Your rental property’s monthly cash flow is important, but that’s not all

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Becoming a real estate investor in Canada can seem like a surefire shortcut to wealth.

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While this has been the case for many, few people become successful real estate investors simply by buying the properties they can afford and assuming the rent will do all the work.

A recent analysis found that, from January 2020 to May 2021, almost all homes purchased in Toronto would lose money for their owners in the rental market. Research has shown that real estate investors in Montreal often lose money on a monthly basis .

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Choosing the right property to invest in requires careful thought. You should examine the surrounding neighborhood to understand the appeal it offers to residents, take a look at the local economy to ensure it is supporting long-term housing demand, and value the property itself. in terms of profitability.

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And one of the most important steps is calculating cash flow, the amount of money the property will make or lose each month.

If this is the first time you’ve come across the term “cash flow,” don’t worry. Calculating it is quite easy.

Monthly income is not everything

Although ideal, a positive cash flow is not necessary for a real estate investment to ultimately be considered a success. A home with negative cash flow can still be a winner in the long run – if it goes up in value over time, as it usually does with real estate in Canada, and if you can afford the monthly cost.

“Most people, and especially newbie investors, believe that successful investing is all about cash flow and that there really isn’t anything else that matters. But real gains in real estate come from taking the long view,” says Tom Karadza of Rock Star Real Estate in Oakville, Ontario.

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Either way, determining what a property will earn (or cost) you each month is key to helping you understand if an investment property fits your budget or overall investment plan.

The cash formula

The first thing to do is to determine the gross income of the property. Based on the condition of the home and local rental values, how much will you realistically bring in rental income each month?

Once you have that number, it’s time to add up your monthly expenses and subtract them from the gross income. Taxes, maintenance fees, and property management fees should all be included here, as should utilities if your tenants aren’t paying them.

This part of the equation can be tricky for inexperienced investors, who may not know what to book for maintenance and management.

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Monika Jazyk, an Ontario-based real estate investor and founder of Real Property Investments, says she typically subtracts 5% from monthly rent for maintenance and 8% for property management. If you don’t hire a professional property management company, you can skip this expense.

Jazyk says investors also need to consider the cost of vacancies. She suggests basing that number on your local market vacancy rate and subtracting that amount from your gross income. So if your local market has a vacancy rate of 5%, you would subtract 5% from the gross income.

“There are times when it might suck because there’s so much demand for housing, but you’ll have times during your holding period when tenants leave, so you should always put that number in anyway,” she says. “I always do three percent.”

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Finally, subtract your monthly mortgage payments from your gross income. What’s left will give you a clear idea of ​​what your monthly cash flow will be.

An example

Let’s look at the numbers for a single family home in Toronto that has been appraised at $1 million. Tenants pay all utilities and you will manage the property yourself, so there is no need to factor in these costs.

  • Monthly rental income: $4,000
  • Monthly expenses: $509 (taxes), $200 (maintenance), $120 (vacation)
  • Mortgage cost: $3,501 ($800,000 principal, amortization over 25 years, fixed rate of 2.29% over five years)

This particular property would have a negative cash flow of $330. For Toronto, around now, that’s not bad.

If that’s not enough, it’s possible to improve a property’s cash flow. Working with your mortgage broker to get a lower interest rate will make a difference, as will adding a second rental unit, renting garage space, or even putting up billboards on your property, if those are options.

But you won’t be able to find solutions to your cash flow problems until you know how to identify them correctly. Make sure you know how much you earn or lose each month.

This article provides information only and should not be construed as advice. It is provided without warranty of any kind.

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