Welcome to this month’s installment of Dear Urbaneer, where I take on real estate questions from both existing clients and my housing-curious readers. This time around, I am helping prospective Buyers who are considering purchasing a multi-unit dwelling downtown.
We live outside Toronto but we are considering relocating to enjoy a car-free life in the central core of the city. We have been following your blog with great interest as you focus on different aspects of the Toronto real estate market. To get into your housing market, we think we should buy a house with 2 or 3 units, where we live in a part of it and rent out the other units to make it affordable. Is there anything we should know about going in this direction?
Property Purchase Perplexed
Here’s my reply:
Your question is timely as I’ve recently been reflecting on how different the landscape is for Buyers today than it was when I first started my career as a realtor three decades ago. The one aspect that has never changed, however, is the importance of completing your due diligence for any property purchase – including fully assessing the potential costs and expenses associated with shelter – whether it’s as a principal residence or part of an investment portfolio. In looking specifically at your query regarding multi-unit dwellings, there are some specific considerations you should weigh out. Remember – a cautious buy is a smart buy!
Although Toronto was incorporated in 1834, it’s important for Buyers relocating here to understand most of the original housing stock still standing in the central core of the City of Toronto dates from the 1850s through the 1940s. Constructed surrounding the port lands and business district, and developed along road, rail, and electric streetcar routes, the residential differentiation in our ‘city of neighbourhoods‘ today reflects the architectural styles and building materials available at the time of construction, and the status, style of life, and ethnicity for whom the shelters were built (see The History Of The Ontario Gothic Revival Cottage, Bay & Gable Victorian Architecture In Toronto and Exploring Edwardian Residential Architecture In Toronto), as well as all the political, economic, socio-cultural, aesthetic, and technological factors, forces and fashions that subsequently shaped these built-forms, their occupants, and the neighbourhoods in which they’re located.
To give you some context check out: my overview on Urban Planning And Toronto Real Estate; the impact of Gentrification & Densification, And The History Of Toronto Real Estate‘ or why the domicology of Toronto’s Housing Is A Reflection & Symbol Of Self. I share the domestic ills of a booming industrial port city in Why Toronto’s East Side Real Estate Has Historically Been Cheaper, how the absurd primacy of the automobile led to over 100 grand Victorian mansions being expropriated and bulldozed in the Eclectic, Elegant and Cool Housing Stock of Parkdale and how Lawren Harris (1885-1970), a founding member in 1920 of the Group of Seven, painted “the picturesque, semi-slum district of ‘The Shacklands’ well before Toronto’s Davenport Village Went From Brownfield To Playing Field in 2006.
Because of the age of Toronto’s dwellings, if in the recent decades a property has not been Renovated In Stages Or As A Comprehensive Full Gut or succumbed to an owner’s desire for the Fashion – And Popularity – Of The Open Concept Space Plan, it’s highly likely the structure is effectively obsolete, both because the capital required is so substantial it’s more cost-effective to build new (presuming the property is not designated heritage), or because the dwelling no longer represents the highest and best use for the site. This means you should exercise caution, because you may upgrade a property that, when the time comes to sell, may still be considered ‘land value’ despite the improvements you’ve completed.
Assess The Property Based On These Six Factors
When you’re assessing the value of a property, it’s essential you understand the six interconnected layers of a property and how each of these influences value. These six layers—Site, Structure, Skin, Services, Space Plan, and Stuff (the furnishings), as illustrated above, are all factors which influence the value of a property – both in establishing its actual cost and its market value.
When you analyze how each of these layers contributes to the market value of a property, and what improvements might be required by you, it gives you the foundation to make an informed decision on whether it’s a contender to buy. Here’s my post –> Understanding The Six Essential Layers Of Property.
Be Careful Not To Buy The Dwelling That Is Near Obsolete
Back in 2016, I posted, Exploring Toronto Real Estate Property Values, which outlines the three different ways one can estimate the value of a property, being the Market Value Comparison Approach, the Income Approach, and Land Value + Development – As A Cost Approach. In it, I explain how most of any older property’s value in the City of Toronto is tied to the land, and that all the structures on the site are depreciating assets.
