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The Basics of Investing in Real Estate
Getting a mortgage for a second property is not as easy as borrowing for a primary residence – you will need at least 20% of the purchase price for a down payment, and only a portion of the income you get from rent will be considered in qualifying you for a mortgage (usually 80%). For commercial properties, you will likely need a down payment of 50%.
In Canada, money collected from rent is considered income and thus subject to regular taxation. Increases in the value of your investment property (from the time it becomes an investment property to the time you sell it) will be subject to capital gains tax. If you are thinking of buying an investment property, make sure to talk to your accountant to fully understand the tax implications.
Most real estate investments should have longer-term objectives. Because of the unpredictability of the real estate market, expecting to profit in a short period of time is risky.
What are your investment goals?
1. Cash flow (cash return) – Cash flow is the difference between your rental income and your expenses. In Toronto, cash flow positive properties (purchased with 20% downpayment) are hard to come by, though it is fairly common for investors to break-even on a monthly basis (meaning rental income will cover the property's expenses). Cash flow is affected by factors outside of the real estate market, for example, your downpayment and mortgage terms.
2. Appreciation – Toronto properties have historically appreciated favourably for investors.
3. Equity (mortgage paydown) – Rental income pays down your mortgage, building your rental income.
Return on Investment (ROI)
Investors use different calculations and tools to calculate the returns on their real estate investments:
Cash flow is the net amount of cash moving in and out of an investment
Calculation: Income – operating expenses – financing costs
Capitalization Rate (cap rate) is the rate of return on a real estate investment property based on the income that the property is expected to generate. Calculation: Operating Income / Purchase Price
Return on Investment (ROI) is a performance measure used to evaluate the efficiency of an investment. It is calculated by adding the cash return, mortgage pay down and appreciation.
There are many tools out there to help you predict the ROI of investment properties.
Option 1: Investment Condos
Ever wonder who is buying all the condos you see changing Toronto’s landscape? Investors. Here is why:
- A good investment condo will break even (or be cash positive) with a 20% to 25% down payment (which you require for a mortgage anyway).
- Opportunity for both cash flow and appreciation in value over time.
- Rental vacancies are at an all-time low.
- Generally less maintenance/repair work than that of a house.
- Unique condos in good locations have historically appreciated more than the stock market.
- Lots of obligations and little flexibility due to the Residential Tenancies Act. Make sure to read our Complete Guide for Landlords for more information.
- Works best as a long-term strategy.
Income properties–houses that have self-contained apartments for rent –are HOT commodities in Toronto.
- Having a basement apartment you can rent out might make the difference in your ability to afford the home of your dreams.
- Historically, houses have appreciated faster than condos, so an income property may be a safer bet.
- With a 20% down payment on a multi-residential house, you should be able to break even (or ideally be cash positive).
- If you’re living in the same house, you will need to cope with your tenanted unit.
- Landlord headaches: repairs, renovations, tenants that do not pay rent on time– make sure to check out our Complete Guide for Landlords.
- Having a leased unit may make it harder to sell your home.
While it is not as popular as it was a few years ago, flipping houses (in other words, buying a house, renovating it and selling it in a short period of time) happens every day in Toronto. It can be risky but also very profitable.
- A proper quality flip in a good neighbourhood will be in high demand (many of todays buyers want the fully done-up house).
- Cash! There are certainly lots of examples of houses bought for $600,000, renovated for $150,000 and sold for $1,000,000.
- Renovations always take longer and cost more than you expected. With a flip, every dollar spent and every day delayed counts.
- Flipping for profit is not easy – it takes a lot of time and can be a risky venture.
- There are just as many examples of houses bought for $600,000, renovated for $150,000 and sold for $725,000.
Option 4: Mixed Use Properties
Many investors turn to Toronto’s mixed-use properties, that is properties that have both a residential and a commercial component. If purchased in up-and-coming neighbourhoods, these can be an excellent investment. The financing and buying process is very different than the standard resale residential market so make sure you hire a real estate agent experienced in selling these types of properties.
Option 5: New Construction (pre-construction)
This used to be the number one way investors made money in Toronto’s real estate market: buying during the pre-construction phase and selling when built (often up to 5 years later).
- Prime choice of units and location.
- Currently, it is cheaper to buy a resale condominium.
- Builders may cancel projects, tying up your downpayment for years.
As an investor in Toronto’s real estate market, there’s a lot to consider. If you want to partner with a team that knows how to evaluate investment options and maximize your ROI, text, call or send us an email.