First of all, there's a wide range of choices when you're looking for income properties. For example, you can buy:
Single family homes or multi-family ones
Commercial or industrial buildings that can be rented to business people.
You can spend less than $100,000, or invest millions of dollars. The question is, will it be worth it?
Is a rental property a good investment?
This can vary, depending on a number of factors. For example:
How will you finance your purchase? It may make sense to buy your house with no money down. But taking on a huge amount of debt for the sake of rental income may lead to financial disaster.
How much income can this property generate? What are rents like in the same area? Vacancy rates? Local market conditions determine the rents you are able to charge. Look for a place where the rental income covers the cost of buying the property and paying for it.
How much will it cost to maintain this property? You can buy a building that needs a lot of work, or one that is newly renovated and will need minimal repairs. You can buy a property that you can manage on your own, without extra help. Or, for larger properties, you can hire an onsite superintendent or a property management company.
What are the advantages of a rental property investment?
You can deduct certain expenses from your income reducing the taxes you owe. The list includes:
- Mortgage interest
- Property taxes
- Insurance
- Maintenance/upgrades
- Property management
- Utility bills (if you include them in the rent)
Losses from your rental property can turn into tax relief. If your expenses exceed your rental income, you can subtract that loss from any other sources of income you have. This could reduce your total tax bill.
You will get regular monthly income. Most other investments that offer interest or dividends pay out only once or twice a year. As long as your tenants pay on time, you know exactly what income you will have and when you will receive it.
Property values will likely be more stable than the stock market. With stocks, you can buy and sell shares very easily and quickly. So, share prices can fluctuate very wildly. It is not unusual for the share price of a company to change as much as 5 per cent in just one day.
Property owners, on the other hand, tend to view real estate as a longer term investment. It takes longer to buy and sell. Even when market conditions change, you don’t see the overnight market crashes and massive sell outs that you sometimes see in the stock market.
What are the drawbacks of a rental property investment?
You may have to deal with problem tenants. Working with non-paying tenants can be challenging and stressful if cash flow is tight. Of course, you can try to screen your tenants. But it’s not always easy to tell who may one day fall behind on paying rent, damage property or cause other problems.
It may be hard to sell your property later. Real estate is not a liquid investment. That means it can take time to sell, depending on market conditions. It can also be costly to sell due to real estate and legal fees.
It can be hard to finance your purchase. Under Canada’s new mortgage rules, your down payment must equal at least 20 per cent when you buy a second property. You may also need a mortgage. And, you will have high monthly expenses to cover when you own a building. Of course, you hope the income you receive from your tenants will cover this.
To get approved for a mortgage, your “total debt ratio” must fall within lender limits. At the risk of oversimplifying, your “total debt ratio” is generally your total monthly expenses divided by total monthly income from all sources, including rentals.
That sounds simple, but you need the right advice. A borrower’s ability to qualify often depends on how much of the rental income the lender recognizes.
You’d think that if a tenant pays you $1,000 a month, you could add that $1,000 to your income when qualifying for a mortgage. But in many cases, lenders will credit you with only 50 per cent of the rental income you receive, making it harder for you to qualify.
One last thing to keep in mind about debt ratios. Different lenders have different limits. Some lenders let you have a 42 per cent total debt ratio. Most others permit just 40 per cent. That extra 2 per cent can make a big difference , especially for folks with mortgages on multiple properties.
Being a landlord is not for everyone. Rental units need repair – sometimes on an emergency basis. You might find it difficult to keep up. Or, you simply would not want the hassle of dealing with tenants. ou could hire a property manager. But this will reduce your income from the property.
Remember: Buying a rental property is an investment. It’s vital to do your research before you commit your dollars.
Here are a few things to consider before purchasing a rental property.
1. Do you have enough saved for the down payment?
Under Canada's new mortgage rules, you must come up with a down payment of at least 20 per cent for a small rental property holding from one to four units. This rule does not apply to borrowers whose principal residence also includes rental units. You can purchase a secondary home if it is owner or family occupied with only 5% down. Ask your mortgage professional for details.
2. How much income will the property generate?
You will need to do some research into the neighbourhood. What does rent typically cost, and what is the vacancy rate in that area? Don't assume that you will always have a tenant -- according to the Canada Mortgage and Housing Corporation (CMHC), the average vacancy rate in Canada's 35 major centres is 2.5 per cent. To be safe, assume a four or five per cent vacancy rate into your financial projections, and don't forget to calculate potential costs, such as repairs and maintenance.
3. Can you be a successful landlord?
Being a landlord is a second job. It's not just about finding a tenant and letting the money come in every month. Not only do you have to be available to field emergency calls and keep up with maintenance such as routine fixes, yard work and even shovelling snow, but if you rent to the wrong tenant, you might have even bigger problems to deal with, such as non-payment of rent. Hiring a property manager can help, but that will greatly reduce your monthly profit from the property -- and you never want to be in a negative cash-flow situation.
4. How will deductions affect your profits?
By deducting certain expenses from your income, you can reduce the taxes that you owe. Applicable expenses include mortgage interest, property tax, insurance, property management, maintenance and utility bills. You can also deduct any losses from your rental property. If your expenses exceed your rental income, you can subtract your losses from any other source of income you have coming in.
Purchasing a rental property can be a great way to diversify your investment portfolio, but it is a big commitment. Being a landlord is time-consuming, and not for people who are interested in an easy, passive income stream.
Want to learn more? Check out the Canada Revenue Agency's Rental Income Guide, where you can get more information on deductible expenses, and most other issues regarding rental property.
Sources: Globe and Mail
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