Why invest in residential real estate that you will not live in?
What do you need to consider before starting a search for an income property?
Follow these 6 steps to a successful search for investment real estate:
Before you begin your search you must first identify your reasons for investing in residential real estate and fully analyze your financial situation.
- Are you tired of the stock market roller coaster ride and are looking to find a more manageable investment?
Do you want to have more control over your money?
- Are you looking for a proven long-term income opportunity where you can generate consistent profits each month and see a potentially high return when you sell?
Identifying your objectives and setting investment goals will help you to focus your search for an income property. Each time you review a listing or visit a property you should ask yourself, "would this property meet my fiscal objectives?"
Some of the specific factors that you should consider are:
Determine which are most in demand among renters and investigate the market in those neighbourhoods. Are they in a healthy state to be buying? Are the prices within your range? Research recent sales and average returns for income properties in your chosen areas to better understand where the opportunities lie.
Consider whether there is a strong enough rental market in your chosen areas. Gather statistics on vacancy rates, etc. Major cities usually have several pockets where rental units are often in high demand. Find out what the real estate market is like in those areas. Consider neighbourhoods that are close to universities or colleges or those that have immediate access to public transportation, and in major cities especially those close to the subway. While many say “location, location, location” many investors prefer “timing, timing, timing.”
Identify whether the general economic conditions are favourable to investing in real estate (look at mortgage rates, economic forecasts, etc.) Be aware of national, regional and municipal economic conditions. Look at market trends and economic forecasts.
Determine whether your residential real estate investment will be short or long term. Most financial experts believe that real estate is better as along term investment but there are investors who buy properties to renovate and resell and achieve success short term. You need to know which path you intend to follow as it may affect the type and condition of properties you view.
Compare your real estate opportunity to other investments (stock, bonds, futures, gold, etc.) Identify what is important to your financial future (short term gain, long term stability, positive cash flow, consistent rates of return, etc.). The common belief is that real estate is safest as a long-term investment. However, many properties are renovated and sold for big profits in short time frames. Both scenarios can offer financial reward but each requires a different search strategy so be clear about which type of opportunity suits you.
Taking the first step means opening your eyes to what is happening in the market around you. You will need to educate yourself on the types of residential real estate available in your city in order to better understand the types of opportunities that are out there. Compare different types of income properties in your city to determine which best suits your investment criteria. Educate yourself on what is involved with having tenants and know your rights and theirs by familiarizing yourself with local landlord/tenant legislation.
There are four key factors you must consider when evaluating your property needs:
Determine what type of income property best suits your investment goals (duplex, triplex, rooming house, etc.) Understand the difference between a rooming house with 10 units each bringing in $500 per month vs. a duplex with 2 units each bringing in $2500 per month. The gross revenue is the same but what are the implications of managing 10 tenants vs. 2?
Give some thought to how you are going to manage your property. Are you willing to own a property that is on the other side of town from where you live yourself? This may not matter to you if you intend to hire a property manager or superintendent to handle your tenants but if you want to manage the property yourself you should be aware that if the basement suite in your property has a flood you will have to inspect the situation personally to determine how to proceed. Even though you don't intend to live there the location is still important.
However, it is important for reasons different than those that determine where you live yourself. A property may be in a suitable area and may have a good financial picture but you may think, "I wouldn't want to live in this neighbourhood." Well, you won't, but many others will, so don't limit yourself to looking in only those areas that appeal to you personally.
Aesthetic Appeal and Property Features
Gain an understanding of what property features will increase your rental incomes. Will attributes like parking or in-suite laundry make your bring you higher rents? Will you charge extra for these amenities or will you include them in your rental price? How important is what the property looks like? Some income property owners take great pride in their investment and ensure that things like landscaping and gardening are at a level they would expect for themselves. This can result in higher rents and more discerning tenants. Consider whether factors like building type or architectural style are important to your purchase decision. Do you only want to consider a detached dwelling? Or is a semi-detached or row house suitable?
Determine if you are prepared to do major, minor or any renovations to a property. You may find properties that meet some of your highest priority needs like neighbourhood and size but do not meet your needs in terms of quality. Are you prepared to bring a potential property up to the quality to maximize its value? Would spending a few thousand to improve increase the value of your investment? And if so, what is your improvement budget? Familiarize yourself with municipal by-laws relating to conversions, severances and general permitted construction.
For a complete renovation and development consultation, please contact Plex Realty.
Before you begin your search for an income property you will need to be clear about your financial readiness in order to understand where and what you will buy.
Some key questions you will need to answer are:
- How much money can you afford to put towards a deposit on your income property?
- How much of a debt obligation you are prepared to undertake? What is the maximum that you will be able to borrow?
- What is your net monthly payment comfort level? Set a maximum dollar amount and do not exceed this threshold when searching for properties
Three key areas to consider when evaluating your financial situation are cash flow, leverage and taxation.
Create a balance sheet that captures all of your income and expenses to better understand your cash flow and how you will cover all monthly expenses related to owning a residential income property. This will also help you determine where and how much investment capital you can access. List all of your current investments - including your own home, stocks, insurance, etc. - and determine if you should be moving money from areas that are not performing well into your real estate investment. Determine an amortization and mortgage term that you are comfortable with and realize the duration of your obligation to a lender.
