Posted by: Don Bayer, CFP
With rental property in Canada being a trending topic, the MonsterMortgage.ca team thought it might be valuable to go over the basics of investing in rental property with confidence.
Most people buy a rental property for one or all of the following reasons:
They plan to pay off their mortgage and use the rental property as a monthly income
source for when they retire a.k.a. they want to create a “Personal Rental Pension”
They hope to create a capital gain by selling the rental property for more than they paid.
They want to diversify their investments by purchasing a rental property; and having an asset
outside of financial markets (e.g., stocks, mutual funds, GICs).
Financing your first rental property can be an intimidating experience. Do you use your cash on hand as the down payment? Should you borrow as much of the purchase price of the rental property as you can? Should you take the equity out of your main residence to purchase the rental property?
The right answer, for these rental property questions, is LEVERAGE.
Given the right situation, you will make more money investing in a rental property by using other people’s money.
Many first time rental property investors fail to understand that financing 100% of their investment is the most effective way to keep more money in your pocket. Financing 100% of your investment property will often create a “negative” cash flow if the financing is arranged properly.
Cash flow can best be defined as total rent received minus all allowable expenses. For example, interest on the mortgage, property taxes and general maintenance are examples of acceptable expenses. If the rental property is highly leveraged, the expenses in almost all cases will exceed the rental income and this monthly deficiency or negative cash flow will be paid by the investor.
This negative cash flow creates two positive outcomes for an investor:
The negative cash flow from the rental property can be deducted from your earned income, reducing your personal income taxes.
A higher leveraging percentage frees up your down payment cash to either reduce personal, non-deductable debt (principle residence mortgage) or to invest in another rental property or other marketable securities.
Canadian mortgage insurance companies will now lend up to 80% of the purchase price for a rental property. Quite often, having a secure line of credit behind your own existing first mortgage will enable you to access your equity easily, with a good paper trail to track mortgage interest deductibility. Having a good credit report is very important in this equation. The quality of your credit score will affect the interest rate you pay on your rental property which will directly affect the return on your investment.
Efficently borrowing on your rental property to ensure you keep more money in your pocket and start contributing to your bottom line is easy with the right knowledge and the right advice.