Tips when investing in rental property

Residential real estate has been called one of the safest assets and is considered part of a balanced portfolio. That’s because when markets are down, you can hold with little risk, as long as your carrying costs are manageable. When markets rise, you can make solid returns.

Still, there are considerations, especially if you intend to rent out the property. To get approved for a mortgage, you must put 20% down. The maximum loan to value ratio can’t surpass 80%, says Jason John, a CIBC mobile mortgage advisor.

And while a broker will also consider your credit score and income sources, the cash flow from the rental property and market value of the underlying collateral are the key factors. “We also look at actual rents versus market rents and whether [you have] other rentals,” explains John. “We want to ensure the rental income from the property will service the mortgage.”

But the biggest challenge? Tenants.

So consider not just the quantitative side of the investment (e.g. financing and the rate of return), but also the qualitative side, says Amy Dietz, investment advisor, BMO Nesbitt Burns in Toronto. After going through her clients’ plans and ensuring they can afford to invest, she’ll ask if they’re ready to dedicate necessary time to deal with tenants.

“Our clients have had situations where the furnace breaks down in the middle of February and the tenant has a new baby,” says Dietz. “You have to have someone fix it immediately, and have the emergency expenses to cover sudden repairs.”

And while hiring a property manager can offload daily oversight of tenants, it’ll also eat into an owner’s monthly rental income — between 5% and 25%, depending on the location and property. This option is typically used by more seasoned investors who own dozens of rental properties.

But if you’re a new investor, you should be able to manage a single property on your own, as long as you pick the right tenant (someone who pays rent on time and doesn’t abuse the property), says Abrar Beg, sales representative at RE/MAX Rouge River Realty Ltd. in Pickering, Ont.

“Unfortunately, the laws in Canada don’t protect the landlord as much as the tenant,” he says. “If the tenant doesn’t pay, she’s entitled to stay for at least three months before having to vacate.”

And, during that eviction process, the landlord is still responsible for making mortgage and property tax payments. “So have a cash-flow buffer to account for non-payment by the tenant,” says Beg.

John agrees. “[You] should have at least three months mortgage payments in savings to cover their property expenses, including taxes and heating.”

When interviewing potential tenants, Beg suggests checking credit and job status by asking for a pay stub, an Equifax or Transunion report, and references. And it’s important to call previous landlords to see if there’s a history of not paying rent or doing damage.

New development or resale?

Finding the right property is also important. First, determine if you’re interested in short-term capital gains, or long-term cash flow.

“If short-term, I’d guide him towards new development areas, possibly even through the builder,” says Beg. “This way, he can get appreciation on the property value as the neighbourhood develops.”

If it’s a residential, freehold property (detached, semi or townhouse) through the builder, the typical possession date is usually 1.5 years. If it’s a condo, he says, the possession date could be three or four years. During this time, the property usually appreciates.

But if you’re looking for long-term tenants, Beg suggests a resale property that allows for multi-income revenue (e.g. renting out the top floors and basement to different tenants).

For instance, Beg bought his first investment property in Pickering, Ont. in July 2012 for $352,000. It has three bedrooms upstairs, and a one-bedroom basement apartment. His total gross monthly income is $2,600, for a positive cash flow of more than $600 after paying the mortgage, property taxes, insurance, and other expenses. And, today, it’s worth $500,000.

Meanwhile, one of Dietz’s clients is a handy couple who wanted a fixer-upper close to their home in Orangeville, Ont.

“Initially they were looking at student housing but realized they wanted longer-term tenants with less turnover,” she says.

They purchased a detached home in July 2010 for $214,000; and spent $65,000 on renovations, including fixing the leaky roof, updating the kitchen and bathrooms, and adding a basement apartment so they could maximize their rental income. The house rents for $1,450 upstairs and $800 downstairs. It’s currently worth $325,000.

To help the couple realize their investment dreams, Dietz connected them with a team of experts, including mortgage and insurance specialists, who worked with the couple’s accountant, lawyer and real estate agent. “They went through the planning eyes wide open, so they better understood the risks and rewards,” she says.