In a housing market like Toronto, where prices are so high and continuing to rise, most people are simply priced out of the market for the average house. This is especially true for first-time buyers. But what about the idea of buying a starter home to get into the real estate market earlier and take advantage of the rising market?
As the name implies, a starter home is a below-average property that you plan to live in for the next 3-6 years or so, and then sell for hopefully a nice profit so you can move into a more permanent home. A 2015 study by Genworth Canada showed that 50% of first-time buyers see their first home as a starter home, from which they plan to move out of within 10 years.
Celia Alves, a Sales Representative at Sotheby's International Realty, who has experience working with young buyers, provides more context about starter homes in Toronto specifically:
Starter homes in Toronto as you can imagine are very much in demand. They are usually in need of a cosmetic face lift and are priced competitively. We have seen a great number of first-time clients move just outside of the Toronto core to areas such as Scarborough, Brampton, Orangeville, Richmond Hill, Markham, and Oshawa. A large segment of the first-time home buyer’s market has also been condominiums.
This article will go into further detail about types of starter homes, what you need to consider before buying, and whether or not they makes sense for your situation.
Types of Starter Homes
In general, there are four types of starter homes:
- Attached homes
- Homes in less desirable areas
Attached homes are homes with at least one wall shared with another home, hence the lower price. That includes townhouses and semi-detached homes.
Condos are getting more and more popular in Toronto. Jenelle Cameron, a Toronto-based realtor, says that the majority of her clients are buying studio condos for their first home. According a torontostoreys article, supply for condos was 6,500 on average between 2012-2015, but in 2019 supply was only 3,000. One reason for this decline is because many owners who have relocated to a larger house chose to keep their condo and rent it out, thereby limiting supply and driving up prices.
Fixer-uppers require you to do some repairs and possibly renovations. These costs can be very expensive, time consuming, and emotionally draining, so think carefully before buying a fixer-upper, especially for your first home purchase!
Homes in less desirable areas refer to areas far away from the city center, where most people work, or areas that are more run-down.
What to Consider Before Buying a Starter Home
There are four major considerations when it comes to buying a starter home:
- The housing market in that area
- Your time horizon
- Your needs
- Your alternatives
If you hope to profit off of a starter home, it’s very important that the housing market is rising. Historically, Toronto’s prices have soared, and most believe that prices will continue to rise, especially over the long-term. That being said, no one can predict the future with 100% certainty, so there’s always the risk that prices may stagnate or decline, and that risk increases the shorter your time horizon is. That brings us to the next point: time horizon.
Experts recommend to buy a starter home with the mindset of keeping it for at least 5 years. The main reason is that it generally takes 5-7 years just to break-even with the transactions costs of buying and selling, as well as all the expenses of home ownership. Additionally, the way mortgage payments work is that in the beginning, you’re mainly paying off interest rather than the actual debt, so you’re building very little equity. However, in a market like Toronto’s, many people have sold their starter home after just 3 years and reaped significant profits. It depends on how fast prices are rising, which again, is hard to predict.
Another consideration is your needs. As mentioned previously, starter homes will likely be much smaller, far from the city center, or be in more run-down neighborhoods. If you are planning to have a family soon and you want to buy a starter home, you might end up having to move within a few years and losing money on that starter home. Or if you hate commuting, if might be better to just continuing renting near your work. And that brings us to the last point: alternatives.
Aside from using your savings to take out a mortgage and to a starter home, how else could you use that money? One option is to continue renting and putting any extra savings into other investments. Low risk and low return investments include GICs, bonds, and mutual funds. Higher risk investments with potentially higher returns include stocks and index funds. Another option purchasing a cottage and renting it out. This torontolife article highlights many cases of people who wanted to buy a home in Toronto but couldn’t afford it, so they ended up buying a cottage and renting it out as a way to save up money.
Does it Make Sense for Me to Buy a Starter Home?
Given all the above considerations, it might make sense for you to purchase a starter home if
- You’re in a soaring housing market.
- Your time horizon is at least 5 years (although you could sell sooner if a good opportunity arises).
- You actually find a starter home that suits your needs for the next 5 or so years.
- You don’t like your other alternatives.
You might be thinking, “Wow, those are some high requirements!” Yes, and that’s because purchasing your first home and getting a mortgage is a very big deal.
Alves gives three major pieces of advice:
We advise our first-time clients to look at properties in up-and-coming neighbourhoods that may need some TLC (tender loving care) or properties that other buyers may have over looked. Another tip is to look for a property that may allow the opportunity for a secondary suite to generate rental income and help offset the mortgage. Thirdly, look for a house with potential to add on or add up so that it can be a longer-term home. This may be important because we have noticed that clients who have outgrown their first home and are looking to move to a bigger home continue to face similar competition and affordability hurdles.
She also gives a couple stories from her clients:
A client who purchased a pre-construction condo lived in it for a few years while she was single and was able to build her real estate portfolio that way. Once she got married, she was able to take the equity from her condo and invest it into a larger townhouse closer to where she ideally wanted to be. Another client bought their first starter home and decided to use it as an investment property. They bought a 'fixer upper' where they were able to renovate it so they could live in the lower level while renting out the top floor for more money to essentially live for free.
Buying a starter home is a great way to get into the rising Toronto real estate market as early as possible. But it’s also extremely important that you don’t rush. If you’re not sure whether buying that particular starter home is a good idea for you, then chances are, it’s better you don’t do it. In the mean time, you can continue to rent and put away savings in a low-risk investment while continuing to search for a good starter home.