Buying An Investment Property
One of the most exciting financial decisions you can make is buying real estate. Whether it’s buying your first home or a retirement property, purchasing real estate can be exhilarating.
Buying your first investment property can be just as thrilling as purchasing a starter home. It can also be a sound financial decision. There are, however, some things to consider before diving into buying a rental property. Understanding these considerations is an important first step to making the move towards owning an investment property.
Whether you’re a novice investor or a seasoned homeowner, we will help answer your most burning questions about buying an investment property. Let’s begin.
What is an investment property?
An investment property is a residence you own but don’t live in purchased as a long-term investment. Also known as an income property, this type of real estate can act as a way to generate a monthly income.
You can turn an investment property into either a vacation rental or a home for short- or long-term tenants. The choice between the two comes down to the type of property you’re looking to buy. Which brings us to our next important question…
What is the best type of investment property?
Buying an investment property is exactly like buying your first home: you never want to buy outside your means. The best type of property to invest in then, therefore, is one you can afford!
Once you’ve established your financial comfort zone, the cost of the property and the rate of return, or the investment potential, should be considered. Then it’s time to determine your target market. Finally, location and the type of property should be factored in to maximize the investment potential of your purchase.
Let’s start with affordability.
Can I afford an investment property?
Before scouring the internet for homes for sale or getting too attached to the HGTV show, Buyers Bootcamp, it’s important to be honest with yourself about your financial situation.
Buying real estate is one of the most capital-heavy purchases a person can make. It requires a decent amount of money up front. Add that to the cost of already owning a home and you have the makings of a serious financial decision.
Here are some questions you should ask yourself to figure out whether or not it’s a good time to grow your property portfolio.
What is my current financial situation?
If you’re considering buying real estate, it’s worth doing a review of your finances to make sure you’re in a sound financial position to do so.
Put your financial health in order. Pay off debts, put aside an emergency fund, and check your credit score before diving into investment property ownership.
Below is an example of an income property purchase in North Eastern Alberta.
The scenario depicts a professional buyer 40-50 years old with existing investments and property equity.
|Annual household income (gross/net)||$100,000/$73,319|
|Monthly household income (net)||$6,110|
|Monthly rental income||$2,000*|
|Total monthly income (net)||$8,110|
|Average Household Expenses||Amount|
|Insurance (home & auto)||$300|
|Cell phone, internet, & video streaming||$200|
|Existing debt repayments (monthly)||$0|
|Total household expenses||$3,300|
|Investment Property Expenses||Amount|
|Down payment (20%)||$70,000|
|Land transfer fees (on property & mortgage)||$190 + $134 = $324|
|Mortgage (80% of purchase price)||$280,000|
|Monthly mortgage (based on a 3% interest rate with a 25 yr amortization)||$1,325|
|Interest cost over 25 years||$117,526|
|Monthly operating expenses (ideally 50% of rental income) broken down as follows:||$1,250**|
|Monthly property tax||$250|
|Monthly condo fees||$250|
|Management fees (10% of rental income)||$250|
|Maintenance & rainy day fund for occasional vacancy (15% of rental income)||$300|
|Total income property expenses||$2,575*|
*The rental income comes to $24,000 per year, while the mortgage payments are $15,900 per year and additional expenses are $15,000 per year. This equals a shortfall of $6,900 annually (or $575 monthly) that would have to be covered by overall monthly income.
Overall income after the buyer’s main household expenses and investment property expenses are taken into account is $2,235. This would cover the monthly shortfall of $575.
**Monthly operating expenses on the income property are more than the recommended 50% in this example.
You can compare mortgage options based on different interest rates and amortizations on the CMHC website.
Qualifying Credit Scores
Your credit score is a number that helps determine your creditworthiness. It gives a lender an idea of the likelihood of you defaulting on a loan.
Credit scores range between 300 and 900. The higher the number, the better your credit score. Scores are calculated using your credit report and take into consideration credit history, the amount of debt you have (including mortgages), and your payment history.
In order to qualify for a second mortgage, a score of 700 or higher is best. Anything else will make you appear undesirable to a lender.
How much should I invest into an investment property?
Once you’ve established you’re in good financial health, you can go about crunching the numbers to see what you can afford.
Some investors recommend you base affordability on how much a property can earn in rent. Specifically, they advise spending no more than 100x the monthly rent on an investment property.
For example, if you’re looking to buy a $250,000 condo, make sure you can rent it for at least $2,500 a month. This is a conservative approach, one that will help keep costs manageable.
How much will buying an investment property cost?
Now it’s time to figure out whether or not you have the capital, time, and willingness to buy, maintain, and manage an income property.
Buying an investment property in Alberta can vary widely depending on the type of property and the location. For example, in the North Eastern Alberta Market the cost of a detached home in St. Paul will run you anywhere from $120,000 to $480,000 (as of October 2021).
How can I finance an investment property?
You can purchase an income property using a variety of means including but not limited to:
- Line of Credit
- Home Equity Line of Credit (HELOC)
- Home Equity Loan (HEL)
- Cash Purchase
Using a HELOC to buy an investment property in Canada
If you already own real estate (your home), you’ve likely paid off a portion of your first mortgage. You could then use the equity you have in this property to finance your second home. This is what’s called using a Home Equity Line of Credit (HELOC), one of the best and most popular options for purchasing an investment property.
Whether you purchase your second home entirely on your HELOC or leverage your HELOC for your down payment, this will depend on what you can afford.
The benefits of using home equity versus paying in cash include tax deductions and low borrowing rates. It’s important to talk to a professional about your options to ensure you haven’t left any stone unturned
Keep in mind that no matter how you plan on obtaining a mortgage for your investment property, you will need to secure a down payment before going too far down the real estate path.
