There are two selling strategies a home seller has. What happens when a bully offer comes in? What is it?
Thinking of investing in real estate? Before you put an offer, find out about the 10 commandments of real estate investing
Will you be at your job at 72 years old or have to be a Walmart greeter to fund your retirement shortfall? Investing in real estate can compliment RRSP investments since Canadians are not investing enough for retirement
Im Buying an investment property is similar to buying a business; it needs to cash flow. Would you buy a business that loses money on a monthly basis? Probably not and you shouldn't buy an investment property that negative cash flows.
Now that we agree cash flow is critical, what should you do with the monthly cash flow surplus?
Let's assume the property cash flows after expenses and reserve fund allocation, $500. We encourage our clients to allocate a minimum of 8% of rental income for repairs, maintenance and vacancy allowance. For a property that generates $3,500 monthly, $280 is set aside.
There are 2 options to consider for the net $500 monthly cash flow:
1. Prepay investment property mortgage
2. Prepay principal residence mortgage
Assume your principal residence mortgage balance is $400,000 borrowed at 2.99% and amortized over 30 years with a monthly payment of $1,680.28. By diverting $500 monthly into your principal residence, the mortgage amortization is reduced to 20.42 from 30 years, saving you 9.6 years or $193,568 of mortgage payments.
Imagine having no mortgage payment!
Another factor to consider is tax efficiency (disclaimer: consult a professional accountant for tax advice, we are not accountants). The interest portion of a principal residence mortgage, for majority of homeowners, is not tax deductible. Whereas the interest portion of the investment property mortgage is tax deductible. A sound financial strategy is to pay off non tax deductible debt first.
Once the principal residence mortgage is paid off, use the rental property surplus to pay down the investment property mortgage to increase cash flow and pay it off ahead of the original amortization.
Buying a house, doing some work to it and selling it for $100,000 profit a few months later sounds like a lucrative proposition, but is it really?
Canada Revenue Agency will tax the profit as income not capital gains. In this instance, the full $100,000 profit would be taxed at your marginal tax rate.
Here is an example of why I prefer to flip the house.....later: Buy, Add Value, Refinance (BAR) then hold
Buy & Add Value
- Property purchase price $500,000
- Downpayment, closing costs & 4 month carrying costs: $113,000
- Renovations: $100,000
- Refinance property at $600,000
- New Mortgage (80% of value): $480,000
- Total Capital (including closing costs): $144,609
- Hold property for 5 years
- Annual appreciation: 3%
- Annual ROI w/ cash flow: 18.55%
- Property equity after 5 years: $237,438
If property is sold after 5 years, only 50% will be taxed at your marginal tax rate. Assuming a sale price of $675,000, only $87,500 out of the $175,000 ($675,000-$500,000 divided by 2) would be taxed at your marginal tax rate. Disclaimer: Always consult a professional accountant who specializes in real estate investment to guide you through CRA's rules and regulations. Capital Costs Allowance are not taken into consideration in this example.
To summarize the 2 options:
1. Sell Now: $100,000 profit taxed at marginal rate
2. Sell in 5 Years: $237,438 profit (difference between property value and remaining mortgage balance) plus $41,588 in cash flow over 5 years, only $87,500 taxed at marginal tax rate
Advanced real estate investor tip: Don't sell the property after 5 years, refinance it to pull equity to buy another investment property which would defer paying capital gains taxes to a future date and build portfolio by acquiring another investment property.
You bought an investment property 5 years ago and it's time to renew the mortgage. Should you renew the mortgage or refinance to pull equity to buy another investment property? This is a common question we get from our investor clients (This question is applicable to your home mortgage as well).
