9 Things You Need To Know About Real Estate Investing
We work a LOT with investors both Canadians living overseas and others who are out of province or living just south of our borders. Are you thinking of investing for the first time? Or are you wondering about adding to your existing portfolio? Helping you to navigate through the buying process to make sound and profitable decisions is our favourite part of real estate. Here are 9 things you may want to keep in mind when purchasing an investment property:
1) When buying an investment, it’s always about math – avoid letting emotions lead the way. Flashy hand-scraped hardwood floors and stone countertops are great…before you buy think about: How will much these features add to the monthly rent? Who is your ideal tenant and will they care? Is this property in a location that demands these types of finishes to get top rents?
Real estate investing really comes down to numbers. You will also need to consider other numbers beyond the asking price: How much are the condo fees? How much are the taxes? What kind of maintenance should you expect? Are you going to manage the property yourself? (i.e. collect rents, negotiate leases, emergency calls) or hire a property manager? What are the area rents? An agent experienced in investments will be able to guide you to the profitable ones and encourage you to run from the ones that look great but don’t give the best returns.
2) You’ll likely need a minimum 20% down payment. If the property you’re buying isn’t going to be your primary residence (i.e. defined as the one you live in at least six months/year), then the bank requires you to have a larger downpayment. In most cases, that’s 20% (more if it’s a commercial property).
Using 20% down, your rent should cover the following: mortgage payment (at 80% financed), taxes and condo fees. If you need 30% down for positive cash this is not the right property; keep searching. The numbers have to work, remember?
3) Most lenders will consider 80% of the rental income when calculating what you can afford. The banks decide how much mortgage they want to give you by looking at your income, debts and credit score. If you buy an income property, they will add 80% of the projected rental income to your income, so will qualify for a bigger mortgage. Some lenders will not consider rental from illegal apartments (i.e. apartments that don’t meet Ontario Building and Fire Codes) and may request to see the actual lease or ask for an appraiser to confirm the amount of rental income.
4) If you have a downpayment of more than 20%, chances are high you will qualify for a 30-year amortization on your mortgage. This would definitely keep your mortgage payments low. Remember, you can write off the interest on your mortgage against your rental income at tax time. Example: If you have a $350,000 mortgage at 3% interest rate amortized over 25 years, your mortgage payment would be $1,159 per month. Increase the amortization to 30 years, and your payment decreases to $1,030 per month. That an extra $129 in cash flow each month!
5) A healthy investment property provides you with 4 ways to make money:
- Monthly cash flow – During the time you have a mortgage, your monthly cash flow from the property (cash flow = rent minus expenses) is likely to be minimal. It’s not uncommon in Toronto, to see properties with $50 or $100 cash flow positive per month. There are investors out there making less rent than their expenses (i.e. cash flow negative). Negative cash flow investors are betting on the benefits of appreciation, equity build-up and/or improvements.
- Equity Build-up - Each month, a portion of your mortgage debt is being paid by your tenant while you build up equity in the property. That $350,000 mortgage at 3% interest will have shrunk to $217,000 by the 5th year, to $186,000 by the 10th year, $149,000 by the 15th year, and so on. The difference between what the property is worth and what you owe is called Equity.
- Appreciation – Appreciation is the amount the property increases in value during the time you own it. The real estate market in (specifically Toronto) during the last few years has been on fire, showing 4-5% annual appreciation for condos and 10%+ annual appreciation for houses. Avoid being naive to think that will always be the case. During the overall time you own the property, there will be years of zero growth and others years where prices take a dip. Prepare yourself for this as it is a natural part of the real estate cycle. Property investment must be viewed through a long-term lens. Big picture thinking needed here.
- Improvements – Based on the type of property you purchase (condo vs. detached/semi/freehold town) and how long you intend to keep it, there can opportunity(ies) to renovate and further increase the overall value. Many multi-family investors renovate and improve immediately (for example, they may turn a 3-unit property into four or five units, or make upgrades to existing finishes to invite higher rents). Other investors make the decision to renovate before selling (very common in the condo market). Just be careful: a $60,000 condo renovation may not pay back $60,000, so talk to your REALTOR about which improvements to make before renovating pre-sale.
6) – Often the best cash flow properties are the ones that are appreciating slower than average. When choosing an investment property, you will need to give some serious thought to your overall goals. For example, in Toronto, some condos sell for less per square foot than the average, yet will rent for nearly the same amount of money – so basically you can pay $375,000 for a condo or $425,000 for a condo and get virtually the same rent. There are many reasons why the $350K condo may cost less (location, finishes, quality of the building, supply/demand in the building, etc.) and these factors may impact the resale value of the condo. You will need to decide what’s more important to you: monthly cash flow now or long-term value?
7) The short-term rental market window is closing in Toronto. While renting out properties for a few days or weeks at a time was a cash cow for years, the short-term rental market’s days are numbered in Toronto, at least for serious investors. There are still a few specific buildings left in downtown Toronto that allow short-term rentals less than 30 days. There is a coveted list of current buildings that allow it. Ask you REALTOR for more details.
8) Consider three kinds of taxes when buying an investment property:
- Land Transfer Taxes – There are two types of land transfer taxes: Ontario and Toronto (if you buy in the city of Toronto). Land transfer taxes are paid by the Buyer when they take possession of a property and are a percentage of the sales price.
- Income Tax on the rental income – Rental income is considered taxable. The net profit you make will be added to your income and taxed. You can write off a many expenses to decrease your profit (i.e. mortgage interest, condo fees, property management fees, utilities, etc.).
- Capital Gains taxes – Selling your investment property, will subject you to capital gains taxes. Capital gains taxes are 50% of profit, which means 50% of the profit you make (after selling expenses) is added to your income and taxed at your regular income tax rate.
- Purchase price : $450,000
- Sold price: $550,000
- Costs to sell: $25,000
- Gain in value = $550,000-$450,000- $25,000 = $75,000
Under current the capital gains rules, an investor would pay taxes on 50% of the $75,000 profit. Check with your Tax Advisor or Accountant for more details.
**If you purchase a duplex (a house with two apartments) and live in one of the units, be careful. If you live in less than 50% of the house, you’ll pay capital gains tax on the whole house and lose your primary residence tax exemption. This is one of the most often-missed points, one that could cost you many thousands of dollars. If you rent out more than one-half your house (i.e. declare the income, and write off the expenses), when it is time to sell, the CRA considers it as an investment property and you will have to pay capital gains tax on the increase in value since you bought. Again, speak with your accountant/tax specialist.
Got questions? We have answers, so don’t be afraid to get in touch!
firstname.lastname@example.org / 416-710-7752