For the longest time, ‘ordinary’ folks and individual investors who can’t stomach the ups and downs of the stock market or who don’t care much for the low performance of GICs and government bonds have chosen to invest in an investment or rental property (or two, or twelve…).
Today’s red-hot real estate market, where the value of a property can rise by 10% or more in less than a year, will do nothing to diminish the popularity of this investment vehicle.
However, real estate investment is not everybody’s cup of tea. One must not take this decision lightly. For every success story you hear about on a reality show or in The Globe and Mail, there are thousands of nightmare stories of folks who lost everything.
So, before buying a multiplex and interviewing potential tenants, here are a few things you should know.
Investing in a property does not mean that you must find yourself a new place to live. You may very well choose to live in a bungalow and rent out the basement unit. Maybe you will opt for a duplex or triplex where you will occupy a space and rent out the other units.
Should you decide to go down this road, keep these 3 items in mind:
- Get a better rate: the CMHC is the only Canadian provider of mortgage loan insurance for multi-unit residential properties. If you don’t have the minimum 20% down payment, you must purchase mortgage loan insurance. This gives a lender additional protection, which leads to access to better mortgage rates for you.
- Down payment rules: the minimum down payment for owner-occupied properties is equal to 5% of the first $500,000, plus 10% of any amount over $500,000. If you are buying a property for $600,000, your minimum down payment will be $35,000.
- Tax implications: as a landlord, you can claim certain expenses you incur from your income taxes. If you occupy your rental property, you can claim the amount of your expenses that relate to the rented area of your building. For example, if the living area you occupy is equivalent to 50% of the entire building, you can only claim 50% of your expenses.
If living in close proximity to your tenants is not your thing, you could always purchase a second property where you will live.
A mortgage on a second property CAN NOT be insured by the CMHC. Which means you MUST have a minimum of 20% of your purchase cost as a down payment. In the case of the $600,000 property used in the preceding example, we’re talking about a down payment of $120,000.
Some smaller lenders do not offer investment property mortgages if the owner does not occupy one of the units. If you do find a smaller lender willing to offer a mortgage in this situation, you can expect to pay a small premium on the mortgage rate.
You can also expect to pay a premium on your landlord insurance if you don’t occupy the property you are renting. Why? Because when the cat’s away, the mice will play.
If you’re not there to keep an eye on your tenants, it’s more likely that they will take certain risks and liberties with your property. It’s just the natural order of things, in the eyes of insurance companies, at least. To them, this increases the risk of claims for fire, vandalism, or even theft. The cost of this elevated risk is passed on to you.
Impact On Your Income Taxes
One of the important financial aspects of investing in real estate is the impact on your income taxes.
As the owner of a rental property, you can deduct certain expenses from your income, which reduces the amount of taxes you owe the government. These expenses include: interest paid on your mortgage; property taxes; insurance; maintenance and upgrade costs; property management (i.e. hiring a property manager and/or maintenance worker); utility bills, if they are included in the rent.
Furthermore, do keep in mind that 100% of your rental income will be considered taxable income. If, during any given year, your expenses exceed your rental income, these losses are also deductible.
Mortgaging a Rental Property
One very important fact to keep in mind is that writing off as much rental expenses as possible on your tax return could be severely limiting your borrowing power.
If you already own a rental property, and you shop for a new mortgage on another property (rental or not), lenders consider this as a risk. An existing mortgage payment, property taxes, condo fees, and utilities costs are all considered as liabilities by potential lenders.
In order to reduce that risk to the lender, you must show them your tax returns to prove that you have positive cash flow. In most cases, the uncertain and volatile nature of rental income (renters often come and go) could negatively impact your borrowing power, even if you have positive rental property cash flow.
Because of this, it is very important that you always declare all rental income in your tax returns and that you never exaggerate expenses and/or losses.
This is definitely a case where honesty goes a long way. (See: What to Know Before Buying a Rental Property)
A Smart Investment, If You’re Smart About It
Investing in real estate can be a veritable boon. A study conducted in 16 countries by economists has shown that, over a period of 145 years (1870-2015), the housing market has outperformed the stock market in terms of annual return. Of course, success is not guaranteed. Far from it. There are too many factors at play.
But if you handle this investment wisely and make sure you have most (if not all) the bases covered, it can be a very profitable venture!