Real estate transactions usually involve the borrowing of funds. How much of your own funds you should contribute and how much you should borrow varies in every situation. Leverage rises as the ratio of debt to equity increases. Educate yourself on the basics of leveraging and seek professional advice to ensure you understand the implications of borrowing, interest rates and both positive and negative leverage.
Tax liability applies to income properties in two areas: taxation on operations (the rental revenue) and taxation on profits from sale. However, real estate can have many tax sheltering opportunities. A chartered accountant or taxation lawyer will be able to advise you on the tax liabilities and tax shelters that apply to owning an income property.
It is best to consult with your accountant or financial planner to adequately understand all the implications of owning an income property before you begin your search.
The rapport that you establish with a lender is key to your future financial success in real estate investing. When looking for a company or individual to handle your mortgage there are several points you should know:
- Ensure that your lender has experience with residential income properties and be sure you clarify how much of a property's income they will consider when determining your eligibility for a loan. Gain a comfort factor by inquiring about how this lender has dealt with other clients in similar properties. Whenever possible make personal contact with the decision-maker directly at your lending institution.
- Learn about the differences between banks, trust companies and private lenders.
Educate yourself on the different types of mortgage products that are available in your area (fixed rate, variable rate, open vs. closed, etc.)
- Understand what other products your lender has available such as chequing accounts, on-line payment options, line of credits, etc.
- Shop around for comparative lending rates and make sure that your chosen lender is competitive.
- Find out in advance what the penalties will be for an early discharge of the loan. Also find out about prepayment privileges, payment doubling and other mortgage features. Ask for a copy of the terms and conditions and be sure that you read and understand all of them. If you don't understand something ask to have it clarified.
- If you are dealing with a mortgage broker, find out what their commissions are in advance and who pays them.
- Develop a bond with your lender that can lead to larger future business transactions.
Once you have determined your goals and needs, found an income property advisor and established a rapport with your lender you are ready to work with your agent to develop a concentrated plan of attack. Start by having your agent search your local real estate board's listings as often as possible. There are many different ways in which income properties are listed on the Multiple Listing Service (MLS®) so ensure that your agent is are being thorough in conducting searches.
Look for listings with multiple kitchens and bathrooms and always check both residential and commercial listings. Challenge your agent to determine an innovative campaign to find you the right income property. If you don't find what you are looking for you may ask them to call income property owners of certain target buildings in your area - you never know when an owner may be thinking of selling. In addition, you may want to place classified ads outlining your specific investment criteria.Network with other investors or other agents who specialize in income properties to increase your pool of resources. Be sure to visit as many income properties as possible that match your preferences and be prepared to present an offer quickly when the right income property comes up. The good ones move fast so don't miss your window of opportunity.
Finally, determine your timelines for buying, taking possession and tenanting your property and devise a critical path that fits in comfortably with your schedule. But above all - be patient. Locating a good income property may take time. Don't expect to wrap everything up within one month. And don't jump at a property that isn't great just because it's the only thing you've seen that's close to your goals. Think about how much you are learning every time you see a property that isn't right. You are learning how to tell the good from the bad. And when the right one comes along you will have a good frame of reference to make an informed choice and be confident that you are making the right move.To learn more please view our Situation Analysis on an investment property purchase scenario.
Working with an agent who is in the know with income properties will be invaluable to your search process. An agent who has experience with this market will understand your needs and desires better and will be current on the availability of this type of property in your area. Engage a real estate professional in your immediate area of choice who has extensive experience in the trade of residential income properties – ideally they will have the appropriate knowledge of landlord-tenant legislation, municipal by-laws, borrowing guidelines for income properties in your area, closing costs as well as a strong sense of market value for different properties in different areas. Ask for credentials prior to spending time with an agent. Request statistics on the overall state of the income property market in your area.
Once you have found a knowledgeable, experienced agent spend time with him or her prior to searching for properties to learn from them as much as you can about income properties (appraisal techniques, market capitalization rates, income analyses, city by-laws, etc.) Learn how your agent works (how they will send you listings? how often they intend to take you out to visit properties? how quickly they respond to your calls? etc.). Get a general sense of their work ethic and how well you will be able to work together.
Using the Internet to find an Income Property
There are many ways to search for properties using the Internet. These can be useful tools to begin your research of different areas and property values. But when it comes time to seriously enter the market, do not try to avoid using an agent to buy a property. Often many properties move quickly and are not made available to the general public. If you rely on searching listings found on the Internet you might miss opportunities. The best properties never make it on to consumer listings sites – they simply sell too fast. Also, the most current information on a property is not in the Internet. Often properties are reduced in price or even sold but this information takes days to be updated on the Net – or sometimes it may not be updated at all.
Income property agents will always be on the cutting edge of what’s happening in your city’s residential income property marketplace. Remember in most cases as a buyer, your agent’s fee is paid by the vendor of the property you buy. Your selected agent will be crucial to drawing up a favorable offer and negotiating a strong deal on your behalf. Educate yourself on who are the leading income property agents in your town and contact them as soon as possible to get their expertise working for you. In Toronto, contact Plex Realty, Toronto’s first residential investment brokerage.