Welcome to Million Dollar Journey! If you're new here, you can learn about me and even follow my net worth updates. A great place to start reading is with the popular articles located in the right side bar. If you would like to join thousands of others and keep up with the free daily updates, you can subscribe to the RSS feed via reader or E-mail.
Criteria for Purchasing Rental Property
Any real estate investors out there? I started in the whole real estate game when I graduated from University in 2003. My wife and I bought our current primary residence in the summer of 2003, and our first rental property not long after.
Let me just tell you that being a landlord is like having a second job, and not always fun at that! I’ve had to deal with all kinds of tenants - from very good to insanely bad. The type of tenant that you pick to live in your investment will make a world of a difference. Point being - be picky over your tenants.
Anyways, back to the point of the post, my criteria for purchasing rental property. I have some set rules that have to met before I purchase an investment property.
These rules include:
1. The property must be cash flow positive.
- Find out what the market rent is for the area, you can typically find this through real estate agents, other real estate investors, or simply by viewing the rental listings in your newspaper.
- Subtract this by the expected expenses with the rental property. Some expenses include: Mortgage, property/water tax, insurance, maintenance, vacancy, and property management costs.
- Your CASH FLOW must be positive from day one.
- If you live in a very expensive housing market and rents don’t cover the mortgage, then I would suggest not becoming a landlord. It simply doesn’t make sense to purchase a property in the “hope” of appreciation. It will only be a matter of time before the property will suck the life out of your own cash flow.
2. Nice neighborhood with low vacancy rates relative to the rest of the city.
- From my experience, it is ideal if you own a house in a nicer neighborhood because you can charge higher rents with lower vacancy rates. I have also found that nice houses attract nice tenants.
3. I prefer houses that are in good shape and move in condition.
- I’m personally not the handiest of people (getting better), so I would prefer houses that don’t need a lot of work. I don’t mind buying home that need minor cosmetic changes (paint, cleaning etc), but no major work.
4. I prefer to buy houses that are under market value.
- You all know that I’m frugal, so I always look for a deal whenever I buy ANYTHING. Housing is no exception.
- Ways to find houses under market value - landlords who are sick of being a landlord, houses that need cosmetic work, pre-foreclosures, foreclosures, and listed houses that have been on the market for a while. I could go on and on about this topic, but that is beyond the scope of this article.
For you real estate investors out there, what is your criteria for purchasing investment property?
If you enjoyed this article and would like to be notified when new money related articles are posted, you can have them delivered right to your e-mail inbox or to your blog reader absolutely free.
39 Comments, Comment or Ping
1. The Financial Blogger
Hi FT,
What kind of rental property do you have? a single home? Duplex, Triplex?
I’m actually thinking of buying a rental property and I also want to have positive cash flow on day one. I am starting to think that if I don’t put 35% cash down, it will not be profitable right away. However, I would like to buy the property with a minimum cash down, 30-35% is silly.
How much (percentage wise)do you suggest to put as a cash down?
Cheers,
FB.
Jul 5th, 2007 @ 7:56 am
2. FrugalTrader
FB, the rental property that I currently own is a single family home. I put 10% down on the property b/c I didn’t have a lot of cash at the time. If I had my time back, I would have put enough to eliminate CMHC fees. So to answer your question, if I were to purchase a property today, I would put a minimum of 20% down.
Jul 5th, 2007 @ 8:01 am
3. Q Cash
FT
I own a couple rental properties. One is a duplex (house with basement apartment). I have an excellent tennant who is very handy and does all the minor repairs and major stuff he just asks if it is okay and lets me know if there is a bill. When that mortgage was paid off, the house was a great investment and provides great cash flow.
I have another house closer to home with two apartments and a commercial outlet. That was a nightmare when I made the mistake of letting someone rent both the commercial portion and the residential portion. When the business faltered, I had to still collect rent on the residential portion and the relationship soured significantly.
I would like to sell the first property and develop the second property. I haven’t listed the first property because I am going to get hit with a big capital gain, so I am waiting until I get a handle on my income tax situation in “retirement”.