The down payment
Most second mortgages in Canada require a 20% down payment. For a property with a ticket price of $250,000, this would mean starting costs of $50,000; not chump change.
Here is a quick reference guide to help determine what you’ll need as a down payment:
|Purchase Price||Down Payment Amount (20%)||Mortgage Amount|
The quick math: For every $50k of your purchase price, expect to pay $10k in down payment.
Can you use CMHC to purchase investment or income properties?
In short, yes you can use CMHC to purchase income properties, however it falls under similar guidelines to most financial institutions. You would need 20% of minimum equity to invest into the property prior to obtaining a guaranteed mortgage with CMHC, with a maximum purchase price of $1,000,000.
Additional costs to owning rental property
On top of the down payment, there are other costs associated with buying an investment property.
- Do you have extra money set aside for closing costs? Add another 1.5% of the purchase price to cover things like lawyer and land transfer fees.
- Can you rent out the property for enough money to cover its operating costs (mortgage, property taxes, condo fees, insurance, etc.)?
- Will rental income from the property cover the costs of ownership? You ideally want to look for a property with a positive cash flow or be in a position to carry the weight of one with a negative one.
- Can you carry the cost of the mortgage if the property stays vacant for a while?
- Can you afford to take on regular maintenance costs? A good rule of thumb is to set aside 15% of rental income for ongoing maintenance and a vacancy rainy day.
- Can you cover sudden unsuspected repair costs or a cash call? Experts recommend having a reserve for these expenses.
- Does the property require maintenance and improvements before renting it?
Maintenance of your investment property
Depending on the type of investment property, it will require a certain amount of time and energy to maintain. There is managing the monthly rent. There will be questions from tenants that will need attention. There will be sudden maintenance issues that require addressing. Not all of us are Holmes on Homes. Be honest with yourself about how much you can take on as an income property owner.
Who will manage the property?
One option is to hire a property management company to handle the day-to-day operations. This is especially true if you’re looking to buy real estate in a location far from where you live. We’ll discuss this more in the section on location.
There are a lot of perks to outsourcing the responsibility to someone else. If you choose to go this route, except to pay anywhere between 6-12% of the total rental cost to cover management fees.
Know your target audience
Your target audience will be the one with the right demographics, including age, interests, and annual income, that you want to attract to your income property. A single professional working long hours has a very different lifestyle than a young couple on Spring Break looking to rent a vacation spot.
We recommend you take the time to decide what type of person you are looking to rent to. Are you hoping to cater to vacation renters or do you want the consistency of a short- or long-term tenant? Would you be open to having kids and pets into your property, or would you prefer adults with only two legs?
Where should I buy an investment property?
Once you’ve determined your target market, it’s time to pick a location. We’ve all heard the old adage that location is key when it comes to real estate. The same is true for an income property.
When looking to buy an investment property, spend the time to find one in a location that will increase the odds of it becoming a good long-term investment.
We’re happy to report that investing in Canadian real estate is always a solid choice. Our relatively non volatile markets and high standard of living make purchasing property in Canada a safe choice.
Location, location, location
We encourage you to think outside the box when picking a location for your investment property. The ideal spot may be one that’s less popular (read: more affordable with a stronger potential for return on investment) and further from where you currently live.
Consider whether the location of the property is better suited for a vacation property or as a long-term rental. If yours is the next big AirBnB hot spot, choose a location known for its tourism.
Rural Airbnb bookings are surging as more people travel in-country. This holds true for Alberta & across Canada as well. Those city get-aways are becoming even hotter to get out of Edmonton and Calgary and head somewhere more peaceful and try to escape the city lockdowns of COVID-19.
If you’re aiming to attract tenants, look for locations that have a viable economy, employment opportunities, and that offer a good quality of life. And consider that if the rental market crashes, can the property be quickly transformed from one with tenants into one for vacation stays?
Put yourself in your renters shoes
Our recommendation is to buy an investment property that you, yourself, would want to live or vacation in. What features would you most like to have in a home or rental? Parking, ease of access to public transport, walkability, and proximity to stores and restaurants may be features most coveted by tenants. Solitude, quietness, and the ability to unplug may be what vacationers are looking for.
And don’t forget about curb appeal! You want your investment property to draw people in, not repeal them away because it looks more shabby than chic.
What are the different types of investment properties?
A cottage, a single family home, and a condo can all act as the perfect investment property. Condos can be an excellent choice for the simple fact they tend to be budget-friendly and require less maintenance. Watch out for condo fees though. They can quickly turn a viable option into one that will break an investor’s bank.
Ultimately, knowing what type of property to choose depends on where you intend to buy and who you intend to rent to.
The right type of property
An important quality to look for in a property, and one that can be overlooked, is whether it has appreciation potential. Look for real estate that will likely increase in value over time. There’s no point in buying an investment property if down the road it’ll be worth less than what you paid for it.
Is it a good time to buy?
You may have decided you’re ready to be a property mogul but the current market may disagree. It pays, literally, to do your research to find the best place to invest in an income property.
An online search of reputable sources and working with a well-respected real estate agent will help you hone in on the best place to buy.
The good news is the demand for housing throughout major cities in Canada has boomed during the COVID-19 pandemic. Now may be the very best time to take the plunge into investment property ownership.
Seek the advice of an expert
At the end of the day, we always recommend seeking expert advice when buying an investment property. A real estate professional will guide you through every step of the process and help you to find answers to questions you didn’t know to ask.
Buying an investment property is a huge financial and life step. It deserves as much the time and attention you gave to buying your first home, if not more so.
Disclaimer: All the figures mentioned in this article are only examples based on estimates.
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