TOP TIPS FOR BUYING AN INVESTMENT PROPERTY
Despite the Covid-19 pandemic, the Canadian housing market as been on fire with prices rising by 9.36% during 2020, marking the twelfth straight year of housing price growth. With those statistics in mind, it’s no wonder that many are considering real estate as an attractive investment.
Not only do you benefit from rising property values but buying an investment property can also yield a relatively passive rental income that can potentially pay the new mortgage off for you. But there are also a lot of responsibilities that come with being a landlord.
Before you jump in with both feet, it’s important to get all your financial ducks in a row, understand what you are getting into and try your best to ensure that your investment is going to pay off. Here are a few the top tips that should set you on the right path:
THINK ABOUT FINANCING FIRST
One of the first things you should ask yourself is: Can I afford a second property? And, how will I finance it? In Canada, getting approval for a second property mortgage is a little more complicated than getting approval for your primary mortgage. Typically, mortgage providers will want to ensure you’re capable of making mortgage payments on both properties, even if your second property isn’t rented 100% of the time. As a benchmark, they look for a debt-to-income ratio of 36% or lower. To see if you qualify for a Second Property Mortgage, your best bet is to touch base with a mortgage specialist.
DETERMINE YOUR MONTHLY MARGINS
Figuring out your monthly profit margins goes part and parcel with affordability. You’ll want to make sure your margins aren’t too tight or a surprise vacancy, for example, can have a big impact on your bottom line. To figure out your monthly margins, also referred to as your monthly cash flow, subtract your monthly expenses from your monthly income.
Your monthly expenses, which include mortgage payments, maintenance, repairs, property taxes and insurance, should generally be approximately 40% of the property’s rental income. That means, if you rent out a property for $1,200 per month, you should expect and budget at least $480 for operating expenses, resulting in a cash flow of $720. Obviously, the larger your cash flow, the more profitable and stable your investment property will be.
TRY TO ENSURE PROFITABILITY
Now that you have an idea of your monthly cash flow, the next step is determining profitability and answering one of the most important questions: is this a good investment? To find the answer, you’re going to want to take a close look at two major metrics.
The first, called your capitalization rate, will help you determine the rate of return a property is expected to generate. It’s calculated by dividing your cash flow by the property value and multiplying by 100. The second metric is your cash-on-cash return which will help you determine the rate of return on your initial investment. It’s calculated by dividing your cash flow by your investment multiplied by 100.
In general, a 6% return is considered a very healthy return in the first year, as this return will likely grow as you pay down your mortgage. One tip to help ensure profitability is the 1% Rule, which involves charging rent equivalent to no less than 1% of your properties value and ensuring your monthly mortgage payment is less than that amount.
GET YOUR FINANCES IN ORDER
First and foremost, before you even consider an investment property, you should pay down any existing debts you might have to increase your chances of getting your second property mortgage approved with a reasonable interest rate. Consolidating any outstanding debts in one place, like a line-of-credit, is a good way to start this process.
Next, make sure you have a decent sized amount of money set aside. Unlike primary mortgages, you’ll need at least 20% of the purchase price of your investment property as a down payment because investment properties are not eligible for mortgage default insurance. And, of course, the more you can put down up front, the higher your profit margins will be.
CHOOSE A DECENT LOCATION
As a real estate investor, it’s important to strike a fine balance between a good location and affordability. On one hand, you’ll want to choose an attractive location to avoid trouble finding renters. But on the other, you don’t want to spend too much that it cuts into your margins or becomes too expensive to manage.
If it’s your first investment property, it’s usually a good idea to start with a less expensive property than your primary residence in a relatively modest neighbourhood. When selecting the location, you should also seek out certain positive characteristics, including proximity to amenities, schools and public transit, high employment, rising housing prices, low crime and few vacant properties.
It’s also important to note, that if you plan on working with a property management company, you don’t necessarily have to limit yourself to investment properties in your own city. Sometimes houses in smaller communities can be much more reasonably priced compared to Canadian real estate hot spots, especially for first time investment property buyers.
DON’T BUY A FIXER UPPER
While minor repairs are manageable, you should likely avoid properties where major renovations are required. You’ll want to get your tenants in as soon as possible so you have money coming in and avoid long, drawn out home improvement projects, which can be prone to delays. So, while buying a fixer upper might be a good option for your primary residence, especially for first-time homebuyers, it’s not necessarily ideal for an investment property.
UNDERSTAND YOUR RESPONSIBILITIES AS A LANDLORD
Being a landlord comes with a lot of responsibilities. Among other things, landlords must maintain a tenant’s home in a good state of repair and fit for habitation and comply with health, safety, housing and maintenance standards.
It can definitely be an asset if you can handle the repairs, maintenance and upkeep yourself. You also should be prepared to jump into action in a moment’s notice. For example, if a tenant’s furnace breaks down, you will have to get the repairs started as soon as possible.
For a full list of your landlord responsibilities, it’s best to consult the Ontario Ministry of Housing and join your local Ontario Landlord Association. Being a landlord isn’t for everyone, which is why some decide to go with a property management firm, even though it cuts into their profits.
As with any complicated financial transaction, it is a good idea to get advice from an expert, who can discuss your second property mortgage options with you, tell you exactly what you need to get approved and help guide you on your homebuying journey.