12 tips for buying an investment property in Canada
Buying an investment property can be incredibly rewarding. It can also be a huge headache if you don’t go about it the right way. Keep reading for some tips on how to buy a rental property the right way.
#1. Think about financing early
Canadian banks are very conservative when it comes to issuing mortgages for rental property investment. You’ll want to think about financing fairly early on to account for the likelihood that getting approved won’t be as easy as it was for your primary residence.
Prime lenders will typically want to see that you’re capable of making mortgage payments on both your primary residence and investment property without your debt-to-income ratio surpassing the 36% mark.
Crucially, they’ll want you to have this capability even without your investment property’s rental income. After all, your property may not be rented 100% of the time. Lenders will want to make sure the vacancy won’t leave you unable to make your payments.
You’ll also need a very strong credit history in order to qualify for a mortgage on an investment property.
Truth be told, those new to real estate investment often don’t meet these stringent criteria, making it next to impossible to get a loan from one of Canada’s big five banks. If you have a substantial portion of your primary residence paid off, consider applying for a home equity loan, which is much easier to get than an investment property mortgage. Click here to read more about how home equity loans for rental property investment work.
#2. Avoid a fixer-upper for your first investment property
Buying an investment property will be stressful enough without the hassle of renovations. Unless you have a professional background in home renovation and can easily gauge the time and effort that will be involved in the project before you buy, avoid a fixer-upper for your first investment property.
If you ignore this advice, it’s very likely you’ll end up overpaying for a renovation that takes much longer than you expect. Avoid this by purchasing a property that’s in good condition. Save the fixer-uppers for once you’re more experienced.
#3. Account for operating expenses
Generally, a rental property’s operating expenses comprise 50% of its income. In other words, if you rent a property out for $1,500 per month, expect to spend roughly $750 of that on operating expenses.
That may sound like a lot, especially since you likely don’t spend anywhere near that amount of money maintaining your own home. However, operating expenses include not just maintenance, but also taxes and insurance unique to owning a rental property.
Remember to keep these figures in mind when shopping for a rental property.
#4. Expect the unexpected
Your investment property costs won’t be limited to relatively predictable things like taxes and maintenance. You’ll also need to prepare financially for unexpected circumstances, such as your tenant losing their job and being unable to cover rent.
It’s generally recommended that you plan to set aside a certain portion of your rental income each month to account for potential unexpected expenses.
#5. Choose the neighbourhood wisely
When shopping for your primary residence, you probably chose the nicest neighbourhood you could afford. The problem with applying this logic to your search for a rental property is that a more expensive home will, of course, cost more to insure and maintain.
Instead, experts generally recommend looking for a cheaper property in a modest neighbourhood.
Additionally, when choosing a neighbourhood, look for one that:
- has a high percentage of employment (anything below 50% is low)
- is not governed by a homeowner’s association (fees and restrictions will absolutely decimate your profit margins)
- has a relatively low crime rate
- has very few vacant properties
- is located near amenities such as highly-rated schools
#6. Figure out your margins
While it’s safe to say that – barring any major mistakes – you’ll make money investing in a hot real estate market like Canada’s, it’s important to calculate your margins carefully to avoid any surprises. By doing this before you purchase a property, you’ll give yourself enough flexibility to change tactics if needed.
There are three very important metrics that can help you determine your margins:
- cash flow: your monthly rental income, minus expenses
- cap rate: (cash flow / property value) x 100
- cash on cash return: (cash flow / your cash investment) x 100
You should also consider the 1% rule, which involves aiming to charge rent equivalent to no less than 1% of your property’s value. Then, you’ll need to find a monthly mortgage payment less than that amount. By doing so, you’ll increase your chances of profitability.
#7. Research your legal obligations as a landlord
Most Canadian provinces have very strict tenant protection laws that can impact your profitability. For example, evicting a tenant in Ontario involves a fairly long process, even if the renter in question isn’t paying.
You also need to be aware that the onus for property maintenance is on you as the landlord. If an appliance breaks down, for example, you’ll need to pay for repairs or a replacement. In many Canadian provinces (including Ontario, per its Residential Tenancies Act), this applies even if you state otherwise in your lease agreement.
#8. Consider working with a property management company
If your job or other obligations are demanding, you’d be wise to work with a management company that can offer guidance regarding how to buy an investment property. Property management companies handle a wide variety of things for you, including:
- collecting rent
- addressing maintenance concerns
- maintaining records
Of course, this comes at an additional cost to you. Expect to pay between 5% and 10% of your rental income to a property management company.
#9. Don’t limit yourself location-wise
You don’t necessarily need to buy a rental property in your own city or even province. There are plenty of great deals to be had outside of Canadian real estate hot spots like Ontario and British Columbia; in Nova Scotia, for example, houses cost an average of $267,500. This is a much more feasible investment for many Canadians than, say, the average Ontario home price of $648,100.
Purchasing a property far away from where you live makes the most sense if you plan on working with a property management company. They’ll be able to keep an eye on your investment and offer peace of mind.
#10. Think long-term
Real estate valuations rise over the long haul. Don’t discount the possibility of short-term turmoil, though. You can mitigate the impact of this turmoil by viewing your real estate investment as a long-term play. The longer you own the property, the more likely you are to benefit from positive trends in the Canadian real estate market (generally speaking, properties here won’t get any cheaper as the country’s population continues to grow).
#11. Look for a low-interest mortgage
Another way to increase your likelihood of turning a profit is by looking for a low-interest mortgage. This is easier said than done since banks usually charge much higher interest rates to account for the greater risk associated with real estate investors. However, even just a couple percentage points can make a huge difference when it applies to the large amounts of money associated with properties in Canada.
Visit this page to learn more about how our interest rates compare to those of other lenders in Canada.
#12. Take care of personal debt before you buy
To increase your chances of getting a good mortgage with a reasonable interest rate, take care of your personal debt. Specifically, if your debt-to-income ratio is above the 36% mark (or dangerously close), you’ll need to address that.
There are many ways to approach this, including getting a debt consolidation loan.
Frequently asked questions
Between rising property valuations and the potential to earn regular monthly rental income, an investment property can generate tremendous returns. As long as you’re confident about investing in an illiquid asset for the long haul and your ability to make the right property selection, it’s a very hard asset class to beat.
If you don’t have any cash on hand, you can still purchase an investment property by tapping into your primary residence’s equity.
You should consider yourself fortunate to generate a monthly profit of $200 or more from your investment property. This means you’re able to cover your expenses (i.e. your mortgage) yet still get ahead.
There are two ways to generate profit from a rental property. The first is by holding the property long enough to see a meaningful appreciation in its value. The second is by renting it out.
The 50% rule in real estate involves assuming your expenses will eat up half of your gross income from your rental property. The rule is based on the typical experiences of real estate investors.
The 70% rule helps real estate investors calculate the maximum price they can pay for a rental property that needs repairs. It involves estimating the after repair value (ARV) and setting a target purchase price representing no more than 70% of that amount.
Contact Alpine Credits to secure your investment property mortgage today
If you’re ready to jump into the highly rewarding world of real estate investing, contact Alpine Credits today. We can help you secure an affordable mortgage by tapping into your existing property’s equity.
At Alpine Credits, Homeowners Get Approved.
Call (1-800-587-2161) to find out how you can subscribe for RESP through your home equity.