The second property would lend itself to a complete makeover and revitalization in line with plans for our downtown. I am waiting for the town to pass a Community Improvement Plan which will waive development charges and provide incremental tax incentives (I expect this within a year) and I will look at this in greater detail.
If I could do it all again, I would probably buy a monthly income fund or REIT and just keep reinvesting the dividends. A lot easier, a lot less time and headaches and now that I don’t want to do it anymore, easier to divest :-)
Q
Jul 5th, 2007 @ 10:09 am
4. FrugalTrader
Q, do you own any REIT’s right now? Which ones do you like today? I’ve been watching REI.UN which own commercial properties across Canada who have tenants like Walmart.
Jul 5th, 2007 @ 10:15 am
5. AJ - IAmFacingMillions.com
FT,
I’ve been wanting to get into rental units for some time, but various circumstances have held me back. After a recent divorce, I’m back to living in a rental myself. When I began house shopping, I quickly realized that I would not be able to afford the size and quality of home that I really want so I decided to downsize my shopping substantially and to deliberately underbuy (I am buying at about 60% of what I was pre-qualified for).
The idea was that this would be my first rental unit and I’d be the first tenant for a few years while I get back on my feet and build myself up to where I can buy the type of house I actually want. I put a townhouse under contract last week and I believe it pretty much meets all of the criteria you set above. And what better tenant could I ask for (myself) to start things off :) I’ve never been a day late on rent/mortgage, never damaged a place I’ve been in and in fact have done self fix-up and left many places in a better state than when I began renting :)
Jul 5th, 2007 @ 11:50 am
6. FrugalTrader
AJ, great story! Since you are single now, I think a good plan would also be to buy rentals, live in them, then buy another and move into it. Meanwhile keeping your old houses to build your rental portfolio. That is, if you want to have a rental portfolio.
Jul 5th, 2007 @ 1:12 pm
7. Warren
Great comments. I fell into the landlord gig when I moved out of my small studio to live with my girlfriend.
I have to agree that tenants can make or break the situation. My rental property is in a strata, with the fees that entails, plus a full time building manager. I think that this type of arrangement helps minimize the work I need to do, and includes a very predictable, regular expense (the strata fees). I’m an amateur handyman at best, and I feel the risk and work involved in being a landlord of a single family home (or duplex) is a little too much for me to handle.
Jul 5th, 2007 @ 2:16 pm
8. ThickenMyWallet
I have a strange question for the landlords- would you be willing to accept less rent from a tenant who is well-behaved, tidy and handy?
I would add avoid condos generally- you have no control over your expenses in that a condo board sets your monthly fees (which are rolled into the rent in Toronto).
Jul 5th, 2007 @ 2:32 pm
9. Mr. Cheap
I recently wrote an 8 part series about my foray into real estate investing (I won’t rehash it here - see my blog if interested), but I agree 100% with each of your points.
It’s actually surprising, but you can get cashflow positive properties in expensive areas (I got a cash flow positive condo here in Toronto), you just have to look for the areas where the prices are depressed and the rent is decent (Point #4 in the post)
I’m willing to accept a LITTLE more damage to the unit then you are (paint, repair holes, replace flooring - I’d even gut and replace a kitchen and bathroom if the price was right), but I expect to get a VERY good deal if I’m going to have to renovate (and I just hire contractors to do it).
Jul 5th, 2007 @ 2:35 pm
10. Warren
I generally price my place a little low when I’m looking for tenants, that way you get your pick. Trying to be greedy and price high is a recipe for disaster.
I’m from Vancouver and I heard recently that condo fees in Toronto were much higher, so I can’t comment on that, maybe its not such a great idea in that part of the country. In Vancouver we (as owners) vote every year on a budget, where the money goes, etc. Anything left over is held by the strata for use the next year, or for major projects, etc.
Jul 5th, 2007 @ 2:38 pm
11. Bootsie
My husband and I have two rental properties. As FT suggests, my husband lived in each of them prior to us buying our house.
