While real estate markets shift over time, we’re firm believers in the idea that owning real estate is a foundation of wealth if you do it right.  That may mean making sure your own home is a good investment, but it also definitely includes income properties.

Here on the Refined team, we love income properties.  Love ‘em!

• We love seeing a mortgage go down each month, paid for by tenants.
• We love seeing the property appreciate over time.
• We even love overseeing renovations that add value and allow us to charge higher rents and attract better tenants.

It’s because we love income properties that we get excited when we start working with a client looking at buying one.  If you’ve been considering buying an income property, we thought we’d share a quick way of assessing different income properties.  It’s called the capitalization rate, or cap rate for short.

Nice cap.

The cap rate for a property gives you a number (expressed as a percentage) that tells you how long it will take for the rental income from a property to pay off the purchase price.

The higher the number, the quicker the purchase price is paid off.

For example, a 5% cap rate means that every year, the rental income (less operating expenses) pays off 5% of the purchase price.  That means that in 20 years, the cashflows from the property have paid for it completely.

Let’s attach some dollars to the example.

Consider a property located in a smaller city outside the GTA that’s for sale for $600,000.  The property is triplex with three one bedroom units in it, which bring in $3,250 per month in rental income.  We have property tax, some basic building insurance, a property manager to handle the calls about problems (at 5% of gross rent) and then some funds for keeping the place up.  That totals $9K a year, which leaves us with net rental income of $30K.

On a purchase price of $600K, that $30K net rental income gives us a cap rate of 5%.

Note that the cap rate is calculated without taking into account the cost of borrowing.  This is done because every investor will have different options for borrowing.  Some may have the money to buy it outright, some may have a connection that will invest for 2% interest a year, others may need to borrow from banks or other lenders at hefty interest rates.

The cap rate allows income properties to be compared on an apples to apples basis.

Investors can look at a $300K single family home in Port Severn or a $1.6M multiplex in Toronto and be able to see what the cap rate will be for each property.

Now that we’re clear on how cap rates work, let’s get into the three rules to follow to make sure you choose a great income property.

Rule #1 – Multi-units Almost Always Beat Single-Family

Properties with multiple rental units in them (whether a bungalow with a basement apartment or a multi-plex with 4 purpose built apartments) almost always beat single tenant properties.  While it can be very easy to rent out a lovely home to a lovely family, the rental rates are not typically high enough to provide the same return as multiple unit properties.

In addition to the higher rental income, multi-unit properties also avoid the all or nothing problem that single family homes have for investors.  When you have a property with three or four units in it, it is quite rare for you to have more than one or two vacancies at a time.  Given you have to pay property taxes, utilities and likely a mortgage payment each month, having some level of income coming in to offset those costs is a very good thing.

While you could own multiple single-family homes to spread the risk of vacancies over your income property pool, you also then have multiple properties where costs can be incurred for issues.  Rather than one roof, one HVAC unit, one front porch, you have one for each of your properties and that means increased risk of higher maintenance costs.

Rule # 2 – The Greater Toronto Area means Greater Cap Rates

While properties in Toronto are certainly in demand with renters, the cost of buying the property means that your cap rate will likely be lower.  An income property in Ajax can literally be half the cost of a nearly identical property in Toronto.  While rents may be lower in Ajax, they aren’t half the rent of Toronto.  As long as you are careful to buy in a good location where you don’t have lots of vacancy, the lower rent can be easily made up for by the lower purchase price, which means a much better cap rate.

While you may not live close to an area that has the combination of lower prices and reasonably high rental rates, the math can be favourable enough to allow you to hire a property manager to properly oversee a place you purchase there.  Yes, you’ve got higher operating costs with a property manager, but the lower purchase price can make up for that.  If you ask us, removing the work of managing a property yourself at no effective cost makes a ton of sense.

Looking even further afield can result in even lower purchase prices, but be cautious you’re not buying in an area where rental rates are too low – or vacancies too high – to make up for the lower cost to buy.  After all, owning an income property with little to no income is not the goal!

Rule # 3 – Focus on the Negatives to get the Positive Returns

Some of the best income properties are properties that we would never advise a client to buy as their own family home.  Stigmatized properties – such as those backing onto power lines, fronting onto a busy street, or located beside commercial elements – can make fantastic income properties.

Buyers looking for their own home are often not too interested in such properties, which keeps the purchase price lower.  Tenants typically take shorter-term views than buyers and are often more interested in the utility of a rental (transit proximity, amount of space inside) than the long-term prospects for the property.

Make sure you don’t ignore issues with a property or neighbourhood that a tenant will care about just as much as an owner.  Homes in areas with bad schools are avoided by parents regardless of whether they own or rent, and health or safety issues with a property are legally required to be addressed by a landlord.  We work to find our clients the right mix of an appealing rental property with some aspects that make home owners shy away.

We really do love working with clients to find them income properties and we’d love to work with you to find a great investment property.  If that sounds appealing, then get in touch with us to discuss next steps!

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.

Given we’re based in Toronto and work with clients largely in the GTA, our approach to income properties is a bit different than smaller real estate markets where prices haven’t seen the same price appreciation over time.

