Real Risks in Real Estate

Interesting piece in yesterday’s Globe and Mail titled, Some new landlords are losing money. With rates rising, tenant could see rent hikes,” written by Erica Alini. The article examined the effect rate hikes might be having on mom-and-pop real estate investors – many who became landlords in 2020 when rates and financing costs were minimal.

Research suggests many of them used their home equity to acquire HELOCs (Home Equity Lines of Credit). Then, they leveraged the HELOCs to secure a down payment while financing the rest of the real estate purchase with a traditional mortgage (NOTE: in Canada, real estate investors must commit 20% of the property value but can finance the rest with a traditional mortgage).

Interest rates on HELOCs float with the prime rate. Borrowers are obligated to pay interest, but not principal. So, many of the investment properties would really have been financed 100% – a problem the author is wise to report on.

Studies indicate 37% of Toronto landlords are already cash flow negative

Benjamin Tal & Shaun Hildebrand – Urbanation

As interest rates rise, landlord’s carrying costs increase. Studies indicate 37% of them are already cash flow negative. Many of them will likely be inclined to raise rents in an inflationary environment. Expect some tension on that front. For the record, I’ll be siding with the tenants on this one – many of whom should have been “first time home buyers” but were sidelined as secondary parties drove up values.

Real estate investors will have bid up the price on properties betting the increase in real estate values will make up for period of negative cash flow (much like owners of NHL franchises who frequently operate at a loss, but are rewarded when they sell the franchise for a premium).

Figures from article.

But, what if values don’t continue to rise – at least over the short – medium term? How much pain can those new landlords endure? What happens if property values decline? Will they stay the course or will they dump their investments and realize losses?

There are some very real risks involved in this scenario. The outcome could be worse than anyone imagined.

Leave a Reply

Fill in your details below or click an icon to log in: Logo

You are commenting using your account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s