Both houses are now student rentals (5-6 bedroom) and are cash flow positive with only 5% down and pretty large insurance premiums. In the early years, we were netting >$1k per house because of very low vacancy rates in the area. Fast forward a few years and things have changed. Many of the family residents in the area started to realize the profits that others were seeing and converted their homes to student rentals.
We’re still cash flow positive but barely. :( I agree that REITs would be a better bet. Mostly because, as Q Cash says, it’s easier to divest (which we would like to do now).
Jul 5th, 2007 @ 2:44 pm
12. Canadian Capitalist
I’ve never invested in rental real estate because I just can’t be bothered. I do have friends who are into rental properties and I always find the way they compute the rental yields strange. So, here’s my question to the landlords in this comment thread:
1. To estimate cash flow do you account for the possibility that the property could be vacant?
2. Is a positive cash flow enough, or do you look for an yield on your down payment that is at least equal to a GIC?
I have no expertise in this area, but my friends ignore (1) and (2) and claim that they are getting an extra $50 or $100 in their pocket.
Jul 5th, 2007 @ 3:00 pm
13. FrugalTrader
ThickenMyWallet: If the tenant was guaranteed to be good (you know them personally), then yip, I would definitely give them a discount.
CC: The way that I structure my deals is that I ensure that the property is cash flow positive. With that established, I personally look for a minimum of $100/month/unit of profit after all fees (not including vacancy).
For me personally, I’m making around $250/month on a $12k down payment, which works out to be an annual dividend yield of 25%. This is a bit on the high side as the down payment is low. I expect my yields to be a bit lower in the future as I will put more down.
Another note that although being a landlord can be highly profitable, it is a second job if you have bad tenants. Find good tenants will make a world of a difference.
Jul 5th, 2007 @ 3:13 pm
14. Mr. Cheap
CC: Its a little bit tough to give an absolute ROI for real estate. Cashflow is important, but there are other ways you get money out of your property (tax considerations, appreciation, buying at a discount, selling at a premium, etc, etc). If I was deciding whether or not to buy a property, I definitely would take vacancy into consideration, and would probably want to be doing better then prime on the investment (I’d want more then beating a GIC). In terms of monthly cashflow, I may or may not take these into consideration (I lost money a last month when I replaced a dryer, but my tenants are on a least for another 10 months or so).
Jul 5th, 2007 @ 6:21 pm
15. GlobexInvesting
Yikes - real estate investing makes me uneasy. In Toronto, the cap rates are now below 8%, and in many cases even at no vacancy and not counting unforeseen repairs, it is very hard to even pay the mortgage with your rental income.
The selling prices of non-rentals has gone up so much that it has actually dragged rentals along for the ride, but rents themselves have not really increased! As a result, you can rent a 2 bedroom apartment in downtown Toronto for $1000 a month, but if you are trying to rent a newer condo (basically a glorified apartment) you’re paying about $1500-2000 a month instead! Therefore, some people are having a hard time renting their units and there is the talk of a bubble forming in the condo market (though I still don’t see how Vancouver hasn’t burst yet - that condo market is even hotter). It is definitely a good time to be a renter - very low rents in Toronto now (in older ‘apartments’, not condos) relative to purchasing. Basically, rents are at the same level they were at 10 years ago, but buying a place has gone up at least 50% over the same period.
Jul 5th, 2007 @ 6:53 pm
16. sam
investing in canadian REIT index through ishares..
i was wondering about investing in REIT…a few questions ..if some one could answer..
1) would REIT’s be affected by nex tax changes for Trusts.
2)REIT pricing would it reflect real estate sentiment or stock exchange sentiment..
any further advice/expeiences on REIT investments would be welcome
thanks in advance..
Jul 5th, 2007 @ 6:57 pm
17. FrugalTrader
Sam:
1. REITs are safe from the tax changes (for now).
2. God only knows the answer to this one. I would say it’s a factor of both.
I will write about REITs next week.
