The Canadian housing market is on fire with prices rising 9.36% in 2020. It’s no wonder many see real estate as an attractive investment.
Despite the Covid-19 pandemic, the Canadian housing market is on fire with prices rising by 9.36% in 2020, marking the twelfth consecutive year of house price growth. With these statistics in mind, it’s no wonder that many see real estate as an attractive investment.
Not only do you benefit from rising property values, but buying investment property can also generate relatively passive rental income that can potentially pay off the new mortgage for you. But there are also a lot of responsibilities that come with being a homeowner.
Before you jump in with both feet, it’s important to align all of your financial efforts, understand what you’re getting yourself into, and do your best to make sure your investment pays off. Here are some tips that should get you on the right track:
Think about financing first
One of the first things you should ask yourself is, can I afford a second property? And how am I going to finance it? In Canada, getting approved for a second mortgage is a bit more complicated than getting approved for your primary mortgage. Typically, mortgage providers will want to make sure that you are able to make mortgage payments on both properties, even if your second property is not leased 100% of the time. As a benchmark, they look for a debt-to-income ratio of 36% or less. To see if you are eligible for a Second property mortgage, your best bet is to hit the base with a mortgage specialist.
Determine your monthly margins
Part of affordability is determining your monthly profit margins. You’ll want to make sure your margins aren’t too tight or that a surprise vacation, for example, can have a big impact on your bottom line. To calculate your monthly margins, also known as monthly cash flows, subtract your monthly expenses from your monthly income.
Your monthly expenses, which include mortgage payments, maintenance, repairs, property taxes, and insurance, should typically be around 40% of the property’s rental income. This means that if you are renting a property for $ 1,200 per month, you should expect and budget for at least $ 480 for operating expenses, which translates to a cash flow of $ 720. Obviously, the greater 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 to determine profitability and answer one of the most important questions: is it a good investment? To find the answer, you’re going to want to take a close look at two main metrics.
The first one, called your capitalization rate, will help you determine the expected rate of return on real estate. It is calculated by dividing your cash flow by the value of the property and multiplying it by 100. The second measure is your cash return which will help you determine the rate of return on your initial investment. It is calculated by dividing your cash flow by your investment multiplied by 100.
In general, a 6% return is considered a very good return in the first year, as that return will likely increase as you pay off your mortgage. One tip for ensuring profitability is the 1% rule, which involves charging rent equal to at least 1% of your property’s value and making sure your monthly mortgage payment is less than that amount.
Get your finances in order
First of all, before you even consider an investment property, you should pay off any existing debt that you may have to increase your chances of getting approved for your second mortgage with a reasonable interest rate. Consolidate all unpaid debts in one place, such as a credit line, is a good way to start this process.
Then make sure you have a decent amount of money. Unlike primary mortgages, you will need at least 20% of the purchase price of your investment property as a down payment, as investment property does not qualify for mortgage loan insurance. And, of course, the more you can put up front, the higher your profit margins will be.
Pick a decent location
As a real estate investor, it’s important to strike the right balance between a good location and affordability. On the one hand, you’ll want to choose an attractive location to avoid having trouble finding tenants. But on the other hand, you don’t want to spend too much that it squeezes your margins or becomes too expensive to manage.
If this is your first real estate investment, it’s usually a good idea to start with something cheaper than your primary residence in a relatively modest neighborhood. When selecting the location, you should also look for some positive characteristics, including proximity to amenities, schools and public transport, high employment rate, rising house prices, low crime and low of vacant properties.
It’s also important to note that if you are considering working with a property management company, you don’t necessarily have to limit yourself to investment property in your own city. Sometimes homes in smaller communities can be much more reasonably priced compared to real estate hot spots in Canada, especially for first-time buyers of investment property.
Don’t buy a top fixer
While minor repairs are manageable, you should probably avoid properties where major renovations are needed. You’ll want to get your tenants in as early as possible so you have cash and avoid lengthy home improvement projects, which can be subject to delays. So while purchasing a repair rod may be a good option for your primary residence, especially for first-time home buyers, it is not necessarily ideal for investment property.
Understand your responsibilities as an owner
Ownership involves many responsibilities. Among other things, landlords must keep a tenant’s accommodation in good condition and habitable and comply with hygiene, safety, housing and maintenance standards.
It can definitely be a plus if you can handle repairs, maintenance and servicing yourself. You should also be ready to take action in an instant. For example, if a tenant’s furnace breaks down, you will need to start repairs as soon as possible.
For a complete list of your landlord’s responsibilities, it is best to consult the Ontario Ministry of Housing and join your local chapter Ontario Homeowners Association. Owning is not for everyone, which is why some decide to use a property management company, even if it reduces their profits.
As with any complicated financial transaction, it is a good idea to get expert advice, who can discuss your secondary mortgage options with you, will tell you exactly what you need to get approved and guide you through your home buying process.