Since the Great Financial Crisis, Canadian and international investors have looked to Canada’s largest cities such as Toronto and Vancouver for investment property allocations with a primary focus on new construction condo units. This was a great investment for those that participated. However, a refreshed data and fundamentally driven look at the investment opportunities in rental residential investing highlights that secondary market single-family rental (SFR) investment properties provide perhaps a superior alternative to urban condos.
Herein we outline several reasons why, for example, Ontario secondary market single-family rental (SFR) investment properties provide a more compelling opportunity for investors compared to the previous focus on Downtown Toronto condos units.
Accelerating demand for detached homes and larger-format rental housing alternatives.
As detailed in our Konfidis Insights Why SFR? Take another look piece from earlier this month, the “why SFR” story starts with supply and demand fundamentals. Demand for single-family and rental housing is primarily driven by a federal “open door” immigration policy bolstering population growth. According to Statistics Canada, Canada’s population grew by nearly 285,000 people in the second quarter 2022. That amounts to a 0.7% increase during the quarter — the largest Canada has experienced since 1949, when Newfoundland and Labrador joined Confederation, according to CIBC Economics.
And within the single-family rental segment, immigration isn’t the only driver of increased demand. Demographic trends and changes in social preferences (including the prevalence of work from home) translate into a dominant millennial cohort seeking larger format housing – trading “shoebox in the sky” urban condos for larger format housing with extra bedrooms for family planning and at-home offices. This trend further bolsters single-family rental demand in Ontario’s secondary cities outside of core Toronto, for example.
With this backdrop, coupled with the reality of Canada’s housing crisis, rental housing demand will be driven by affordability. Unlike a decade ago, with the emergence of work from home and hybrid work solution adoption, one does not need to pay more rent for less space to be in close proximity to their employer. And further, with the skyrocketing of condo prices (and as average condo unit sizes have shrunk), secondary market single-family rental provides a “more for less” alternative to urban condos.
Stark undersupply of single detached homes compared to the new construction focus on urban high-rise.
Single detached home new construction has experienced a sharp decline as a proportion of total new housing starts in contrast to a stark rise in condo unit starts. And aside from the type of new housing starts, the total number of starts is not keeping pace with household formation, and the shortfall is compounding. As a result, the demand for preferred housing alternatives is far outpacing supply. Please see last week’s Konfidis Insights - A Deep Dive into (the lack of) Housing Supply – for additional information.
Further to the overall existing and new construction housing base available for resale purchase, the supply of rental availability is even further mismatched. As a result of the voracious investor appetitive for condo units, there have been a tremendous amount of condo rental units created to support rental demand, leaving prospective condo unit tenants with a variety and depth of alternatives. In contrast, single-detached home sales have a very small proportion of investor penetration. As such, there is a very small pool of detached home rental alternatives available for tenants seeking larger format rental housing.
As Konfidis considers the investment attractiveness of owning a condo versus a single-family home investment property, it is important to consider the total return profile – i.e. both the net rental cash flow dynamics and growth, as well as the capital appreciation profile. When considering the capital appreciation profile, or the ability to resell the investment property in the future at the highest price, we highlight the “commoditized” profile of condo units compared to idiosyncratic single-detached homes with the ability to differentiate your listing at a time where similar listing may be in abondance. We experienced this risk play out in downtown Toronto condo units in the initial months of the Covid-19 pandemic when dozens of virtually identical condo units in the same buildings were all available for sale at the same time.
More compelling valuations with superior rental income metrics.
While each investment property opportunity can be different, and Konfidis seeks to find the best of the best (the proverbial needle in the haystack), on an average composite basis, secondary market SFR opportunities profile a higher rental yield than urban condo alternatives, with less risk (see the “Defensiveness” section below).
