Perhaps sparked by reality TV shows or by good-old fashioned advice about buying land (they’re not making it any more), many clients start to consider a second property after they have bought their primary residence.
An investment property can range from a recreational cottage or condo to a piece of raw farmland to a bay in a strip mall, but I’m going to focus on two more common examples today – a single-family house and an apartment-condo that you rent out to residential tenants.
The first thing I will say is that real estate is almost NEVER a good short-term investment. Considering the costs and complications of selling real estate, I would recommend keeping any rental property at least five years.
Typically the longer you keep it, the better it is, since the market generally continues to increase and your mortgage continues to decrease.
It’s important to remember that the biggest benefit of owning a rental property is using someone else’s money (the bank) at a low interest rate. If you have $50,000 burning a hole in your pocket, you could put that $50,000 into the financial markets but if you buy real estate with it instead, you can use it as a downpayment and buy a $250,000 asset. Good luck getting a bank to loan you $200,000 at a reasonable interest rate for you to play the stock market!
If your $50,000 financial investment increases by 10%, you have earned $5,000 but if the real estate market increases by 10%, you have earned $25,000.
However, many condo owners in Calgary have been in a difficult situation over the past decade, with condo prices taking big hits. Compared to how your money could have done in the financial markets over the same time period, many condo owners have taken a big loss. In the example above, if your $50,000 in the financial market goes down by 10%, you’ve lost $5,000, but if the real estate market drops 10%, you’ve lost $25,000 which is in essence 50% of your initial investment.
If you don’t need to sell, these values don’t really mean anything and you can focus on one of the other benefits of rental properties – cash flow.
Some people envision their future selves as landlords with thousands of dollars in profit rolling in every month carefree. This can happen but it takes time and planning. If you keep your rental property for the long haul, add more properties to your portfolio and pay off all the mortgages using the rental income, then you might have a handful of properties each bringing in a couple thousand dollars a month, a nice sum.
But this takes decades to get to and is hardly carefree. Even once the mortgages are paid off, each property takes continued investment to keep both their rental value and their resale value up. It needs to be treated like a business where a percentage of the profits are reinvested into improving the business. There are always toilets that leak, fridges that need to be replaced, new shingles to install. So after your property tax, property insurance, income tax and repairs, that nice sum might be quite a bit lower. And if you don’t want the responsibility of actually fielding the calls about the leaky toilets, you’ll need to pay a manager as well.
Let’s take a look at a couple of examples in today’s Calgary market to see if it’s possible to break even if acquiring a rental property today. Breaking even today should mean cash flow tomorrow as your mortgage decreases and rental rates increase. These are two real life MLS listings right now that are also listed for rent on rentfaster.ca. I allowed for a bit of negotiation room on the purchase price and did not include any utilities since the tenant would pay these in both cases.
Single-family house
Sale listing / Rental listing (just got taken down, sorry!)
Purchase price: $515,000
Mortgage payment with 20% down: $1,739
Property Tax: $269
Property Insurance: $100
Total expenses: $2,108
Rental revenue: $2,200
Condo
Purchase price: $260,000
Mortgage payment with 20% down: $878
Property Tax: $180
Property Insurance: $50
Condo Fee: $568
Total expenses: $1,676
Rental revenue: $1,700
Interestingly both examples worked out to be almost bang on break even. Of course, this doesn’t give you much buffer in case of an unexpected expense and it also doesn’t allow for paying a property manager to take care of the place for you.
There are many nuances to owning a rental property and these are two basic snapshots. I do recommend speaking to your accountant and/or financial advisor if you are considering a rental property to make sure it fits into your long-term financial goals.
The two ways to try and make the above numbers work more in your favour are decreasing the purchase price or increasing the rent. One of the best ways to do this is to spend a bit more on a house that has a legal basement suite. Your rental revenue in the above house example should increase by about $1,000/month while the mortgage payment would only increase by about $200 (for a $50,000 higher purchase price).
For a chat about your own rental property or one you are thinking about buying, drop me a line!