Further to that, Buyers run the risk of choosing the wrong property type appropriate to their long-term objectives. In this post –> Dear Urbaneer: What Do I Do With My Dated Bungalow? (Plus A Brief History On This Housing Type) I use the example of an older bungalow in the central core to guide a client through his options, illustrating how investing more time, energy and capital does not guarantee a more lucrative return on investment. Sometimes even after upgrading a property, it’s the ever-evolving highest and best use of a site that trumps the value of a recently improved structure.
Almost a decade ago Dear Urbaneer was addressing –-> Why So Many Downtown Houses Are Being Renovated, prompting blogs like How To Keep Your Flip from Flopping?, Is Flipping In My Future? and the series We Flip Eggs Over-Easy, Not Houses.
Five years later, I shared Ten Toronto New Builds That Recently Sold For Between $2M And $10M, several of which were located in formerly working-class neighbourhoods, prompting the observation that Toronto Real Estate Is Shifting From ‘Fixer-Upper’ Flips To ‘Tear Down’ New Construction. And then two years ago I noted that the fashion of housing was Trending In Toronto: Single-Family Houses Replaced By Boutique Condo Townhomes.
More recently, in this –> Dear Urbaneer: Should I Sell My House In As-Is Condition, Upgraded, Or Elevated? I explore how the Covid19 pandemic shifted the priorities of many property Buyers from pursuing smaller renovated houses to larger dwellings that needed upgrading. I called this The New Space Race. The challenge for you in your pursuit for a dwelling of sufficient size to contain multi-units is that right now there exists more demand for bigger places needing work than there was pre-pandemic.
Is The Multi-Unit Dwelling Legally Retrofitted To Current Standards?
One of the City of Toronto’s dirty little secrets is that the majority of older dwellings that have been carved into multi-units actually aren’t code compliant or legal. There are many reasons for this, including our long history as an immigrant destination when it wasn’t unusual for an owner to rent out portions of their house by the room, by a floor, or by dividing it as they chose to earn an income supplement. This was occurring well before building codes stipulated how this must be done.
Over time, as the city updated its tax rolls by completing property assessments, what were once single-family dwellings that had already been converted into multi-units would be deemed ‘legal non-conforming’, meaning that the city acknowledged the properties didn’t comply but were grandfathered as-of-right into the system.
Adding to the confusion is there are many multi-unit properties that, when originally constructed, were legal at the time they were built but, given building and fire codes are always changing to reflect new building technologies and higher standards, they may be legal but may not be fully compliant. Owners of these properties are still obliged to take precautions to mitigate potential risks, such as having smoke detectors, fire extinguishers, and ladder kits that can be hooked onto a window sill to ease egress in an emergency.
Back in 2015, I posted Can I Have An Income Suite In My Residence?, which addresses putting in a secondary suite like a basement apartment, I outline both the risks of non-compliances (which includes fines and even a prison sentence) and how the unit must meet the following criteria to be recognized as legally retrofitted: residential zoning requirements; property standards; occupancy standards; health and safety requirements; and fire and electrical codes.
Further to that, a few years ago I shared How To Strategically Purchase An Income Property by purchasing a single-family dwelling that has all the right existing design and space plan features to make a conversion into multi-units easier. Now, this post was aimed at creating what I call the ‘accordion dwelling’ whereby the space plan and can expand or contract based on the needs of a multi-generational family, but it did not address building and fire code compliance, which is an important consideration when you’re converting a property for the sole intention of investment.
And, buyer beware it is standard practice for listing realtors to insert a blanket clause that does not warrant the legality or retrofit of a multi-unit dwelling. Furthermore, it also amplifies the opportunity that the property has had work completed that is not to code, which I wrote about in –> To Code, Or Not To Code?, and in –>Dear Urbaneer: What Happens When I Sell My Renovated Property Without Building Permits? and in –> Dear Urbaneer: Will Title Insurance Cover A Prior Renovation Completed Without A Building Permit?
The Risks Of Purchasing A Fully-Tenanted Older Dwelling
I will admit I’m resistant to selling fully-occupied tenanted properties in older dwellings because the risk of finding serious issues that oblige you to remedy as soon as possible as they could be compromising the health and safety of the residents. The potential to discover issues such as knob and tube wiring, mold and mildew, asbestos or lead water pipes ranges from possible to probable in the City of Toronto’s older housing stock, which means the unsuspecting investor/buyer may find – when they embark on refreshing a recently-vacated suite – unwittingly having to do a significant transformation when an issue (like Kitec Plumbing) snowballs into a comprehensive and costly undertaking that could require placing all of their tenants in alternate accommodations until the building components are replaced before bringing them back at their existing rents.
