The GTA real estate market is going through a big transition. Houses are sitting for days on the market and sales are falling well below
asking averages. The Bank of Canada continues to aggressively rise up interest rates and with it, lendor mortgage rates go up. This whole cycle has led to dramatic price declines throughout the GTA (one of Canada’s hotest real estate markets). So with home prices dropping, that should lead to more affordable rent, right? Well, not exactly.
TL;DR: Mortgage payments are around the same or higher due to rising interest rates regardless of a drop is house prices.
To understand why rent prices seem to continue to shoot up, even with the turmoil in the housing market, we need to delve into the basics for a minute. Like all markets, when someone sells a house (maybe because they can’t afford the mortgage payments, maybe they want to cash out in a hypothetical peak, or maybe it’s just for personal reasons), they require a buyer. That means there has to be a price that is agreeable to both the buyer and the seller. The seller feels they’re not offering a discount and the buyer feels they’re not overpaying. Of course, in reality, there’s never that happy medium, but things are still pretty close to it, or else a deal would not be made. Let’s assume that this house has great rental potential (close to public transit, good schools, amenities, etc.) and both the seller Sam (previous owner) and buyer Bob (future owner) use it as a rental property. Let’s take a look at how they might price rent to help pay for their expenses (the big one being the mortgage).
This is a theoretical situation and there are some assumptions being made. They are as follows:
- Seller Sam bought his house in June 2019. We would like to avoid the lockdown-induced volatilities that shook both the rental and housing markets.
- Buyer Bob’s closing is June 2022 so he has access to the most recent data as of writing this article.
- Both Sam and Bob chose to get 5 year fixed rate mortgages. This is to allow a fair comparison, but also avoid complex calculation with variable rates. Both fixed and variable rates have their advantages and if you’d like to know more, reach out for a more detailed explanation on the respective differences.
- We will be using the average sold price from the TRREB website for both periods to account for any outliers in specific locations.
- The house did not have any major renovations, but was upkept so that there is minimal price decline due to poor maintenance.
- Property taxes have not increased in the past three years.
2019 Sam’s Rental Property Purchase
- 5 year fixed interest rate: 2.5%
- Amortization period: 25 years
- House price: $1,040,000
- Down payment: 20% ($208,000)
Final monthly mortgage payment: $3,733
2022 Bob’s Rental Property Purchase
- 5 year fixed interest rate: 4.9%
- Amortization period: 25 years
- Hypothetical House Price ($200k drop): $840,000
- Down payment: 20% ($168,000)
Final monthly mortgage payment: $3,890
Edit: It should be noted that Bob would be paying a lower downpayment (~$40k less than Sam had to). That means he would need less cash on hand to enter the market, which could be used to hedge against the higher mortgage payment.
*For more information on how mortgage payments are calculated, check out our newsletter article on it!
Yes, you read that right. Even with a drop of 200k in the house price from 2019 (which isn’t really the case in most parts of the GTA), the rise in interest rates actually increased the monthly mortgage payment by $150 for Buyer Bob. These interest rates are accurate to the time frames that they were pulled and hopefully illustrate the huge impact they can have on mortgage payments. Since both the Buyer and Seller are interested in using the property as a rental property, they would like the rental income to cover as much as the mortgage (plus other expenses like taxes/utilities) as possible. So even though housing prices might go down, new home purchasers cannot pass that on to their renters due to the increase in interest rates.
The more years you’ve paid into a mortgage and making extra payments to the principal, help hedge the risk of rising interest rates. An owner with a smaller mortgage or lower interest rate would not need to charge such a high rent to cover their costs, but that doesn’t mean they wont charge more if other similar rentals are priced high. There are also other factors that effect the rental market, like supply and demand. But simply put, mortgage payments not changing is one variable that is keeping rental prices from dropping.
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