The primary challenge with buying an income property in the greater Toronto area is that while the rental rates are high and vacancy rates are low, the cost to buy is high enough that it often doesn’t make financial sense.

Way back in 2016 we wrote about what makes a great income property and in that article we explained the concept of a capitalization rate, or cap rate.

While the cap rate is a great way to compare income property options, it’s worth noting two important things about cap rates.  They’re both fairly self-evident but it can be easy to forget them if you are just doing simple math and moving on if it doesn’t work.

First, if you buy for less, the same income generates a higher cap rate.

The first thing impacting the cap rate on a property is the price you pay to buy it.  Any property can be an amazing income property if the purchase price is low enough.

Secondly, if you increase the rental income, you increase the cap rate.

The second part of the cap rate equation is the rental income.  When you buy a property the income (or potential income) is what allows you to calculate your cap rate.  If you can do something after purchase to increase the rental income, you also increase the cap rate.

Yes, both of the above are obvious if you stop and think about how cap rate calculations work.  The implications are less apparent and there are ways in which you can structure your search for an income property that allows you to realize an improved cap rate.

Here are our three rules on how to buy an investment property so you get the best deal – and therefore the highest cap rate.

Rule #1 – No properties holding back on offers.

These types of listings are inherently competitive, which means that sellers and listing agents often do not provide all the information we should know about the property.  It is a function of our current market that buyers are taking huge risks on homes that may have serious defects.

As an investor in real estate for income purposes, you need to go into a purchase with as complete an understanding of the property as possible.  This includes information such as surveys, home inspections, permit and notices of deficiency review and much more.

Listings that are holding back on offers until an offer date are often priced below-market value to attract multiple offers and most sellers are expecting a clean offer with no conditions.

If you are constantly in competition with buyers who don’t have the same perspective and who are willing to overlook concerns (or missing information) that they shouldn’t, you will regularly be outbid by buyers with more money than sense.  The alternative is to overpay for a property which may have costly work to be done, resulting in a lower cap rate.

Rule # 2 – No properties that are fully renovated and in near perfect shape.

The principal behind this rule is an extension of the thinking behind Rule #1.

Properties that have been significantly renovated (or appear to be significantly renovated) attract greater interest from buyers who have no ability or willingness to do renovations.  As a result, they sell for a higher price and any current or estimated rental rates have already built in the impact of these renovations.  This is particularly troubling as we have no idea if the work that was done was to a high quality or whether the cosmetic updates conceal troubling issues with the home such as water leakage, structural issues or more.

The cap rate for such renovated properties could be higher based on the higher rental rate (on the assumption that a premium rental unit commands a premium rental rate) but the higher purchase price means that the cap rate is often the same or worse than a property that needs work.

In essence, the sale price that incorporates the renovations is often higher than a similar home without those renovations.  The end result is that the home costs more than the renovations actually are worth and it means that you have no opportunity to add value through doing some renovations.

Contrast this against a home that needs updates and work in order to show better and to command a higher rental rate.  Fewer buyers are willing to consider the property as many investors are looking for turn-key solutions and are not interested in a renovation project.  As such, the sale price is likely to be lower due to less competition.

At the same time, the rental rates (either currently being charged or estimated) are lower due to the lower level of finishes in the home.  By arranging vacant possession, you can do the necessary renovations to increase the appeal of the property and then rent out at higher rental rates to a better class of tenants.

A lower purchase price and a higher rental rate after our renovations equals a better cap rate.

Rule # 3 – No properties that also appeal to an end-user directly.

The attributes of a good income property can be quite different from the attributes of a good family home.

• As an investor, you want to be close or on transit routes to appeal to tenants who have no vehicle of their own.
• As a home owner, you want to be on a quiet side street where you aren’t bothered by the noise of buses or streetcars.
• As an investor you want as many units as possible within a property to maximize rental income while minimalizing potential replacement costs.
• As a home owner, you want a property that works for your family and gives you privacy and space.

Whether it is location or housing type, when you’re looking for an income property, you need to focus on properties that aren’t appealing to end-users themselves.  By doing so, you realize significant benefits, including a much higher likelihood of:

• Appropriate zoning (such as for a legal triplex)
• Renovations done with permits (properties with a history of being used an income properties have often come under increased scrutiny over time and required permitting for work)
• Legal secondary suites and registration with the local municipality

Individual or families buying a home have far different metrics for their purchase considerations and income properties typically sell at a discount compared to end-user properties.  If you focus on properties that are inherently less appealing to an individual or family who would live in it themselves, you reduce the level of competition, which should mean a lower sale price.

All real estate is bought and sold within the prevailing market conditions for the area, but not all properties have the same opportunity to be bought for a lower price and to increase the rental income from the property.

If we follow the above three rules, we have:

1. Sellers who are motivated to deal with our offer and who provide the information we need rather than simply sell to another (non-existent) buyer who doesn’t ask questions.
2. Properties that we can buy for less, where we can oversee some renovations after purchase that add value in terms of increased rental rates and valuation over time.
3. Properties we can buy at better prices as we don’t compete against emotional end-user buyers who drive up the price.

If you’re keen on buying an income property, make sure you work with agents who know and appreciate what it takes to find a good investment.  We look forward to hearing from you!