We work with investor clients all the time and the journey to finding and buying a great income property often starts with the same question these days.
“Are there really still good income properties out there?”
The answer to that is yes, but not that many and it very much depends on the parameters of your search.
Let’s review what qualifies a real estate investment property as a “good one”, what’s changed over the years and how we help our investor clients find their next purchase.
Gimme the good stuff.
A “good” income property can be defined in many different ways, depending on what’s important to the investor.
- Some investors want a passive investment that requires very little management, so a “good” income property for them is one that they can largely ignore for years and let the market appreciate over time.
- Some investors are after the best possible exit result and look for real estate that appreciates the highest during their planned length of ownership, regardless of what the cashflows look like during ownership.
- Some investors can’t stand the idea of having to put money into an income property on a monthly basis and consider anything that generates positive cash-flow to be a good income property.
While different investors place different emphasis on the above options, the holy grail is of course a combination of all three. When we talk with an investor client about a “good” income property we’re talking about a place where:
- There are quality tenants who pay the rent, don’t trash the place and who stay for quite a while.
- The property itself shows great appreciation over time so that you’re building significant equity in the property based on market changes during ownership.
- The purchase cost relative to the down-payment, the cost of financing and the rental rates all combine to give you a positive cash-flow each month.
Before we get into where such properties are located, let’s review a couple of key points.
Put enough money down and anything is cash-flow positive.
Years ago, one of our agents was showing a condo unit and as he was waiting for his client, a fellow in the lobby asked him if he was a real estate agent. The man proceeded to tell our agent how he owned a dozen investment units in the city, including four in the building and how all of them were cash-flow positive. Our agent congratulated the investor and asked how he managed to do that despite real estate price growth exceeding rental rate growth and the man proudly told him he put down at least 50% on each property.
We still reference that story as it illustrates a very important point when it comes to investment properties. It is easy to have a cash-flow positive property if you put down enough money. If you paid cash for a condo unit and received one dollar above your maintenance fees and property tax obligations, you technically own a cash-flow positive property.
We’ve previously written about capitalization rates and how calculating cap rates for various investment property options is a great way to compare apples to apples by stripping out the down-payment or financing costs.
When we identify a “good” income property, it isn’t one we’ve made look good by requiring our clients to put down lots more money than other properties. We most often start by asking our clients how much of a down-payment they have available and then look to see where that down-payment is best invested.
That has become more challenging in recent years due to one simple reason.
Rents are up but so are all your costs.
We’ve seen a marked increase in the rental rates that can be charged in most markets in the GTA in the past number of years, but at the same time, we’ve also seen costs increase in many different areas.
The most impactful increase in costs for some investors has been the cost of financing. Variable mortgage rates are based on the bank prime rate, which in turn is based on the Bank of Canada overnight rate. Back in March, 2020, the rate was lowered to 0.25% as a result of COVID and concerns about the economy. We had two years at that rate and then in March, 2022, it started going up, and up, and up. From March 2, 2022 to July 13, 2023, it went from 0.25% to 5% and that made any variable rate mortgages go up with it.
For investors who had bought properties with as little down as possible and who choose a variable rate mortgage, this created the perfect storm. A high mortgage amount, with a rapidly increasing cost of financing. While rental rates did go up during the same time, it was at nowhere near the same level of as the cost of financing so many “good” investments became bad investments.
In addition to the cost of financing, the level of inflation has risen sharply in the past couple of years as well, meaning that everything related to the property has also increased. Whether it is a freehold or a condo property, the costs of owning and maintaining real estate has increased over the past few years.
With costs higher on a number of fronts, the key factors for what makes a “good” income property remain how much the property costs to buy (as that directly impacts how much it costs to finance it) and the rental rates that can be charged for the property.
Let’s discuss rental rates, shall we?
Oh wait, rental rates are mostly unknown.
One of the biggest challenges with general extrapolations of where the “good” income properties exist has to do with a major variable in the equation, namely rental rates.
This is because data around rental rates are disbursed among a number of different players and gathering any sort of accurate and timely data is quite difficult.
The Toronto Regional Real Estate Board regularly releases rental rate data, but it is focused on condo apartment rentals and doesn’t look much at freehold property rentals. This is due to the majority of rentals on the MLS system being condo apartments of defined types – 1 bed, 1 washroom, 2 bed, 2 washroom, etc.
When you start to get into freehold rentals, there are so many variables that impact rental rates, any averages are inaccurate or flat wrong. Ask us for how much a house rents on average and we’ll ask you how many bedrooms it has, whether it has a backyard, if there is a garage, if the basement is included and so forth.
In addition to the fact that the data held by organized real estate is quite variable, it is also only a portion of the rental data out there. Unlike homes for sale, which almost exclusively sell via the MLS system, many rentals are done privately or via platforms that don’t receive or track rental rates. For every property rented via MLS, who knows how many are rented by platforms like Kijiji or via signs on lawns or in apartment lobbies?
When we work with investor clients, we can determine likely rental rates for a specific property by looking at all the data sources we have available, but we can’t do an aggregate analysis to push our clients to one neighbourhood or area in particular. The data just isn’t available, so we have to focus our search for “good” income properties on a key factor we can determine.
The cheaper the purchase price, the higher the chance it qualifies as a “good” investment.
While there are some exceptions to this statement, by and large, if you buy real estate as a lower price than other comparable properties in different areas, you stand a greater chance of it being a “good” income property.
While rental rates do vary depending on area, our experience has been that the variability of purchase price is much more than the rental rate spread. While a home in Toronto may be able to charge more rent than a home in Ajax, the difference in rental rates is nowhere near the difference in purchase price.
Our starting point for conversations with investor clients is therefore a series of simple questions that lead to us identifying some good options that fit their criteria.
- What makes a “good” investment property in your mind?
- How much of a downpayment do you have?
- Are you willing to go to where the best return is? If not, where are you willing to invest?
- Will you invest in any type of residential real estate? If not, what types will you consider?
The above questions give us the ability to start focusing the search.
Consider an investor who has $150K for a downpayment, hates paying CMHC mortgage insurance fees, who wants to stay within a reasonable distance of their primary home in Markham, and who thinks condo apartments are terrible investments. Such an investor has a budget of $750,000, is limited to York and Durham region and wants a freehold property. Understanding these requirements means that we look to find a “good” income property within them – or, if that isn’t possible, showing the investor why their requirements don’t allow a purchase to take place and figuring out what we can adjust.
Once we have the parameters set, our focus becomes finding properties that fit those criteria, determining rental rates for those properties and analyzing the results. In some cases, investor clients shift their preferences as they understand the potential returns and in others they choose to move forward with a property that makes them feel comfortable, with a rate of return they find acceptable.
Despite the run-up in real estate prices in the past couple of decades and the increased cost of financing in the last few years, we regularly work with investors who are buying income properties that suit their requirements. We can find you “good” income properties that suit your comfort level, or we can help figure out what you’re willing to accept if the numbers work.
By helping clients understand the options based on their preferences, we are able to search for the needle in their particular haystack! If that sounds like an approach you’d be comfortable with, then don’t hesitate to get in touch with us.
