High costs, population changes complicate the math for investors with tiny condos

Tiny apartments in Toronto, Canada’s largest condo market, are increasingly turning into a financial riddle for real estate investors.

On the one hand, owners renting out the smallest units in recently completed buildings are the most likely to still be able to cover monthly expenses – which have soared alongside higher interest rates and construction costs – according to a recent report by housing research firm Urbanation Inc. president Shaun Hildebrand and Canadian Imperial Bank of Commerce deputy chief economist Benjamin Tal.

On the other hand, a separate analysis by Urbanation highlighted a more worrisome shift for tiny-condo investors: Studios, the smallest condo units, have seen the steepest annual declines in rents for recent leases. By comparison, rents recorded smaller declines for one- and two-bedroom apartments and held roughly steady for three-bedrooms.

The two trends reflect the impact of high borrowing and building costs, supply issues, the housing affordability crisis and the changing needs of an aging millennial generation, Mr. Hildebrand said.

Smaller units make it easier for new condo investors to make the cash-flow math work, a feat that has become increasingly challenging, he said. Elevated construction and financing costs meant average monthly expenses for owners of freshly completed units have grown even faster than the city’s soaring rents between 2021 and 2023, Mr. Hildebrand and Mr. Tal’s analysis shows.

But owners of smaller condos often have smaller mortgages and can get higher rents on a per-square-foot-basis, according to Mr. Hildebrand. Among owners of condos completed in 2023, those holding studios are, on average, breaking even, while those with three-bedroom apartments had the largest monthly net losses, at $866 on average, the report shows.

At the same time, a combination of supply and demand factors have been weighing on rents for smaller condos, Mr. Hildebrand added.

In the greater Toronto and Hamilton area, average rents for condos leased between April and June decreased 3.9 per cent compared to the previous year, while those for one-bedroom and two-bedroom units were down 1.8 per cent and 0.9 per cent, respectively. Three-bedroom rents were down just 0.6 per cent, Urbanation data shows.

Part of what’s behind the rent decreases for smaller condos is that many more of them have recently become available on the rental market following a slew of new building completions, Mr. Hildebrand said.

“A lot of these units are going through the construction process and getting ready for occupancy,” he said. “And so that’s added a lot of units that all kind of look the same.”

By contrast, only 3 per cent of the condos completed in 2023 that were held as rental investments were three-bedroom units, according to Mr. Hildebrand and Mr. Tal’s report.

Yet tenants covet bigger apartments, which helps explain why three-bedrooms rents have barely budged, Mr. Hildebrand said. Many people are looking for larger units to be able to have roommates and split monthly expenses, he said.

But aging millennials who are still financially shut out of home ownership are also driving the demand for bigger rentals, he added.

“For the first time in a long time, we’re seeing really strong growth in the population in their thirties. And this is sort of typically when you start to form a household, right?,” he said. “You’re starting a family and you need more space.”

Simeon Papailias, managing partner with real estate brokerage REC Canada, which caters to investors buying condos that have yet to be built, said he has traditionally advised clients to buy the smallest two-bedroom units available.

“We honed in and found that the secret sauce is to buy the smallest bigger units available,” he said.

Having two or more roommates helps landlords command higher rents and achieve greater cash-flow stability, reducing the chance the unit will remain vacant for a period of time or that rent payments will stop if a tenant runs into financial difficulties, Mr. Papailias said.

But Mr. Papailias has also noticed investors becoming more interested in three-bedroom units, especially along the city’s outskirts. And those larger condos, in buildings that have been recently completed, have been among the first to be rented out, typically with young couples moving in, he said.

Still, Mr. Papailias is also optimistic about the prospects for investors holding tiny condos. He sees the city’s housing supply shortage reaching a new high by 2026 or 2027, an outlook shared by several housing analysts as developers have recently cancelled projects due to high costs and weak investor demand.

That expected supply crunch will drive up values for condos of any size, Mr. Papailias said.

“So if you have a condo, you hold on to that thing.”