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By Marie Engen, Boomer & Echo
Special to the Financial Independence Hub
Buying an investment property is a popular option for many people looking for different ways to invest their money. Rental properties can provide you with steady monthly income and could appreciate in value over the years. But are you cut out to be a landlord?
Finding the right property
Finding the right property as an income producing investment is important. Do your homework. You want your rental to be attractively priced for your local market, and in a quality neighbourhood.
Related: How to invest in real estate
Consider a property that allows for multi-revenue, such as renting out the top floor and basement to different tenants.
If you’re handy you might consider a fixer-upper close to your home to renovate and maybe add a basement apartment.
Buying a property
To get approved for a mortgage you must put down 20% of the purchase price. Your mortgage lender will consider your credit score, income sources and market value of the property, just as with a personal mortgage. However, the key factor will be whether you can generate enough cash flow from the rental payments.
Before buying a property, you should scan the classified ads and websites like Kijiji to determine what you can reasonable charge in rent. The rental income should be enough to cover all of your operating costs – mortgage payments, utilities, maintenance, insurance and property taxes – and generate income as well.
Related: Leveraged investing – A guide for those who can’t help themselves
One suggestion is that you get an annual return of 6% to 9% of the amount you have invested. For example, if you buy a property for $300,000 and have a down payment of $60,000, your goal should be to pocket $3,600 to $5,400 per year after operating costs are covered. Be realistic. Will the rental market allow you to charge enough to cover that?
You should have at least three months of mortgage payments and other expenses in savings (or line of credit) as a buffer in case the property is vacant, or the tenant doesn’t pay.
Challenges of owning a rental property
You have to ask yourself if you are prepared for the day-to-day grind of looking after a property – dealing with tenants as well as trades people that can provide you with service for a decent price.
The biggest challenge is finding the right tenant – someone who pays the rent on time and doesn’t abuse the property.
When interviewing potential tenants, check their credit and job status by asking for a pay stub, credit report and references. Also, call previous landlords.
Repairs and maintenance can be expensive and time consuming, especially in an emergency situation.
You may consider doing away with these problems by hiring a property manager. They can do background checks on potential tenants and take care of the 3 a.m. clogged toilet. This option will eat into the your monthly rental income, though.
Tax considerations
You must pay tax on your rental income, but you can deduct from that income certain expenses related to the property, including:
- Mortgage interest
- Property taxes and home insurance
- Advertising for the right tenant
- Fees for professional services – legal, accounting, property management
- Maintenance and upgrades
- Utility bills (if included in the rent)
If expenses exceed your rental income (perhaps in the first year of ownership) you may be able to deduct the loss from your other sources of income.
Related: Managing proceeds from a rental property sale
When you sell your property 50% of the capital gain is added on to your income.
Would you make a good landlord?
Check to see if you have these traits. A good rental property owner:
- Enjoys doing small home improvement projects.
- Has the spare time to deal with problems and emergencies as they arise.
- Doesn’t mind having occasional difficult interactions with problem or demanding tenants.
- Has sufficient liquid assets to cover expenses if the rental is vacant.
- Doesn’t have the majority of his or her net worth tied to real estate.
Final thoughts
Real estate is not a liquid investment. It can take time to sell and market conditions could be unfavourable.
Most successful landlords regard real estate as a long-term investment. You enjoy a steady stream of rental income while your mortgage gets paid off, building equity all the while. Then, if the market is good you can sell, or continue to enjoy your rental income indefinitely.
Owning rental property is a good option for some people. Keep your eyes wide open to better understand the risks as well as the rewards.
Marie Engen is the “Boomer” half of Boomer & Echo. In addition to being co-author of the website, Marie is a fee-only financial planner based in Kelowna, B.C. This article originally ran at the Boomer & Echo site on March 15,, 2016 and is republished here with permission.
