Vacancy tax is pointless, say Vancouver sales agents

Empty abodes in Vancouver will be slapped with a vacancy tax, that one sales agent says amounts to little more than a slap on the wrist.

While the hope is that the tax could free up as many as 25,000 empty units for rent in a city suffering from a rental supply shortage, the 1% vacancy tax likely won’t dissuade owners willing to forgo rental revenue, says Marilou J. Appleby of Dexter Associates Realty.

Homeowners must declare their property’s status annually, however, properties for which no declaration is filed by February 2 will be considered vacant and, in addition to being subjected to the tax, will be fined $250.
An amount Appleby believes is palty.

Moreover, she says it’s affecting Vancouverites who spend part of the year away and don’t want to rent their homes out to strangers.

“Owners are not thrilled about it,” said Appleby. “A lot of people in Vancouver spend winters down south and they have to have their places rented. In my opinion, it’s not going to solve any problems. Really, who it will hurt again are Vancouverites who are living a very normal life, who want to have the opportunity to spend winter in a warmer climate.

“I live in downtown Vancouver and people talk about dark buildings, but I don’t see that. There’s a very vibrant downtown community.”

She also said that if a homeowner can afford to leave the place vacant, taxing them 1% practically amounts to asking them for their pocket change.

“One percent could be substantial to some people, but if you’re allowing your place to stay vacant then you’re losing revenue anyway, so what’s 1%?” she said. “That’s why it’s a useless tax.”

Mahmoud Ahmed, managing broker of Nu Stream Realty, agrees with Appleby.

“The vacancy tax won’t do anything,” he said. “There’s a lot of money in the city, so 1% won’t make a lot of difference. If they don’t need the rent, that’s why it’s sitting empty anyway. It’s not going to be the solution for affordable housing.

“Most homes that are vacant are not entry-level homes, they’re mansions. It won’t make an impact on the rental market because most people don’t have $10,000 a month to spend on rent.”

As for how the tax will affect the market, Ahmed says it’s far too early to tell. But he says the 15% foreign buyer tax only managed to cool down the market temporarily, therefore, a 1% tax probably won’t even make a dent.

“Fifteen percent is a big hit, but 1% won’t do damage,” he said.

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Veteran estimates foreign investment as much as 70%, argues for regulation

One Toronto brokerage owner is calling for foreign buyer regulation, despite some blowback from his own brokers.

Carl Langschmidt, president of Condos.ca, recently penned a blog entitled Foreign Investor Tax and Regulation Please! – a polite, yet assertive call to action.

In the piece, Langschmidt argues foreign ownership stats are much higher than the CMHC’s estimate of 2.3% of sales in Toronto. He went so far as to call that figure “laughable.”

“Our talks with sales reps in the trenches indicate it is much higher; some reported as high as 70% foreign ownership at developments like CityPlace,” Langschmidt wrote.

Anecdotal evidence, to be sure. But how about this other piece of sobering hearsay?

“Personally, this week alone, one of the agents in my brokerage who was meant to be listing a 50 unit condo building was just informed today the developer sold the entire building to a Chinese consortium and that we’re not getting any of the listings,” Langschmidt told Canadian Real Estate Wealth. “That’s how hot the market is.”

Vancouver had success with its own foreign real estate regulation when it implemented a 15% sales tax. That helped contribute to double-digit cooling in what was once Canada’s hottest market.

And Toronto may soon have its own measures introduced, with Ontario’s budget expected in the coming weeks. Ontario Finance Minister Charles Sousa said the budget will contain policy aimed at addressing housing affordability.

“Demand is high for a number of factors,” he said, per the Canadian Press. “Could be speculators, could be people from outside the country, it could very well be the many who are now moving into Ontario creating that demand.”

While many have argued in favour of a similar approach in Toronto, Langschmidt suggests a multipronged strategy that could also include special regulations for prebuild home sales.

“Preconstruction sales has morphed into a totally separate specialization in real estate; it’s almost as if agents who specialize in that are so different from traditional real estate where you’re showing properties,” he said. “Preconstruction sales is all about pitching investors and often agents and groups go overseas to pitch. I’ve seen their presentations. I cringe at their presentations. It induces the speculation; half of them use numbers are (off). A lot of them don’t calculate ROIs correctly. This is where I think some regulation is required.

