on our real estate team. In fact, this is a speciality of ours.
For this next part, it’s best if you just forget what you think you know about real estate ownership for first-timers. Don’t bring baggage with you on this part of the discussion. Bear with me, I swear I’ll make this all make sense!
I’m a property investor. As an investor in real estate (in Toronto), my life and my future is infinitely better. I have created wealth, I hold tangible investments that I directly control, and I can make decisions about every part of these properties. These investments reward me over and over again.
I followed the old rule: own your first home, and then you can add to your real estate portfolio. Your 2nd property should be your first investment property. I accepted it for what it was, it made sense to me. What’s not often discussed is the fact that there are some massive tax planning opportunities that open up to you when you’re a property investor (when you own a home that you don’t live in).
Typically, when buying any property, you show up with some of yours and likely a lot of someone else’s (bank) money AKA, a mortgage. It’s pretty typical to see buyers put down 20% of what the purchase is and borrow 80% to make up the difference. In exchange for that 80%, you agree to hold a mortgage and commit to paying back what you owe over a 25-30 year period.
Maybe it makes more sense to use dollars for this example? Let’s do that.
Scenario: buyer buys a property for $600,000.
Her down payment of 20% = $120,000 (normally comes from savings, and/or the Bank of Mom and Dad)
Mortgage = $480,000 (monthly payments at 3% would be $2,272)*
*see end of article for all the math of this post
[I’ll refer back to this scenario as we progress through the chat, so park these numbers in your mind.]
It’s likely she can rent this place for less: let’s call it $2,000. Renting is cheaper than owning in this case and that’s why a lot of renters stay renters, and won’t make the leap into ownership.
A lot of renters CAN afford, to buy something/somewhere, just not the home they want to live in. She dismisses home ownership entirely because she’s only considered buying the home she’ll live in. Years pass, properties appreciate - and she gets further and further away from grabbing on to that property ladder. Not sure if you’ve noticed, home prices have grown waaaaaaaaaaaaay more than salaries/savings. Waiting isn’t a winning formula.
Let’s stay in this scenario, just 5 years later. If rents weren’t increased (and rents do increase, by the way), this non-buyer would have paid $2000 per month for 60 months = $120,000 just in rent. All that money will go towards paying the landlord’s mortgage. 5 years in, she essentially made a choice to trade $272 monthly savings in rent (total “savings” of $16,320 during that time) in exchange for not owning for these 5 years. She paid rent of $120,000 that went to paying down a big chunk of the home - all to the benefit of someone else.
This is the classic “biting off your nose to spite your face” tale. To save $16,320, she was happy to pay $120,000 in rent dollars. Money that is all gone. Well, she nets out at only $104,680 gone - she did “save” $16,320, after all.
This happens ALL THE TIME, because we really only consider the one option of living in the first home we buy. Why can’t we separate out the wealth creation side of real estate from the “home” side?
We should. And we can.
This is where things get super interesting, buckle up!
If the property we’re talking about here increased in value 5% per year for each of those 5 years (FYI: the Toronto real estate market has appreciated on average 9.5% per year over the last 5 years**), that property that could have been bought for $600,000 is now worth $765,769. A gain of $165,769 in value.
If her landlord from above bought this property years ago for - call it - $500,000 a few years before this non-buyer moved in, with a 3% mortgage rate with a 25-year amortization, this landlord paid down $67,429 on her mortgage while this tenant lived there.* The tenant contributed $120,000, and nearly $70,000 of that went directly to paying down the mortgage for the landlord.
Another if here: If the property appreciated 5% per year during these 5 years (years 6-10 of ownership for the landlord), the property owner has seen appreciation during these 5 years of $176,307.*
Let’s go even further. Assume the landlord made no money each month - if rent just covered all carrying costs for the landlord without net profit each month, for example - this landlord just increased her equity by $67,429 + $176,307 = $243,736.
$243,736. In 5 years. With no effort.
You think this landlord may be able to do something pretty friggin’ awesome with $243,736 in 5 years? Like, perhaps, using that as the 20% she’d put down on her $1,000,000 home in the neighbourhood she’d love to live in?
Is there any reason why we can’t buy our 2nd property first? Absolutely not. It defies common knowledge, sure, though it makes complete sense!
If that tenant switched roles, and became the property owner on a home she herself did NOT live in, the landlord story could belong to that tenant instead.
Yes, if you could have you should have bought property sooner. And yet NO, not all hope is lost.
So, what do you do to make this a reality for yourself? You buy something. You figure out a way. You talk to people. You ask for help!
You don’t need to move. Keep living where you’re living. You’re happy there, right? Just stay there. And make a plan to buy something less expensive than the home you’d be happy with, and rent it out. Start building your wealth in the exact same way your landlord is.
If the real estate market where the property you are buying takes off and appreciates 10% (as it has done in Toronto for each of the last several years), your $80,000 investment will turn into equity growth of $40,000+ each year, just in property appreciation alone. Remember, the tenant is also paying down your mortgage which directly increases your own net worth/equity.
It’s not easy, though it’s simple. We can’t do what our parents did. Accept it and move on. There are alternative paths to achieving the same goals. You CAN own your home. It’s not a straight line anymore. Who says it needs to be? I don’t.
Full disclosure, and to elaborate on a point above: I do run an amazing real estate team that helps people achieve this very goal in Toronto. We are open, honest, friendly and genuine. If there’s a will, there’s a way. I’ve shown you it’s possible. The next step is yours. We’re ready to plan with/for you (at no cost to you, by the way). You just need to ask -> info@teammangos.com.
*Math from above:
Purchase price of $600,000.
Typical down payment is 20%, which equates to $120,000. Mortgage for remaining $480,000 priced in a 5-year term, 3% mortgage amortized over 25 years. Monthly mortgage payment is $2,271.58, made up of principal and interest. In 5 years principal pay down is $69,722 and total interest paid is $66,573.
Appreciation is compounded annually. If this property appreciates 3% per year, here is where values would be after each year:
End of year 1 - $618,000.00
End of year 2 - $636,540.00
End of year 3 - $655,636.20
End of year 4 - $675,305.29
End of year 5 - $695,564.4
Gain in appreciation in 5 years is $695,564.45 - $600,000 = $95,564.45
Purchase price of $500,000 - 5 years before tenant moved in (when the landlord originally bought the rental property).
Typical down payment is 20%, which equates to $100,000. Mortgage for remaining $400,000 priced in a 5-year term, 3% mortgage amortized over 25 years. Monthly mortgage payment when purchased was $1,892.98, made up of principal and interest. We’re looking at years 5-10 of ownership if we are matching the 5 years the tenant lived in the property. Whatever happened in the first 5 years (owner rented to someone else, owner lived in it) doesn’t matter. In the 5 years the tenant we are talking about lived in this property the principal paid down is $67,429 and total interest paid is $46,150.
Appreciation is compounded annually. If this property appreciates 5% per year, here is where values would be after each year:
End of year 1 - $525,000.00
End of year 2 - $551,250.00
End of year 3 - $578.812.50
End of year 4 - $607,753.13
End of year 5/Start of year 6 - $638,140.78
End of year 6 - $670,047.82
End of year 7 - $703,550.21
End of year 8 - $738,727.72
End of year 9 - $775,664.11
End of year 10 - $814,447.31
Gain in appreciation from year 5-10 is $814,447.31 - $638,140.78 = $176,306.53
**Market price appreciation from Toronto Real Estate Board over the last 5 years
2017: 12.7%
2018: -4.2%
2019: 3.9%
2020: 13.5%
Nov 2020-Nov 2021: 21.7%
Average of these is 9.5%