Here is an example to best illustrate the options:
Current Property Value: $720,000
Mortgage Balance: $465,000
Option 1 - Pull Equity to 80%: new mortgage $576,000 amortized over 35 years. Access $111,000 of equity to acquire another investment property (35 year amortization is available for investment properties)
Option 2 - Renew mortgage at current remaining amortization and mortgage balance remains unchanged at $465,000
If the real estate investor is in acquisition phase, it is best to proceed with option 1. This also provides a tax advantage; the interest costs for the additional $111,000 are tax deductible since it is used for investment purposes (disclaimer: consult an accounting professional for tax advice). A key point to consider when deciding how much equity to pull out of the investment property is to stress test the cash flow using higher interest rates to ensure the investment property will not negative cash flow in the future.
If the real estate investor has completed acquiring the number of properties required per the plan, it is best to proceed with option 2 to pay off the investment properties and increase passive income.
Having a plan upfront helps you, the real estate investor, in knowing how many properties are required to achieve your long term financial goals and deciding what to do at mortgage renewal time.
Over the years working with real estate investors, I have come across very interesting answers when I ask "How many investment properties do you need to buy?" I have heard from 1 property to 40 properties, 1 every year for the next 5 years, don't know... Most stumble when I ask why? It starts with why. Simon Sinek explains the importance of starting with why in his TED Talk
There are many reasons for buying investment properties, here are some:
- Retirement income
- Fund children's post secondary education
- Job replacement (one spouse might be considering leaving their job)
- Supplemental income
- Family legacy
- Full time real estate investor
- Investment diversification (real estate and stock market)
Once a reason or multiple reasons are chosen, determining how much monthly income the investment properties are to generate is the next step. This goal can be achieved via different investment properties options (single family, duplex, multi-family, commercial....) and various geographic locations.
To complete "why invest in real estate" analysis, reverse Engineer the number of properties you need and have your personalized "how and where" plan developed, click here.
There have been many changes with respect to mortgage qualifications in Canada. Above and beyond the 4 major changes announced by the Minister of Finance over 4 years, there have been changes on the backend on how lenders qualify applicants. The most recent one is mind boggling!
Investment Property Mortgage Qualification
For an applicant reporting a surplus on their T1 general (line 126), the surplus (line 126) is added to their income.
Example: Applicant's income is $100,000 and line 126 is showing $5,000, total applicant's income is $105,000. If the applicant owns other investment properties, here is the part that makes no sense: The principal portion off the annual mortgage statement is deducted from applicant's income!
Example: Applicant has paid down $10,000 of mortgage principal in the previous year, total income: $100,000 plus $5,000 less $10,000 = $95,000. This rule effectively penalizes real estate investors who build equity in their investment properties. Last time I checked statements made by Minister of Finance, Bank of Canada, Bankers..... they all advocate paying down debt and building equity now while interest rates are low (Canadians are at record high debt to income ratio).
This rule effectively encourages not paying down mortgage principal. Had the applicant paid more interest than principal in the previous year, the mortgage principal deduction would have been less and therefore their net income higher!
If you are thinking of showing a loss on line 126, it's even worse: Income less loss on line 126 less mortgage principal.
Are you confused and frustrated with all these guidelines? Rest assured this is what I do on a daily basis and I am here to help you navigate through the mortgage qualification land mines to build your real estate investment portfolio. It's all in the setup.....Happy Investing!
- The days of 5% downpayment and 40 years amortization are long gone
- Some lenders have a minimum square footage requirement
- Some lenders require more than 20% downpayment
- Some lenders require borrower pay for insurance premium above 65% loan to value
and the list goes on. But don't be discouraged. Here is mortgage underwriting 101 and a road map to help the investor mortgage 8 Toronto investment condos:
1. Start With The End Goal
The mortgage setup of each investment condo plays a critical role in helping or hindering the qualification of the next investment condo. Knowing what the investor's ultimate goal (8 condos or 3 condos) requires a different mortgage financing strategy. Some investors approach investment properties with "I'll buy another one" which is a problem in today's financing world. Over the years, I have come across many situations where the mortgage was setup with a short amortization period or the wrong mortgage product which restricted qualifying for another property.
