Entries from November 2012 ↓

Smart ass condo math

Boxes from hell, part deux:

It costs $1,800 to rent a one bedroom-plus-den apartment in a swishy downtown condo in Toronto. Or, you could buy it for $353,496, putting 25% down – that’s $85,000. Then the monthly cost would be $1,218 for the mortgage, plus $312 for condo fees and $283 in property taxes. It comes to $1,813.

Yes, spend $85,000 and then pay $13 more a month to live in the same unit. Why the hell would anyone do it? Especially in light of what I told you yesterday – condo fees (and taxes) can and will rise frequently (over which you have no control) and modern buildings are being thrown up with little regard to long-term structural integrity.

After all, buying a condo is not like scoring a house. You don’t own any actual dirt. If the pipes on the 15th floor burst, then your 10th floor unit is toast. Worse, if the building needs new plumbing in 15 years, you could face a special assessment of gargantuan proportions. You can never add a room or a window. Factors materially affecting your unit’s value – like a homeless dude in the lobby or a leaky underground garage – are beyond your ability to change. In short, it’s a massive leap of faith requiring significant cost/benefit analysis.

And how are these things being sold? On emotion and misinformation. Tens of thousands of them, imperiling the entire real estate market in cities like Vancouver, Calgary, Montreal and Toronto as legions of buyers assume liabilities they never expected, and discover losses they never imagined.

Cue Brad Lamb.

He’s now the condo king of Canada. His marketing sets the tone for an entire industry. He has amassed significant wealth, and works at showing it. His rise from salesguy flogging cheesy waterfront boxes two decades ago to developer deity, TV star and the coolest guy in the room is legendary. But lately there’s more than a tinge of desperation in his message. His weapon against a gathering storm of fear is simple. Greed. For Brad Lamb knows, greed works.

So, back to that one bedroom-plus-den condo renting for $1,800 in the heart of 416.

According to Lamb pitch to naive investors, buying this baby and renting it out (at a loss) will give you an annual yield of 23.9%. Hang on to it for ten years, and the return on invested cash is a gigantic 314%. Wohoo! How could anyone walk away from that?

Of course, it’s an illusion. The rental income is negative, but Lamb’s guaranteed return adds in a $13,596 annual capital gain (at a time when condo prices are falling), plus repayment of some of the mortgage principal ($6,890 in year one). Trouble is, to have that $6,890 repaid, you have to subsidize the tenant for $160 in rent plus put up $85,000 in cash which, at a 7% return if invested elsewhere, would yield almost $6,000. So the actually return is less than 1%.

Remove that from the equation, and you’re left with only the capital gain on the value of the unit, which in this market is probably phantom. In fact, with 63,000 more units in the pipeline, 5,500 resale condos currently for sale and 17,000 vacant, it’s a safe bet capital losses are more likely.

“This (Toronto) is the only big city in the world where all of the fundamentals are positive,” Lamb tells his flock. “Behave like the successful and wealthy; and use this buying opportunity to your advantage. Below is a real example of what you can do at a Toronto condominium development, a potential 349% gain over 10 years.”

As I’ve said before, if this was a pitch for an ETF or an IPO (initial public stock offering), anyone making such claims would be out of business, shut down by the regulators. Compared to the selling of liquid assets, flogging condos is a complete gong show. Worse, investors are encouraged to use leverage to buy assets which are often illiquid, and entirely speculative.

Plus, sometimes they leak. Read what Paul just sent me:

Garth: enjoy your blog, and have something to add in terms of another cautionary tale re condo costs.

My mother was fortunately only renting a Port Coquitlam condo where water damage was discovered.  I’m told the contractor had built the balconies sloping inwards so water drained into the building envelope.  Owners were notified of costs of about $75K per suite.  (Builders long gone of course; probably a numbered company disbanded after each project.)  Scaffolding and tarps went up and work started.  The strata council managed to get a series of inept builders in and the building was covered in scaffolding and tarps for two years during which no-one had a hope of selling, and sunlight was severely restricted.  Noise was a problem all day long.   Contractors announced doors had to be left unlocked all day in case they needed to come in.  It was a comedy of tragic errors.  Some poor retired souls had exhausted their wealth just getting into the building.