“Anyone selling a stock or investment vehicle, there’s regulations in the securities business about what you can say. Whereas with (real estate sales) it’s the wild west.”

Many believe foreign ownership is having a major impact on Toronto home prices and will likely applaud Langschmidt’s comments. However, that may not include a portion of real estate agents, his own included.

“The reason why I’m saying it is I don’t mind saying what I think is true,” Langschmidt said. “It will upset people who deal with foreign investors; even in my own brokerage I had someone call me up and say ‘we have a lot of foreign investors and they’re not going to be happy with our opinion on us.’”

Related stories:
Ontario hints at measures to cool real estate market in the budget
Don’t tax foreign buyers says real estate board

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The new biggest challenge for investors

Until recently, I always believed the toughest part of investing in real estate was finding the “right” income property (eg. good geographic metrics, under market rents, purpose built, good shape, good location, etc.). In the past, my ability to find “diamonds in the rough” is what made me an effective and successful investor. However, my opinion has now changed.

Looking back over my past few deals I realize that in today’s environment, putting the right financing in place for an investment property is now more difficult than finding a good investment property and dictates your ultimate success or failure.

Financing

Most novice investors just assume that the bank is going to use the purchase price when determining Loan-to-value. They look at how much money they have available and work backwards. If they have $300,000, they can use $250,000 for the down payment and $50,000 for closing costs. This means they can buy a property for $1 million and the bank will give them a mortgage of $750,000 based on a 75% LTV. However this couldn’t be further from the truth today.

How did this situation come about?

Historically low interest rates in Canada have been the catalyst leading to:

Cheap cost of funds
Market cap compression
Increased demand for real estate as alternative investments (Bonds, T-Bills, GIC’s) offer poor returns
Limited supply

As an investor looking to acquire an income property, you welcome low interest rates but cheap cost of funds is a double edged sword. On the one hand you want as low an interest rate as possible to minimize expenses. However, there is a direct correlation between cost of funds and market caps. Both move in sync which means as interest rates go down, market caps follow suit (which means the price goes up).

Why does this matter?

Market cap compression directly affects cash flow. For instance, most income properties on the market in Toronto, and in surrounding areas, are being listed with cap rates of 4% to 4.5% (and in prime Toronto locations sub-3% market caps). The problem is that there is a big disconnect between actual valuations dictated by the market and the criteria that banks use to value an income properties for financing purposes.

Just this week I approached two majors banks regarding an income property in a prime Toronto location and was told they use a cap rate of 6% to determine value. A 6% cap rate on a good income property in Toronto is like a unicorn — they just don’t exist.

The numbers

Most people, like myself, like to see the real math and numbers to truly understand a concept. So here it is.

Assume a property nets $40,000. Based on a 4% cap, a seller would list that property for $1,000,000. Bring that same property to the bank for financing and based on a 6% cap, that same property would be valued at $667,000. The bank will typically offer 75% LTV which would translate into a mortgage of $500,000. The purchaser would have to come up with the balance, or $500,000 in cash, to complete the transaction. One of the great benefits of investing in real estate historically has been the ability to leverage and borrow from the bank.

As if that wasn’t a big enough obstacle…

To make things even tougher, most banks have their own internal guidelines when determining a property’s cash flow and they differ significantly from what you see on the property’s fact sheet when it is for sale.

For example, most real estate agents will assign $400-$500 in annual repairs and maintenance per unit under expenses on the income statement. Banks and CMHC tend to use $800-$900 per unit. If you plan to manage the property yourself, it doesn’t matter, they will assign a 4% (of gross) management expense.

Capital expenditures warrant another 1.5% to 2% of gross. What does this mean? It means that if you apply these guidelines the cash flow gets even weaker making it tougher to get the financing you need.

Unless you are a REIT or have deep pockets, the erosion of leverage makes it almost impossible for the average investor to enter this market.

The solution?

That will be my next entry. Stay tuned…

Author: Paul Kondakos, BA, LL.B, MBA – Professional Real Estate Investor

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