2. Focus On Cash Flow
Setting up each condo to positive cash flow helps to qualify the next investment condo. There are 4 methods of cash flow analysis lenders would consider in mortgage qualification:
T776 Statement of Real Estate Rentals
Some lenders would use line 9946 to add to investor's income if the figure is positive. This is where many investors go wrong. They try to show a loss which reduces taxable income however it hinders qualifying for the next investment condo since the negative figure translates into a liability on the mortgage application. Showing a positive figure and paying some taxes is not a bad thing!
50% of Rental Income
This method is a deal killer. For example, assuming the investment condo is rented for $1600 per month, the lender would only use $800 as revenue then deduct 50% of condo fees and mortgage payment. Good luck getting a positive number without a large downpayment.
Rental Surplus Calculator
Lenders use the rental income generated by the condo and deduct mortgage payment, condo fees and 15% of the rental income figure.
The Wash Method
This is where the lender would look at the rental income being generated and as long as the rental income covers mortgage payment, condo fees and property taxes, the investment condo would not help or hinder in qualifying for a mortgage.
Stretching the amortization to 30 or 35 years and getting a variable mortgage would increase cash flow and help qualify the next investment condo. In real estate it is location, location, location and in the investment property mortgage world it is cash flow, cash flow, cash flow which sometimes means a greater than 20% downpayment.
Keep in mind today's qualification guidelines could be different next month. The mortgage financing landscape changes frequently based on government requirements and lenders' risk analysis. So what works today, might not work tomorrow!
Mortgage Broker or Bank
Most, not all, lenders have a cap of 4 investment properties per borrower. Understanding where the investor wants to be long term helps in structuring the mortgages appropriately and placing them with lenders who accept a portfolio of more than 4 investment condos. Choosing an experienced mortgage professional who knows where and how to place these mortgages can save the investor tens of thousands of dollars. No investor wants to be in a situation where they walk into the bank to finance their 5th investment condo and get "sorry, we can't help you since you are capped". Then what?
Looking to invest in Toronto condos or have an existing portfolio? Please contact Nawar to help you achieve your long term goals.
Basement rental apartments are popular in Toronto and make homes affordable for many in the city since they have the potential of generating $1000-$1500 per month in rental income. Legalizing a basement apartment requires meeting electrical, fire and building codes. It seems daunting initially but working with a knowledgeable architect can alleviate lots of headaches. As a real estate investor, I have viewed many properties and found the most challenging part of legalizing a basement apartment to be the ceiling height requirement. There are 2 building code requirements; one for existing basement units and one for new basement units.If the basement rental apartment is existing, the code requires at least 50% of the floor area to be 6'5" high. If the basement rental apartment is new, the code requires at least 50% of the floor area to be 6'8" high. The majority of homes' basements built in the city of Toronto were used as utility /storage areas and not as living space. Nowadays, basements are considered part of the living space for in-home offices, guest bedrooms, children's play area and entertainment space. Lowering the flooring to achieve legal height can be accomplished through underpinning or benching. Both methods can be costly depending on the house foundation conditions, soil conditions and existing interior walls. In cases where the basement ceiling height is 4"-6" below the required height, there is a third more cost effective option: lowering concrete slab (see image below).
A bonus of this option is installing new PVC drains since the old ones are made out of clay and over the years have deteriorated in condition. This method requires drilling holes into the existing concrete slab to locate it relative to the wall footing. In my experience, I had to underpin one property and managed to lower the concrete slab on another to achieve required legal basement height. The cost of underpinning can range between $50-70,000 where as concrete slab lowering $15-20,000.
References For Adding A Secondary Unit in Toronto
- Carson Dunlop Basement Apartments Untangling the Web
- Second Suites
- Basement Accessory Apartment Specifications
If you are looking for an experienced mortgage broker to help you navigate through adding a basement rental apartment and analyze the investment property, please contact me.
**Disclaimer: The above information is for reference only and it is best to consult with a professional architect and a licensed basement lowering company as part of your due diligence**