Jul 5th, 2007 @ 8:15 pm
18. Q Cash
FT
I don’t currently own any REITs although I have my eye on a couple to add to my portfolio REI is one of them. But, with my current portfolio heavy on realestate (in real numbers), I am hesitant to head there right now.
I do like the idea of the ishares index, but I haven’t done too much with the ishares (yet, they may be my first foray into leveraged investing — still don’t have my wife’s blessing ;-)
Q
Jul 5th, 2007 @ 11:30 pm
19. FinancialJungle.com
A few random thoughts
* My preference is still REITs over direct ownership of a property. Since landlording a second job, I’m basically earning a salary rather than passive cash-flows from REITs. Most REITs have yields > 5-year fixed, and they’re diversified and managed by professionals.
* Is positive cash-flow enough though? If I have a 100% down payment, any house in the city can generate a positive cash-flow. An investment should stand on its own merits independently of how much down payment one has.
* How does one manage taxes when he moves into a second home, and rents out the previous one? For instance, say he’s mortgage-free. If he refinances to take out a loan against 80% of the equity to buy the second home, the borrowed money is used to buy a primary residence, which doesn’t quality for tax-deductions.
Jul 6th, 2007 @ 12:22 am
20. FrugalTrader
FJ: Great points! Landlording is definitely more involved that REITs, but buying investment properties @ great prices can yield huge results. But again, it requires a LOT more work to own properties. On top of that, people use leverage to purchase investment properties b/c of the tax benefits, it’s not very often that you’ll see an investor use all cash to purchase a property.
Great points about the tax deductions when changing primary residences. You are right, when you borrow to purchase a primary residence, the loan is not tax deductible. Probably best to talk to a tax professional to advise on the situation.
Jul 6th, 2007 @ 9:05 am
21. Mr. Cheap
FJ: Very good points. I was going to comment on the amount of down-payment to make it cash-flow positive. Basically I want any property I buy to be cash-flow positive by MORE then what I’d earn if I was GETTING the mortgage rate instead of paying it (e.g. if I made a downpayment of $20K and my mortgage was 5.69%, I’d want the property to be over $95 / month cash flow positive. So if I bought a property outright, I’d want to be getting about a prime level cashflow ROI.
Borrowing 80% out of a investment property to buy a principle residence wouldn’t be a very tax efficient approach (since, as you say, the mortgage wouldn’t be tax-deductible). You’d be better to either get the mortgage (or not pay it off) while you’re living there (and I believe it would then become deductible when you moved out and turned it into an investment property), or else spend the minimum of the 80% on a downpayment on the new house and invest the rest (and your accountant will hate you).
Jul 6th, 2007 @ 9:23 pm
22. Jason
How does one determine market rents. Do you use the Canadian equivalent to MLS?
Everyone keeps talking about how hard it is to land lord, what about property managers? It may decrease your profit margins, but if you can manage to find a good one, then your life will be allot simpler.
As for REITS, i like them, but they aren’t real. I think its a good idea to have a mixture of real assets and paper assets. The stock markets can take a dive just as easily as the real estate market. That’s why I like the idea of having some money in natural resources like gold too.
Disclaimer: I am in school now, so I don’t actively invest. I fully intend to when I am done.
Jul 11th, 2007 @ 4:35 pm
23. FrugalTrader
Jason, property managers around here take 50% of the first months rent, then 10% a month. In terms of finding market rent, you can generally get a feel for this by looking in the newspaper classifieds or craigslist for your area.
Jul 11th, 2007 @ 8:07 pm
25. J at Home Finance Freedom
Hello. FT or others wondering about the best downpayment might want to look at the numbers I crunched in “Inflating Leveraged ROI Can Ruin You” (click name link if interested). Thank you.
