The number of properties for sale in September increased as expected after a slower July and August. Not surprisingly, the market picked up right where it left off before the summer. In most cases, multiples offers with no conditions and sale prices over asking continue to define houses in downtown Toronto. Quality income properties remain in high demand and continue to trade well in excess of the list price.
I’d like to wish everyone a very Happy Thanksgiving. I hope you all get to enjoy some quality family time. – P.A.
Even in this Sellers’ Market Income Properties Still Make Sense
In my early days as a real estate agent, as I was learning the ins and outs of real estate investing, I wrote a book called “Live for Free”. The premises was simple enough – if you were able to buy a duplex or multiplex that you could live in a portion of, your tenant’s rent would cover the cost (or a portion) of living in your suite. Back then, over ten years ago, it was possible to accomplish this. Prices were such that you could buy an income property for a price that the rents could completely cover all your costs including the cost of your suite. As prices started to increase in the Central Toronto core, it became harder and harder to find anything that would completely cover your rent. By the time I did the first rewrite in 2008, the goal had moved more toward being able to live in your suite and have it cost you less than what it would cost to rent on the open market. In effect, in a few short years, the notion of “living for free” evaporated.
Thus was born a revised concept for me in real estate investing: living for less. Given that the cost of home ownership was skyrocketing if you could live in a nice suite for less than market rent, then that was the new goal. Over the long term your tenants would end up paying for a significant part of your mortgage which would be another obvious benefit to income property ownership. This still remains the single largest benefit of owning an investment property – having your tenants pay down your mortgage for you over time allowing you at some point in the future to own the property free and clear.
Nowadays I evaluate income properties based on two criteria. One is its ability to fully fund itself with a conventional 20% deposit. In other words, the income that is generated from all rents has to cover all costs including mortgage payments, property taxes, heat, hydro, insurance and maintenance. If you are living in one of the suites, we attribute a market rent to that suite for our calculations. If you end up negative each month, then you have to top up the amount you are paying for your suite, thereby paying over market value. Thus you have effectively overpaid for the property as the rents do not fully cover all the costs with a 20% deposit.
The second rule of thumb is that the property has to have a cap rate of least 5% and ideally we would like that number to be closer to five and a half. Cap rates take your net income and divide that by your purchase price to get a return that is not influenced by how big your mortgage is. This allows us to do an apples-to-apples comparison with other investments outside of real estate. If your return is less than 5%, are you better off buying stocks, mutual funds, gold or baseball cards? If the best return for your money is what you are after then there may be other things that make more sense than buying an investment property.
However, I believe that income properties in Toronto are a good buy and can make really good sense in the long term. If you have to find a place to live, why not offset some of your monthly costs by renting of a portion of the space? A basement apartment can get up to $1000 a month. That often would pay a good chunk of your monthly housing costs. Imagine living on the top floor of a triplex where there is upwards of $2500 coming in each month. That could go a long way towards getting the property paid for sooner.
The second positive thing about income properties is what I mentioned earlier about your tenants paying for the asset over the long term. If you have funds sitting in a bank account, earning a marginal amount of interest, why not put the money into a property where the tenants will pay it down for you over time? You might not be making a lot of extra cash each month from the building, but ten years down the road, your equity position with the property will be much stronger, all paid for courtesy of your tenants.
Another inherent benefit is potential capital appreciation. It is hard to put an exact figure on how much the value of your property will go up over time, but any improvement is money directly in your pocket. Look at how the housing prices have gone up over the past ten years. A $350K semi has risen to over $500K in many cases. This is a nice profit for the live-in investor. Remember there are taxes to be paid on the gain in the property, but only on the portion that you did not live in. Many people in the GTA have essentially been living off the increased value of their real estate.
One last benefit is that a strong rental market (which we have had in this city for years and years), guarantees you continued cash flow each month. Many folks will not have retirement income or a pension when they stop working. Many will have to rely on their savings to survive day to day. The regular positive cash flow that an income property produces can come in very handy in these types of situations. If you start thinking about your golden years long before they arrive, an income property purchase today can yield some very nice monthly cash flows for you in later years.
Once interest rates start to rise again, there may be a bit of a slowing down of this voracious demand that we have been experiencing. Until then duplexes and triplexes will continue to be desirable as they provide many benefits as I have just described. You might not be able to live for free any more, at least in this market, but there is nothing wrong with keeping a few more bucks in your pocket each month.