There are several important factors to consider when buying a property with the intention of renting it out and going to the long term gain or selling in a more favourable real estate market. At the end of the day, it’s very much a game of numbers that either work for your goals, or don’t.
You will likely to have a minimum 20% downpayment on a rental investment. In an ideal scenario, you would be cash flow positive when purchasing an investment rental house. Meaning that your monthly cash flow is higher than your mortgage plus expenses. For investors buying in Toronto today, it’s more common that they have a negative cash flow but are hoping for the benefits of equity and long term appreciation in value. Tenant rent can pay a portion of the mortgage and help to build equity. For long term appreciation, there may be years that the property doesn’t appreciate at all, but the goal is that over years the market will increase.
The majority of financial lenders will take into account approximately 80% of the rental income anticipated when calculating what you can afford. With this in mind, you may qualify for a larger mortgage. Some lenders will only consider rental income from properties that have legal apartments.
Incidentals: There will be a variety of expenses in addition to the monthly mortgage and standard expenses (utilities, property tax, house insurance). You have to factor in renovation and improvements; possibly a leaky roof or the need for a new furnace. These are expenses that you can not always plan for, but need to have funds available for the ‘what it’ situation.
Rental Income: Is considered taxable so taxable so it would be added to your annual income. Fortunately you can write off a lot of expenses which helps bring the profit down.
Capital Gains Tax: Is calculated when you sell your investment property. You will likely have to pay 50% of your profit to capital gains tax. This means that after you have deducted selling expenses, 50% of the profit you make will be added to your annual income and taxed at your regular income tax bracket. Clearly, it’s more important to speak with your accountant to determine your individual tax situation.
Many people choose this option, especially when they need the extra rental income to afford the mortgage. It’s a creative and smart way to get into the real estate market. Living in the house makes it easier for you to be present for your tenants and quickly address any issues that may come up. There are a few financial factors to consider. One point that many people don’t realize is that if you live in less than 50% of the house then you may have to pay capital gains tax on the entire house. Keep in mind, capital gains are calculated on your profit less expenses. Also, from a financing perspective, if the property is your primary residence, it’s unlikely the bank will include rental income in your mortgage approval. That said, if you have appropriate leases in place and documentation to substantiate the income the bank may consider up to 80% of the income towards your mortgage approval. It’s worth discussing with your mortgage broker.
There are so many factors to consider when considering purchasing an investment property. Get in touch!