There are other factors to be cognizant of when buying an older dwelling that I cover in my Healthy Home Series, including the Potential Health Hazards Of Living Near Power Lines, the issue of Light Pollution, the possibility of a Buried Oil Tank, Radon Gas, and Sick Building Syndrome.
A Tale From The Real Estate Trenches
Not too long ago I had an inquiry from a client regarding a 6-unit vintage apartment building they had spotted. After receiving financials around income and operating expenses, and very little other information (no presale inspection or other supporting info), we took a look, and there were a few things that caused me concern.
It looked like the building was a bit tired and likely needed some capital investment (exterior work, new windows, old electric baseboard heating, etc). The rents were pretty modest, suggesting that the units were dated. And access to viewing the entire building – beyond the one unit that was vacant – was contingent on a conditional offer.
In the context of all of this, what was my response? This was a rent-controlled building in need of capital investment. And given the low rents, I suspected that most of the units had long-term tenants. This is problematic for a new owner, for the rent increase guideline is set each year by the Ontario Government, which is based on the Consumer Price Index. One can apply to the Landlord and Tenant Board to have the rent increased for capital expenditures but it cannot be for more than 3% above the guideline each year. And if the landlord can justify an increase that is more than 3% above the guideline, the increase can be taken over three years, at a rate of up to 3% above the guideline per year. Given the rents are so low, that increase at best won’t offset much of the real costs.
In this scenario, this means that the longer you own the building, the more money you’re going to have to spend out of pocket without being able to recover much of it from the rental income. The only way this will change is if a tenant vacates, at which point you could change market rent (or you try to buy them out).
This isn’t an ideal investment when most of the units currently have low rents.
More Due Diligence Is Required
In the case of this older vintage apartment building, without the listing realtor providing a building inspection or engineering report, it was effectively impossible to determine what the building was truly worth, especially given we couldn’t even view the property to eyeball the deficiencies. Proceeding without any reports creates a number of risks, including overpaying at purchase or underestimating costs to make units tenantable – or fully understanding the timeline that one might be looking at to generate cash flow sufficient to support the investment.
Basically, in this unique but not unusual situation the buyer would have to submit a full price offer conditional on due diligence and then spend a couple of thousand dollars bringing in the experts to assess it, and then go back to the Sellers and renegotiate the price by revealing all the deficiencies your experts discovered along with their estimated costs to remedy.
Of course, this could easily result in the Seller refusing to renegotiate while becoming privy to all of the due diligence, leaving the Buyer with nothing other than wasting their time, money, and energy. As a realtor representing Buyer clients, when a multi-unit property is on the market and an Engineering or Building Inspection Report is not being provided as part of a due diligence package, I’m inclined to interpret this to mean the Sellers are not very motivated to sell. Here is a recent post of mine: The Benefits Of A Presale Inspection Report For Property Sellers & Buyers.
There are always potential costs that can impact making an investment profitable. This is why investors should have deep pockets or easy access to capital to address unexpected costs. It’s important to understand in advance of purchase how much of a loss you can absorb and for how long? After all, what if you run out of money before your repairs are completed or your project is finished? You could be left with an uninhabitable space, potentially extending the time frame you may operate at a loss.
Being an end-user with income supplements can be an intelligent strategy to reduce your mortgage debt faster or provide an income while you age in place but it requires a sound strategy, a business plan, extensive due diligence and a patient timeline to weather investment cycles. To complete the trifecta of my posts for potential end-users and property investors move on to these two further helpful reads:
Thanks for reading – we appreciate it!
(Title Image: John Cox Cottage – ‘Gilpin House’ – which is the oldest (still occupied) residential home in Toronto. Courtesy of NOW and Samuel Engelking)
Here’s some further reading for you!
Are you looking for a property with income potential? Decades of experience in the Toronto real estate market allow me to scrutinize and examine potential opportunities to help guide you to the right match. Sometimes that means having the patience and knowledge to walk away, keeping on eye on meeting your overall goals. We’re here to help!
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Thanks for reading!
-The Urbaneer Team
Steven Fudge, Sales Representative
& The Innovative Urbaneer Team
Bosley Real Estate Ltd., Brokerage – (416) 322-8000
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