One of the most common questions we get asked on the team is “Where should I buy an investment property?” so let’s take the time today to answer that question.
The question of where to buy an investment property is a complex one and your particular situation is of course very relevant. Your financing options, budget, level of desired management, comfort with vacancies, tenant interactions – all of these play a big part in what makes the right investment property for you.
We can, however, talk in a general sense about where there are opportunities to buy an investment property in which the numbers work.
Let’s start with one core concept.
Multi-unit properties beat single-unit properties
This is true every day of the week, 52 weeks a year.
I have met many investors who proudly talk about their investment portfolio of X number of “units” they own, valued at X millions of dollars. While any income property is something to be proud of, not all are created equal.
Whenever you have a single-unit property, such as a single family house or condo, you run into three limiting factors.
- Vulnerability to vacancy
- Repetitive repair costs
- No additional income
Let’s go over these three factors quickly before we get to where to buy an investment property.
Vulnerability to vacancy
With a single-unit property, you are reliant, by definition, on a single tenant. Tenants lose jobs, break up, over-extend themselves and generally have the financial and life issues we all do. When there is only one tenant paying for your property, you can lose 100% of your income that pays the mortgage, utilities, maintenance fees and so forth. You are very vulnerable to any vacancy, as you are either fully tenanted (one tenant) or totally vacant (no tenant). With a multi-unit property, you are rarely in a situation where all of your tenants can’t pay their rent or need to leave their lease.
Repetitive repair costs
The second factor that makes single-unit properties less desirable is that your upkeep responsibilities (and therefore repair costs) are virtually the same as a multi-unit property with less income. If you own three single-unit properties, you can be on the hook for three roof repairs, three lawn mowing services, three foundation cracks, three AC units, three washing machines and so on. If you own a triplex with three tenants in it, you only have one roof, one lawn, one foundation, one AC unit and so forth.
No additional income
The final factor is of course the income levels. When you have a single-unit property, the level of rent you can charge is based on what your tenant can afford. With multi-unit properties you charge rent based on what multiple tenants can afford. Any house with a basement apartment is proof of this principle. A house with a separate basement apartment is worth more to many buyers because they can charge X amount for the basement and Y amount for the main/upper levels. The rent you can charge for X + Y is almost always more than you can charge for Z, which is the rent for the whole house. After all, how much is the basement worth to a tenant who is also living in the main/upper levels? It’s worth something for sure, but not as much as to a tenant for whom that basement is the entire housing option. With multi-unit properties, you have additional income at relatively low incremental costs. This additional income often means the difference between a good investment and a poor investment.
Our recommendation for the vast majority of cases is that investors consider a multi-unit property.
The question then becomes, where can one buy an affordable multi-unit property that is a good investment?
The options as of today
As of July 7, 2017, there are 117 multi-unit properties for sale in the GTA.
The prices range from $399,900 up to $8.6 million. Let’s see what you get at the low end and the high end.
Currently listed at $399,900, we have a duplex located in Oshawa at 272 Haig Street. It’s a legal detached duplex, bungalow style, with two separate units.
The rental income for the property is $1,915 per month according to the listing. With a purchase price of $399,900, operating expenses of just over $300 (monthly property taxes and insurance) the capitalization rate for the property is 4.84%.
From a financing perspective, the $399,900 purchase price means that with 20% down ($80K), you have a mortgage of $320K. At about $450 per month for every $100K of mortgage (for a principal and interest payment, amortized over 25 years), you are looking at a mortgage payment of about $1450 per month. With interest rates as low as they are, from your first payment you are paying more than 50% of that payment towards principal repayment.
So for $80K down, with about $6K more for closing costs (legals, land transfer tax), you own a property that is bringing in $1,915 per month and costs about $1,750 per month. Roughly speaking, you clear about $165 per month. Don’t forget that each month, your tenants are allowing you to pay down about $725 in principal on your mortgage. Add in some property appreciation over the years and you have a decent investment property.
Now let’s look at the high budget option.
Currently listed at $8.6M, we have 336-340 Jarvis Street. There are three buildings located in Toronto near Jarvis and Carlton Street, with 13 units total. No virtual tour for this one.
The rental income for the property is $37,750 per month according to the listing. With a purchase price of $8.6M, operating expenses of just about $3,600 per month, the cap rate for the property is 4.77%.
Financing for three buildings with 13 units is quite different than a two unit duplex, but in order to compare apples-to-apples, let’s assume the same approach as our lower end property. To be clear, the financing for this unit would likely be considerably higher as once you get over 4 units in a building (or buildings in this case), fewer lenders are interested and rates generally rise.
The $8.6M purchase price means that with 20% down ($1.72M), you have a mortgage of $6.88M. Using the same rate and terms as the duplex in Oshawa, we have a monthly principal and interest mortgage of about $32K. Again, we’re using the same interest rates, which means about half of that is principal repayment.
So with $1.72M down and about $340K in closing costs (land transfer for both Toronto and Ontario in this case), you own three buildings in Toronto that are bringing in $37,750 per month and costs about $35,600 ($32,000 mortgage payment, plus $3,600 in operating expenses) per month. That means you clear about $1,150 per month, plus the principal repayment your tenants pay for on the mortgage. These numbers are optimistic given the likely higher cost of financing.
With three buildings, this multi-unit complex still faces the same issue with three roofs, three HVAC systems and so forth. I would be much happier with the numbers on this 13 unit investment property if it was in one building rather than three.
From a cap rate perspective (which is independent of the cost of financing, basically as if you bought it outright), the properties are almost identical. You have a cap rate of 4.84% for the bungalow in Oshawa and a cap rate of 4.77% for the three building complex in Toronto.
Both properties cashflow positively on paper, but with the Oshawa bungalow costing about 1/20th the price of the three buildings in Toronto, the cashflows for the Toronto property should be much higher. Again, given the financing is likely more expensive than our apples-to-apples comparison, the cashflow numbers will get worse for the Toronto property.
We find that when we work with investors we see variations of this scenario happen quite often. The high price of properties in Toronto means that properties outside of the city are often better investments. Rents may be lower, but the significantly lower purchase prices often means the cashflows are still better.
This is shown by looking at the stats for the 117 multi-unit properties for sale today in the GTA. If we look at the properties that in Toronto proper (61 of them), the average list price is 1,934,511. Compare that with the 56 properties outside of Toronto, where the average list price is $912,259. That’s less than half the price on average. Are rents less outside of Toronto? Sure. Are they less than half the rent of Toronto? Nope.
While every investment property needs to be examined to consider how the purchase price, operating costs and rental income shake out, the lower the purchase price, the lower rent you need in order to have positive cashflow, the more vacancies you can tolerate and less of an investment you actually need to make.
With that in mind, our top three locations for multi-unit investment properties in the GTA are Oshawa, Whitby and Brampton. The combination of lower prices, reasonable operating costs and decent rental income means these locations offer investors the chance to get a good return on their investment.
If you or someone you like is considering buying an investment property, you need to work with a Realtor that is an investor themselves and understands what goes into making a great investment property. If that’s the case, please get in touch with us.