Saturday, August 31, 2013

Buy a condo: I don't want to, mom?

Condo life is perfect for a person who likes city living, has very small real estate demands, and doesn't really want to spend much on housing. Someone who has no trouble sticking to a single room in a house, a box in the sky. A person like me. Or maybe I own the unit and rent it out to someone like me.

Prices in Canada, especially the big cities, are a bit out of whack right now. If they're not, then they are just plain expensive. Ignoring the direction of the housing market, I thought it'd be fun to run by some of the numbers for buying a condo. Not being a financial anything, I'm just thinking aloud with some random numbers, and trying to rationalize my thoughts somehow.

Reminder that I'm talking aloud and not giving any sort of financial advice. I don't know what I'm talking about...

Price of a Condo
In the locations that I've been searching, the cost of a studio or bachelor condo in the city starts around $200k. Move up to a 1 bedroom, it moves to $250k and up, a 1+1 keeps it going, and a 2 bedroom runs around $300k and up. The perfectly ideal areas close to the "action" require something like a $50k to $100k premium on top of those prices, so a 2 bedroom starts around $400k. Areas that I've checked out have varied from right downtown to suburbs near subway lines -- both obviously command premiums.

There are cheaper units available in really "edgy" areas of town. For example, I've found at least one studio condo for $130k or less in an older building in a shady part of town. Shady means that there is a history of shootings, rapes, and murders -- that made the news -- within a couple block radius within the past few years.

Let's say that a person went ahead and bought a $130k bachelor condo at a fixed 5-year rate of 3.79% with 20% down. That means borrowing $104k with payments of $535 per month with a 25 year amortization period (online calculator).

If the person went with the $300k 1+1 condo, it'd be payments of $1235 per month under the same conditions. I want to be friends with this person who has 20% down.

Maintenance Fees
Sharing a building and lot of land along with "amenities" means that someone has to be pay for them. Who better than the occupants and owners to pay for them through maintenance fees.

Let's say that $130k bachelor condo has a monthly maintenance fee of $200 and the 1+1 sets you back $400 per month.

Other Expenses: Property Taxes and Utilities
And like any responsibly homeowner who wants the room to be warm and powered, and not seized by the government, there are taxes and utilities to pay for. I'm just going to pull a number out of nowhere and say it's $200 a month for both items combined.

Running Tally
When everything is added up, the $130k bachelor would cost $935 per month, and the $300k 1+1 would be $1635 per month. This is assuming all my fake numbers are accurate and I didn't forget about any other expenses.

According to news reports I've heard, a lot of people can't afford 20% down and 5% is "mandatory" in Canada. But anything less than 20% down requires mortgage insurance, which could set someone back at least a couple grand. Over the long run, I don't think it's that big a deal, especially when spread out over 25 years relative to the mortgage. The bigger issue is that not paying that extra 15% down means borrowing it and having to pay interest on it for 25 years, adding to monthly payments.

Then there are the record low "emergency" interest rates still in effect because of the world economy and stimulus efforts. Those two properties would go from $535 and $1235 per month at 3.79% to $605 and $1395 per month -- calculated for starting principal amounts without factoring in paid down principal after a 5 years for a renewal mortgage.

Oh, and every building I've stalked for years has had maintenance fees go up over time. Things get old, need replacement, and someone must pay for them.

Remember how I said that I was going to ignore the direction of the housing market? I'm not going to lie, that seems kind of dumb. If condos were at an inflated price, it may take years for the prices to recover, maybe decades. Condos are kind of the new "starter home" that may make them difficult to live in forever if life changes due to things like work and family. This is especially true for the bachelor and 1+1 condos I've been looking at that sit around 600 sq.ft. or less. That could necessitate having to sell the property at a loss or holding onto it to rent out. Doesn't sound too bad, right? Renting out a condo to make money? As long as you don't need the locked in equity to pay for a new property?

Renting out a condo (e.g. investment property)
So, it's come to this: having to rent out a condo do avoid selling at a loss. Or maybe this is what the owner had in mind in the first place. The going rate for bachelor and 1+1 bedroom condos in the areas I've looked at range from $1000 to $1500 monthly. That is $12k to $18k per year on, let's assume, either a $130k or $300k condo, respectively.

This is where it gets sketchy. Calculating the rate of return is complicated and not something I really know how to do. I could think of it as a $12k return on $140k and $18k return on $300k, which translates to an 8.6% and 6.0% return annually. Everything like appreciation or depreciation, selling expenses, taxes, expenses, etc. are ignored though.

If I were to factor in expenses, which I laid out earlier just for the mortgage, taxes, and utilities, then a slightly better number can be arrived at. The numbers become $1000 - $935 = $65 and $1500 - $1635 = -$135 per month in revenue. Not so pretty anymore. A chunk of those expenses go into paying down the mortgage and building equity though. Kind of like having someone else pay down the property for you? This would be especially nice if the property appreciated in value -- oh wait.

Factor in opportunity costs like where else that money could be sitting, a lack of price appreciation, periods of vacancy, having to maintain the property, finding tenants or paying a company to do it, and it's not as pretty once again.

In way over my head
Unless my numbers are way off base, I don't believe that I want to play right now.

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