Aug 4th, 2007 @ 4:08 pm
27. Connie
Buying a rental property and becoming a landlord is not rocket science. I bought my first primary residence with 5% down, (it was cheaper than renting). When the market went up I took the equity out and bought a 2nd home. This one had a basement suite so I rented the 1st one out and the suite. The rents paid both mortgages and I lived rent free. Market went up again so I did it again, took the equity out and bought the 3rd house. Rented out 2 of them and that paid all 3 mortgages, the 2 new purchases I put 20% down to avoid CMHC. Just sold the 2 rentals and put over 500k in my pocket. Now it is income tax time and I have a sizable capital gain so I am looking at super flow thru shares. If you are in a hot rental market it is a no brainer. I did all this in 2 1/2 years following a ugly divorce which left me starting from scratch.
Oct 29th, 2007 @ 11:40 pm
28. FrugalTrader
Connie, you’re like the super real estate investor mentioned in the last money sense magazine.
Oct 30th, 2007 @ 9:04 am
29. Connie
I haven’t read it but I must say just about everyone I spoke with while I was buying told me I was crazy…I was gooing to lose my shirt. The way I looked at it, I only had my original 10k down payment invested, if the market went south I would have to let the bank foreclose, my credit would be no different if they took back 1 house or 3. On the other hand if the market continued to soar I stood to make a good buck. At the time the fact that I was living rent free was the most appealing part of it. I am in a very hot real estate market, last I heard we have the highest rent in Canada and an average home is approx 600k. So yeah it is a bit of a gamble and you for sure need to find a “deal” but they are out there. I don’t look at the house per say but at the rental potential. I have had numerous renters most of which have been very good, the odd bad apple. Like someone mentioned earlier I had one renter who was a Mr. Fix It so I cut him a deal on rent to maintain all 3 as I am not handy at all. Now I am actively searching in another market to do it again.
Oct 30th, 2007 @ 10:43 pm
30. Connie
I found it amazing how once you have 3 mortgages the bank treats you completely different. Now when they need a signature they bring the paper work to my office. No more waiting for appointments. So it is true money talks…kinda sad
Oct 30th, 2007 @ 10:49 pm
31. Steve
Hi Connie, I as well went down a similiar path, divorce,3 rental properties,banking stories… however still have one left. I’m also exploring the superflow share route as well… mineralfields out of toronto….for tax advantages and cpaital gain offset…does anyone have any information or thoughts….thks in advance
Dec 19th, 2007 @ 9:42 pm
32. Spydergc
Ill be graduating this April and will be starting a fulltime job. I know I cant afford to buy a place yet until a few years so I will be renting out. The rental property and portfolio game is interesting. How much work is it as I do not want it currently to interfere with my main source of income that is employment. I’m looking to buy my first place, live in it then rent it out if its worth it, get a new place and so on and so on, thus building a portfolio of properties. Is there another detailed article on the Toronto area landlording scene? Advice would be greatly appreciated.
Mar 25th, 2008 @ 5:07 pm
33. JR
My expeience in REI began way back when I first came to Canada.
Working for just above minimum wage in T.O, me and the new wife of one year bought a rooming house after being in Canada one year, We came with almost zero, and scrimpped every penny for the down payment. It was the late 60’s when we did this, the house was old, in fact it had 5-rooms in a 3-story link house circa 1918.
We lived on the main floor, living room, kitchen and one bedroom. The basment was not rentable, too low ceiling, we used for storage and the bath stall was there
The rooms were rented weekly and the cash flow was positive from day-one. Saving the cash flow (never paying off the mortgage even back then) and taking our net wages, me and the wife after one year delved into small discounted second mortgages, that we got for 80% of there value.
We ran the house for 7-years, traveled extensively using every opportunity (we were DINKS) limited by long weekends and annual vacations from our employers We did night classes to get those degree’s (took 10-years before the first child came along), but thats not what this is all about, thats another post for later.
Through the years we have had several rental properties, never more than two at any one time. We have never owned single family units for rental purposes .. doesn’t make any sense.
It got that we would buy the fixer uppers, got take back mortgages from the seller and we gave or should I say held short term seconds on them when we flipped them, generally holding for no more than 1-2 years.
Please understand, my version of REI is not everyones cup-of-tea. The rules we have used for REI are infact esier today than when we first began back in the late 60’s.
