After working with a lot of investors, my favorite part of the job is helping guide them to make solid and profitable decisions. Whether you’re just considering getting on the real estate ladder, or you’re a seasoned investor, read on to find out 12 Things You (probably) Don’t Know About Investing in Toronto Real Estate.
- If you’re buying an investment, it’s all about the math – don’t let emotions get in the way. I know, granite counters and bamboo floors are awesome, but how much they add to the monthly rent? Real estate investing really does come down to numbers, and it’s not just price that matters. How much are the condo fees? How much are the taxes? What kind of maintenance should you expect? What kind of rent can you expect? An agent experienced in investments will be able to guide you to the profitable ones and encourage you to run from the ones that look great but don’t give the best returns.
- You’ll likely need a minimum 20% down payment. If the property you’re buying isn’t a primary residence (a primary residence is defined as one you live in at least six months of the year), then the bank will require you to have a bigger down payment. In most cases, that’s 20%.
- The good news? In Toronto (as of writing), most investors reach the break-even point with a 20% down payment. What does that mean? Your rent should cover your mortgage payment (at 80% financed), your taxes and your condo fees. If you can only become cash flow positive with a 30% down payment, something is wrong with the property you’re considering- keep looking.
- Most lenders will consider 80% of the rental income when calculating how much you can afford. When banks decide how much mortgage they want to give you, they’ll look at your income, your debts, and your credit score. If you’re buying an income property, they’ll add 80% of the projected rental income to your income, so you’ll qualify for a bigger mortgage. Keep in mind that some lenders won’t consider rental from illegal apartments [Related: Is that Apartment Legal?] and may require an actual lease in place or an appraiser to confirm the amount of rental income that will be generated.
- As an investor with a down payment of more than 20%, you’ll likely qualify for a 30-year amortization on your mortgage. This will keep your mortgage payments low (and don’t forget, you can write off the interest on your mortgage against your rental income come tax time). Example: If you have a $300,000 mortgage at a 3% interest rate amortized over 25 years, your mortgage payment is $1,362 per month. Increase the amortization to 30 years, and your payment decreases to $1,211 per month. That an extra $151 in cold hard cash flow a month!
- Good investment properties provide 4 ways to make money:
Monthly cash flow – During the time you have a mortgage, your monthly cash flow from the property (cash flow = rent minus expenses) is likely to be minimal. In Toronto, is not uncommon to see properties that are $50 or $100 cash flow positive each month, and there are plenty of investors out there who bring in less rent than their expenses (cash flow negative). Negative cash flow investors are betting on the benefits of appreciation, equity build-up and/or improvements.
Appreciation – Appreciation in an investment property is the amount it increases in value during the time you own it. The real estate market in Toronto during the last few years has been on fire, with 4-5% annual appreciation for condos and 10%+ annual appreciation for houses. Don’t be naive and think that’ll always be the case – during the time you own the property, there will likely be years of zero growth and years where prices go down too. Be prepared for that and remember that investing in real estate – like investing in the stock market – is best viewed through a long-term lens.
Equity Build-up— every month, a portion of your mortgage is getting paid by your tenant, and you’re building up equity in the property. That $300,000 mortgage at 3% interest will have shrunk to $265,000 by the 5th year, to $216,000 by the 10th year, $160,000 by the 15th year, and so on. The difference between what it’s worth and what you owe is the equity.
Improvements – Depending on the type of property you buy and how long you keep it, there may be an opportunity to renovate and increase its value. Many house investors renovate and improve right away (for example, they may make a 2-unit house into three units, or they may upgrade the finishes to justify higher rents). Other investors will choose to renovate right before selling (this is common in the condo market). Just be careful: a $50,000 condo renovation may not pay back $50,000, so talk to your REALTOR before renovating pre-sale.
- Usually the best cash flow properties are the ones that are appreciating more slowly than average. When choosing your investment property, you’ll need to give some serious consideration to your goals. For example, right now in Toronto, there are some condos that sell for less per square foot than the average, yet rent for nearly the same amount of money – so you can pay $350,000 for a condo or $400,000 for a condo and get the same amount of rent. There are lots of reasons why the $350K condo may be cheaper (location, finishes, quality of the building, supply/demand in the building, etc.) and that may impact the resale value of the condo. What’s more important to you: monthly cash flow now or long-term value?
- The short-term rental market is pretty much over in Toronto. While renting out properties for a few days or weeks at a time was a cash cow for years, the short-term rental market’s days are numbered in Toronto, at least for serious investors [Related: How Airbnb Killed the Short-term Rental Market].
- There are three kinds of taxes you’ll need to consider when buying an investment property:
Land Transfer Taxes – There are two types of land transfer taxes: Ontario and Toronto (if you buy in the city of Toronto). Land transfer taxes are paid by the Buyer when they take possession of the property and are a percentage of the sales price. Click here to calculate land transfer tax. [Related: All About Land Transfer Taxes]
Income Tax on the rental income – Rental income is considered taxable, and the net profit you make will be added to your income and taxed. The good news is you can write off a lot of expenses to decrease your profit (mortgage interest, property management fees, condo fees, utilities, etc.).
Capital Gains taxes – When you sell your investment property, you’ll be subject to capital gains taxes. At the time of writing, capital gains taxes are 50% of profit, meaning that 50% of the profit you make (after selling expenses) will be added to your income and taxed at your regular income tax rate.
Purchase price: $400,000
Sold price: $500,000
Costs to sell: $25,000
Gain in value = $500,000-$400,000- $25,000 = $75,000
Under current capital gains rules, an investor would pay taxes on 50% of the $75,000 profit.
There are lots of intricacies when it comes to taxes, so make sure to talk to your accountant to determine your individual tax scenario.
10. If you buy a duplex (a house with two apartments) and live in one of them yourself, be careful. If you live in less than 50% of the house, you’ll pay capital gains tax on the whole house and lose your primary residence tax exemption. This is one of the most-missed points, and one that could cost you tens of thousands of dollars: if you rent out more than half your house (and declare the income, and write off the expenses), when it comes time to sell, the CRA will consider it an investment property (notwithstanding #12 below) and you will pay capital gains tax on the increase in value since you bought. Again, talk to your accountant.
11. As an investor, your qualification for government Buyer programs is limited. The First Time Home Buyer RRSP Plan and Land Transfer Tax Rebate for first time buyers [Related: Government Programs] both only apply to your primary residence. Sorry.
12. If you live in it, it doesn’t really count as an Investment Property from the bank’s perspective. If the house is your primary residence, even if you only live in one part of it, then you can’t run the mortgage numbers as an investment property from the bank’s perspective (although that’s usually a good thing). If there are leases in place or the bank’s appraiser can back up the potential rent from an apartment, then they may be able to use 80% of that income to reduce risk, but that’s all.
Have questions? I have answers, so don’t be afraid to get in touch! 416.282.2444