Utilizing the Konfidis technology and data platform, including our proprietary rental survey data, we assess that secondary market SFR provides approximately a 100-150 bps rental yield premium compared to Toronto urban rental condos. For example, a two-bedroom condo in Toronto’s urban M5 postal code region averages over $1.1 million and would garner a monthly rent of approximately $3,800 on average, representing an annualized gross rental yield of approximately 4.0%. Alternatively, a three-bedroom single-detached home in London, Ontario averages less than $625,000 and garners a monthly rent of approximately $2,600-$3,000 on average, representing an annualized gross yield of 5-6%. Further, through Konfidis’ proprietary acquisition strategy, in recent weeks we were able to provide two exclusive acquisition opportunities for SFR homes representing greater than 7% rental yields, both of which have subsequently been taken over by Konfidis investor clients.
And taking a step further beyond gross rental yields into ultimate net rental income and cash flow, SFR provides more efficient, i.e. higher margin, rental income than condos. As one example, average condo fees in Toronto last year were $520 per month for a one-bedroom (and even higher for newly constructed buildings). Condo fees generally pay for building maintenance (elevators, etc.), common areas, and building amenities (which most owners and tenants don’t typically get value from). With no “common area” or high-rise building-related maintenance, secondary market single-detached properties at comparable prices to one-bedroom Toronto condo prices typically require maintenance of approximately $100 to $250 per month. There are also control benefits of SFR in this regard such as no exposure to underfunded condo reserves which are detailed further in this report.
Single-detached homes and SFR are the most defensive and liquid real estate property type on the globe.
Vacancy is a very expensive risk for landlords of all real estate property types – rent cheques stop coming in but expenses keep ticking. The Covid-19 pandemic highlighted this risk for owners of Toronto condo investment properties with Toronto’s rental apartment vacancy rate hitting 5.7% in the fourth quarter of 2020 according to Urbanation, a 50-year high when examining historical CMHC survey data for Toronto back to 1971. During that period landlords were forced to offer incentives to entice renters as average rents declined 6.2% year-over-year (compared to only 2.2% in the 905-region surrounding Toronto). By contrast, given the lack of availability of single-family rental inventory, SFR landlords did not experience a similar impact. As a proxy to Canada, in the U.S., with an abundance of relevant data, U.S. SFR REITs experienced dramatically better collections and rent growth than their U.S. Multifamily Apartment REIT comparables throughout 2020. Please see the REIT stock price outperformance by SFR vs. Multifamily in the Konfidis Insights Why SFR? Take another look article.
In addition, SFR generally attracts a higher credit quality tenant base such as families, compared to smaller urban condos which is more oriented to students and young professionals. Related thereto, single-family rentals are rented at a lower rental rate per square foot than urban condos, providing a more defensive floor for affordability and better growth profile.
Lastly, we address condo vs. SFR investment property ownership fallacies.
Single-family rental home ownership can be headache free. Today, there are high quality SFR property managers available at very reasonable rates across Konfidis’ target geographies. Please contact us at hello@konfidis.com to learn more.
As detailed above, urban condo expenses as a percentage of rental income are higher than single-family properties. And while there is perhaps comfort in a fixed condo fee, one must look deeper. Toronto condo buildings are compounding an inevitable crisis related to underfunded reserves. As quick background, condo fees include an estimated maintenance reserve for future capital improvements required at the building. But condo boards are notoriously inefficient, poorly aligned, and underestimate reserves. When there is not enough money in the reserve to complete capital projects, condo boards advance “capital calls” forcing all condo owners in the building to cough up their pro rata share of the shortfall. Each individual condo owner has limited voting power to influence control of their own destiny and risk losing their unit if they do not have the liquidity to fund the capital call. Contrastly, single-family detaches homes represent “fee simple” or “freehold” ownership in which the owner has full control of their capital improvement decisions. This provides a significant long-term ownership advantage than many investors ignore.
Perhaps there is a comfort to living in the same city as your investment property, but what cost do you pay for that comfort? How much rental income and appreciation upside are you leaving on the table?
In conclusion, while market conditions and data are always evolving, we hope this article outlines several benefits to SFR that Konfidis believes will drive investment outperformance.
As always, don’t hesitate to reach out at hello@konfidis.com to continue the discussion.