How Income Properties Work

Mudit Buying

In this write-up, I will try to go through the basics of Revenue properties and what we should keep in mind when trying to make a decision and before signing on the dotted line.

The three principal benefits of Realty Investments are for generation of Capital growth as the value of assets increases over time, Rental income to offset any costs associated with the property and Tax deduction benefits which CRA allows for rental properties. The rental revenue beats any typical equity dividend benefits when you invest in stocks.

Real Estate investments are your hedge against economic inflation as their growth tend to have a direct proportion to the inflation in the economies historically.

To understand the calculations behind an Income property, let’s consider a simple scenario, Mr X takes a lending of 80% from a bank and puts down payment of 20% as his equity for buying an investment property. At the time when he decides to dispose of the property, the appreciation entirely is his to keep; this makes it an excellent proposition in performing markets like Greater Toronto Area.

Let us dig a bit deeper in the above ratio of pledging funds to simulate buying/selling investment property, and in the process we will aim to account for every cost and revenue over a period of 5 years, considering the annual appreciation rate of 6%.

At Investment Initiation ->

Purchase Price$400,000
Down Payment$80,000
Mortgage Amount (taken @ 2.6% five year closed)$320,000

After Five Years ->

Resale Value (considering 6% annual appreciation) after 5 years$535,290
Rental Revenue (considering $1500 per month) after 5 years$90,000
Total Principal Repayment done in the term$48,538.87
Total Interest Cost for the term$38,565.53
Mortgage Balance at end of term$271,461.13
Closing Cost for Resale (Lawyers + Land transfer tax + Brokerage fees at @ 5% of sale price)$26,765
Maintenance for Property ($1500 per year for 5 years)$7,500
House Tax Paid (assumed $3,000 per year)$15,000
Net Gains (Appreciation + Rent Revenue + Principal Repaid - Interest Cost u2013 Closing Costs - Maintenance - House Tax)$185,998.34
ROI (Return On Investment) = [Net Gains / Cost of Investment] x 100232%

With evident benefits and calculations we went above, and before you get too excited, we need to take care of some basics which we will take point by point here, these are critical for any investor contemplating income property:

Research Property types and their returns – consider your budget and determine by working with a realty specialist on how best your money can be invested. Different property types exhibit a varying rate of return based on neighbourhood. Vertical high rises had single digit growth in past one year in GTA; other property types had double digit growth both in Toronto and suburban GTA markets with suburbs surpassing Toronto core, below bar graph, for instance, shows the increases in GTA markets.

toronto-core-growth                                           gta-suburbs-growth

Note: Based on data released from TREB MLS® system for yearly duration Aug 2015 - Aug 2016.

Be within your cash flow & have reserves – meaning the carrying costs of the property (EMI + Property Taxes) should be within your regular cash flow, this becomes even more important when you have a primary residence, and that requires repayments as well. Simply put, for a revenue property you should have carrying capacity in forms of reserve funds in case there is couple months delay in meeting with the right tenants or for maintenance up-keep, you should be able to cover monthly repayments in the interim. If your exposure in your investments is within your means you will be comfortable.

Tangible Property at Right Price – After deciding on the asset class based on your investment budget comes the hard work and grill one have to go through to get to the ‘right’ property, this would mean looking at multiple properties till you get one which meets your objectives. Qualify the stability of neighbourhood and the MPAC assessment of the asset to determine the holding worth of the property. The more houses you see in the area, better you would become in ascertaining the worth of the investment, and you will be able to spot bargains in the process quickly. If the property prices are on the higher side in a particular neighbourhood due to last solds which went at an extraordinary price, it’s better to select a different community. You don’t want to overpay for a property and would rather want to invest where prices are within rational; a skilled realtor would come handy here.

Understand Closing Costs for completing the deal – when you do your budgeting for investment property take into account the closing costs and other initial investments you might require for painting, carpet cleaning/replacement, lawyers fees, city levies, etc. for the home to make it ready for rental revenue.

Never Sell the Property in down market – if the investment property bought is within your reach, in the down market you will not do distress selling, you are more liable to do that if you stretched at the first place. In the down market rental property demand increases as people coming off their homes would need a roof to live, so one should hold on and keep revenue coming to handle the cash flow, following the cyclical process realty prices would go up again in medium to long term.

Multiple Instead of One – the rule for investments is rather than having one big investment property, have multiple smaller investment properties, this would allow you to take flexible decisions to buy/sell based on your future cash flow needs, rather than dissolving one big asset. Another benefit is that smaller properties are easier to exit when time comes and have lower days on the market ratio. The third benefit is that the rental increase on a bigger property is not in proportion to the higher undertaking you would have to take to get it financed in the form of monthly repayments.

Give the time to grow – Most importantly for anything to flourish most important ingredient is the time, once you have decided on the property, made the closing, selected the right tenants. Give it time to grow and do regular upkeep when required. A right time horizon between buying & selling a property would give you expected returns.

Wish you all the very best and for more interesting blogs refer ->