Guide to Assessing a Rental Property
Have you read Rich Dad, Poor Dad, and are interested in getting into rental properties? Real estate is one of my favourite investments, because the business model is (relatively) eco friendly, and because you are buying a physical asset, not only a piece of paper denoting ownership.
I have been a landlord dealing with tenants for the past 8 years. I have to disclose that overall, I have made money off my rentals, both in property appreciation and monthly cash flow. However, physical properties need a lot of maintenance to keep running. One of my least favourite memories is when my tenants had no heat or hot water for 4 days over the 2015 new year. Or having to give another notice to vacate when we had sold our house.
If you are willing to put in the work to upkeep the property, complete a full background check on your rental applicants, and give your tenants excellent customer service, I would recommend rental properties to you.
Here is my guide to determining whether to buy a rental property in your city.
Speak with your mortgage broker and determine what mortgage amount you prequalify for. Ensure you disclose that you are buying a rental property, as you may be required to make a 20% down payment. This step is important, as no decent realtor will bother showing you a property until you have been prequalified. Also, it doesn’t make sense to start shopping until you know what amount you are eligible to borrow.
Let’s say I qualify for $300,000. Now I have to determine what I can buy for that amount.
Second: Research Comparables and Calculate Monthly Cost
I can purchase a one bedroom, 500 square foot condo in Toronto, which is listed for $260,900. Assuming I purchase it with 20% down, my mortgage will cost $962 a month, with a 2.75% variable loan. With $334 maintenance fees, and appx $250 a month for property tax (I would ask my realtor to confirm this when running the numbers), appx $50 a month for property insurance, my monthly carrying costs for this condo are $1560.
When calculating the carrying cost of a real estate property, you need to think about the following costs:
- Maintenance fees or a maintenance fund
- Hot water or furnace rental fee
- Heating and cooling
- Property Taxes
- Snow removal or lawn care
Think over each item to determine whether you as the landlord will pay this, or whether your tenant could pay for it. Any real estate investor would advise that any city property should charge for a locker (in a condo), or parking separately, since you can usually make $25- $50 on these.
Once you have a decent estimate, add these up to determine your monthly cost.
Third: Check Rental Sites to Verify the Market Rate
My comfort is to have a 10% contingency or flexibility in my rental income, so in order to feel comfortable with buying this property, I want to see $1716 (1560 x 1.1) in monthly rental income.
Looking at Kijiji, market rates for this street range from $1595- $1650. That’s below our contingency rate. It could work, but it would be tight, so I won’t recommend buying this property.
Fourth: The Decision
In fact, my calculations show me that at this time, it does not make sense to purchase this rental condominium in Toronto. If you qualify for more, and believe you can charge a premium (for example, boutique building, two or three bedrooms), then you need to asses the property you are buying. There is no hard and fast rule with real estate investment. The numbers need to be run on each property so you are conducting your due dilegence.
What about your city?
PS- Sometimes multiplex properties allow you to get into real estate investing, rather than single units. For example, if I buy a duplex for $600,000, then, using the numbers above, I would want to ensure I have $3000 a month to cover carrying costs, or $3300 with my 10% contingency- $1650 per unit. That would be realistic with a two bedroom apartment.