Current property in Oshawa (and I always advise owning rental properties in small to mid sized college towns and cities). This property was purchased 3-years ago for $125k, the market appraised value was $140k. We did the roof, fixed a few things. The Oshawa property we called our primary residence, since the home we lived 10km away we say we pay rent to our free-loader daughter that lives there also (tax planning)
1. Our REI is always to have a property with max leverage, 100% or better, and why, because you can always walk if there is a problem or the market down-turns. In other words, we dont care if its 100% mortgage with full posted rate, as long as we can positive cash-flow.
The idea always is to have minimum risk, zero down (yes its possible in Canada)and take the cash-flow for other investments. At some point along the road, I advise folks to set up a numbered company when doing this for tax reasons.
2. On the current property, the income is $2400/mth (6-rooms), after paying the mortgage and all expenses we net $1000/mth. Our mail goes to that address, even though we dont bunk there. Our drivers licenses show we also reside there.
The property is maintained by a bossman, he collects all the rents and pays us one amount. He can charge whatever he wants. Yes the house complies to fire code, we did that.
Apr 6th, 2008 @ 1:34 pm
34. MAC
Hi
I will be purchasing my first real investment propertey soon. The price is ~249K and is expect to generate ~8%net.
I have 2 options
1) A relative can lon me the money for 3%, but i wont be able to use the intrest payment as enxpense
2) i can finance the whole amout using a secure line of credit at prime (4.75%)
I also have some cash to use towards the property.
What should i do, what would you do
MAC
May 6th, 2008 @ 4:40 pm
35. FrugalTrader
Is it a tax rule that you can’t deduct the interest paid to a relative for business? Perhaps it’s because your relative doesn’t want to report the income on their end?Regardless, borrowing money from family can be messy (imo). In addition, it may be a better deal if you use your own line of credit at current rates. If you are in the 40% tax bracket, your net interest after tax return would be: 2.85%.
May 6th, 2008 @ 4:47 pm
36. pearlygirl
Hi!
Enjoying reading this very much! I started, luckily, in the property market at the bottom where I live. Have moved several times, each making money (first one doubled in 5 years!) until a few years purchased second proprty and rented out my house. (Current joke of friends is “where are you living now..in your trunk?” I tell them I am doing research for my book…”If you have to spring clean you might as well move and make money” ;)!)
Biggest plus is watching the value of house increase 50+% over the past 3 years! I know, it can certainly go down from there but…looking at this capital gain at some point being split to purchase more rental property….much better than a second job!
Recently however, I did run into a wall as I do use CMHC. BEWARE! CMHC has DRASTICALLY changed the way that it assesses your rental income! That house that I was talking about, based on market value had enough value in it that I was going to take on another property by increasing the mortgage on the house to completely pay for the second. Originally banker agreed thinking it a great idea to have one property completely mortgage free….with the rental house holding the full amount (don’t forget about write offs with the rentals…interest on mortgage!) Based on what we knew at the time, banker didn’t envision any problems at all.Then I got the frantic call to not do anything until I called her! Turns out CMHC has changed from being able to look at 70% of the rental income down to about 15% based on a complicated formula! That hurts! So current plans on hold…thank you US subprime mess!
Just thought anyone reading might want to investigate further if using CMHC for purchases.
Keep up the great blog!
May 18th, 2008 @ 12:30 pm
37. FrugalTrader
May 18th, 2008 @ 12:50 pm
38. nobleea
Quick question, does the term cash flow positive include or exclude the principal portion of your mortgage payment? I assume it includes it.
For example, if your mortgage (P+I) is $1000 a month and taxes, condo fees, insurance is another $300 a month, you should rent it out for at least $1301/month. But if $400 of the $1000 mortgage payment is principal repayment, are you cash flowing $1/month? Or $401/month?
Jul 18th, 2008 @ 8:30 pm
39. FrugalTrader
Jul 18th, 2008 @ 8:55 pm
Trackbacks
Reply to “Criteria for Purchasing Rental Property”