At the end, yet another contractor somehow convinced strata council that all windows needed to be replaced as the outside envelope went on.  My 85-year old mother’s apartment was without a  glass balcony door for a day in freezing weather.  The one they fitted had the latch so out of line with the door that it would not lock.  We had to put a stick in the runner to secure it.  Weeks went by before it was fixed (badly).  Her previously nicely locking while partly open window was replaced by one that had to be fully closed to lock.

Following all this, residents were notified the roof was going, for another $20K (I think) per apartment.  My mother passed away around this time, grateful that she was poor and could only afford to rent.

Sacrificial virgins

A few months ago a brand-new condo owner in Toronto’s sexy distiller district saw her balcony explode. Seconds later hunks of tempered glass were raining down on the hopelessly-trendy streets below. Hours later a city building inspector ordered the property maintenance company to replace the glass – with more of the same glass. Duh. Days later City Council passed a motion forcing buildings to be checked for kamikaze suicidal balconies and come up with a long-term solution.

Add one more nail to the condo coffin. Do all those new owners have any idea where this is headed?

“Tempered glass is the standard of the industry,” a spokesman for the developer said at the time. “ It’s been that way for 23 years. It’s come off buildings in the past but it’s never been a newsworthy event.”

Well, times have changed. And the issue is not just acres and acres of glass cladding scores of Toronto high-rises. It’s also glass-wall construction with short-life seals, questionable quality cement, slap-dab plastic tube piping, plus condensation and mold. Not just Toronto, either. In recent weeks condo owners in Alberta have made headlines complaining about deck drainage mistakes, windows set improperly, leaking roofs and wafer-thin stucco.

As Calgary architect Tang Lee says, “It’s not going to fail in the first couple years, but it will fail five, 10 years, 15 years down the line.”

Why is this happening, and what does it mean for the broader real estate market?

Demand for multi-unit housing – condos – has never in history been higher. Right now Canada’s the condo capital of the world, with Toronto its epicentre. The reason’s simple: cheap money and lax lending standards pushed real estate prices past the point of affordability. A generation ago young couples would buy ‘starter homes’ – 900-square-foot bungalows on suburban lots. Today those places can command a half million dollars or more, forcing first-time buyers into boxes in the sky.

As a result, there are now 55,000 new condos under construction in the GTA alone, and another 31,000 being marketed and sold. But the construction industry can’t keep pace, turning out only 15,000 units in 2012 – and doing that at a breakneck pace leading inevitably to shortcuts and efficiencies. Meanwhile as sales slow, banks exit financing and prices ratchet back, developers find their margins thinning. Wouldn’t you want to cut a few corners?

So not only are purchasers waiting a long time – as much as four years or more – to get what they paid for, they’re often buying into buildings which could deliver some nasty surprises. Replacing the glass skin on a 35-storey tower, for example, could take a year and cost several million dollars – with every penny coming out of condo fees and special assessments against the owners. If they chose not to pay, they’ll face legal action, and be unable to sell their units until it’s resolved.

How many of those property virgins, shunting into their mortgaged 500 square feet, know that?

According to a new survey this week, not many. When TD asked condomaniacs in Toronto, Montreal, Calgary and Vancouver about condo (strata) fees, almost 70% said they had no idea these things could actually go up. And they certainly can, especially if you move into a new building with no history of establishing reserves against major work.

Scarier still, the bank found about 40% say they “have no confidence” they could actually afford to pay an increase in those monthly charges. Note: that is any hike in fees, let alone a bill for ten or twenty thousand dollars that could arrive in five years when the glass goes Bruce Willis or the parking garage starts leaking.

This is what happens when people without savings, investments or actual money are allowed to buy high-rise units they should actually be renting. Human nature, greed and naiveté being what they are, most of these kids (and amateur investors) mortgage to the max, leaving nothing in reserve. If you were worried what might occur in two or three years when mortgages reset at higher levels, the news that four in ten can’t afford $30 more a month in condo fees should terrify. Especially given the trendy junk they’re moving into.

It seems certain the rush into these cement rabbit warrens will look like a poor decision in the years to come. A lot of people are on the verge of losing all their equity, first to Mr. Market, then to the hype and avarice which led them there.

Exploding balconies we could probably handle. Imploding virgins, not so much.