The Basics of Investing in Real Estate
Getting a mortgage for a second property isn’t as easy as borrowing for your primary residence – you’ll need at least 20% of the purchase price for a down payment, and only a portion of the income you get from rent will be considered in qualifying you for a mortgage (usually 80%). For commercial properties, you’ll likely need a down payment of 50%.
In Canada, any money collected from rent is considered income, and thus subject to regular taxation. Increases in the value of your investment property (from the time it becomes an investment property to the time you sell it) will be subject to capital gains taxes. If you’re thinking of buying an investment property, make sure to talk to your accountant to fully understand the tax implications.
Most real estate investments should have longer-term objectives. Because of the unpredictability of the real estate market, expecting to profit in a short period of time is risky.
What are your investment goals? There are three ways to make (or lose) money by investing in Toronto real estate:
- Cash flow (cash return) – Cash flow is the difference between what you collect in rent and the expenses you pay out. In Toronto, cash flow positive properties (purchased with 20% downpayment) are hard to come by, though it’s fairly common for investors to break-even on a monthly basis (meaning that the rent they collect is equal to the expenses they pay). Cash flow is affected by factors outside of the real estate market, for example, it depends on your downpayment and mortgage terms.
- Appreciation – When you a sell your investment property for more than you paid, that’s called appreciation. For example: you buy a triplex for $1,000,000 and later sell it for $1,300,000, that $300,000 difference is the appreciation in the value of your investment. Toronto properties have historically appreciated favourably for investors.
- Equity (mortgage paydown) – When a tenant pays down your mortgage, you’re building equity. For example: you buy a property for $400,000 with an $80,000 downpayment and you apply the rent to the mortgage and rent it for 25 years. Eventually, you will have a mortgage-free property. When you then sell that property for $450,000, you’ll have built up $370,000 in equity (and you’ll get your original investment of $80,000 back).
Return on Investment (ROI)
Investors use different calculations and tools to calculate the returns on their real estate investments:
Cash flow is the net amount of cash moving in and out of an investment
Calculation: Income – operating expenses – financing costs
Capitalization Rate (cap rate) is the rate of return on a real estate investment property based on the income that the property is expected to generate. Operating Income / Purchase Price
Calculation: Operating Income / Purchase Price
Return on Investment (ROI) – a performance measure used to evaluate the efficiency of an investment or to compare the efficiency of a number of different investments
Calculated by adding the cash return, mortgage pay down and appreciation.
There are many tools out there to help you predict the ROI of investment properties (and of course, the BREL team has a proprietary Income Analysis tool for our clients).
Option 1: Investment Condos
Ever wonder who’s buying all the condos you see changing Toronto’s landscape? Investors. Here’s why:
- A good investment condo will break even (or be cash positive) with a 20% down payment (which you require for a mortgage anyway).
- Opportunity for both cash flow and appreciation in value over time
- The rental market is at an all-time low for vacancies, so finding a good tenant should be easy
- Generally less maintenance/repair work than being the landlord of a house
- Unique condos in good locations have historically appreciated more than the stock market
- Lots of obligations and little flexibility due to the Residential Tenancies Act.
- Works best as a long-term strategy
Option 2: Income Properties
Income properties–houses that have self-contained apartments that are rented out–are HOT, HOT commodities in Toronto.
- Having a basement apartment that you can rent out just might make the difference between affording the home of your dreams and not. At current interest rates, $1,000 in rent can cover over $200,000 in mortgage!
- Historically, houses have appreciated faster than condos, so if you’re looking to make money when you sell, then an income property may be a safer bet.
- With a 20% down payment on a multi-residential house, you should be able to break even (or ideally be cash positive)
- If you’re living in the other upstairs (or downstairs) apartment yourself, you’ll need to cope with the noises and smells of your tenant
- Landlord headaches: repairs, renovations, tenants that don’t pay their rent.
- Having tenants in leases may make it harder to sell your home when the time comes
Option 3: Flipping
While it isn’t as popular as it was a few years ago, flipping houses (in other words, buying a rundown house and renovating it for profit in under a year) happens every day in Toronto. It isn’t for the faint of heart – but it can be hugely profitable.
- A proper quality flip in a good neighbourhood will be in high demand (many of today’s buyers want the fully done-up house)
- Cash! There are certainly lots of examples of houses bought for $600,000, renovated for $150,000 and sold for $1,000,000
- Renovations always take longer and cost more than you expected. With a flip, every dollar spent and every month where you have to pay a mortgage counts.
- No matter what HGTV tries to tell us, flipping for profit isn’t easy – it takes a lot of time and can be a risky venture for someone who isn’t a contractor or tradesperson
- There are just as many examples of houses bought for $600,000, renovated for $150,000 and sold for $725,000.
If you’re considering buying a home to flip it, make sure you’re working with a REALTOR, who knows the game and can make sure you buy the right property, put the right amount of money into it for the neighbourhood and sell it at the right time.
Option 4: Mixed Use Properties
Many investors turn to Toronto’s mixed-use properties for their ROI. MMixed-useproperties have both a residential and a commercial component and if purchased in up-and-coming neighbourhoods, can be an excellent investment. Note: the financing and buying process are very different than the standard resale residential market so make sure you hire a REALTOR experienced in selling these types of properties.
Option 5: New Construction
This used to be the number one way investors made money in Toronto’s real estate market – buying condominiums during the pre-construction phase and selling them when they were built (often up to 5 years later).
- Prime choice of units and location, as you aren’t at the mercy of what happens to be on the market
- Currently, it’s cheaper to buy a resale condominium
- Builders may cancel projects, tying up your downpayment for years