Creating wealth long-term is tricky. Do you invest in life insurance? In stocks? In RRSPs? In real estate? If you’re thinking of investing in real estate, do you look for a home to buy low and flip high? Or, do you look for a home that has income potential with multiple units you can rent? In this article, we’re going to compare real estate investing and the potential investment income you could reap if you play your cards right. But, before we do, there are a couple of other things to think about first.
Like, how does a mortgage for a rental property or income property differ from a primary residence?
When you buy a home for the purposes of renting it out, the minimum down payment you can have is 20% whereas, when you buy a home as your primary residence you need a minimum down payment of 5% so long as you qualify for mortgage insurance like CMHC.
You’ll also find differences in interest rates as well.
When you secure a mortgage for a rental property that has 1-4 units in it or you’re thinking of creating 1-4 units in it, the interest rates aren’t going to skyrocket. It will, however, be more difficult to qualify for that mortgage in comparison to a mortgage for a primary residence. However, if the property you are looking at buying has 5 or more units, you’ll need a commercial mortgage for that property which comes with a substantially higher interest rate. It’s also important to note that some lenders don’t even offer investment property mortgage loans at all. This is partly why you’ll want to work with an experienced mortgage broker to get the job done.
And, you’ll need to consider if you’re going to live in one of the units or not.
If you do live in one of the units and rent out the others, that means that the property is considered owner-occupied. If you buy a home and it’s owner-occupied you don’t need 20% down, you just need 5% -10% down depending on the total number of units in the home and so long as you can get CMHC. This isn’t a quick loophole though, in order to be owner-occupied you can’t also live somewhere else and just say you live there. You actually have to live there full-time.
Now that we’ve got the fine print covered let’s talk investment. Once you buy it, what kind of profit could you make if you rent the property versus selling it after you’ve renovated it?
Let’s say the home you are looking at buying for the purpose of renting it out is listed at $400,000.
You need a 20% down payment which would be $80,000 and about $15,000 for closing costs. So your investment upfront is a little steep being that you need to have $95,000 in liquid cash – meaning that it’s cash you can access by writing a cheque or getting a bank draft. It’s not money locked into long-term investments or any other inaccessible form.
Alternatively, you look for an find a fixer-upper home for sale that needs a little work. Let’s say this one is listed at $235,000. You still need a 20% down payment which would be $47,000 and about $10,000 for closing costs. That means you’ll need $57,000 in liquid cash to make the purchase.
At this point buying a property to flip it once you renovate is looking like the easier option financially. But, don’t forget that home may need considerable help to bring it up to code if it’s quite outdated and to make it attractive to potential buyers as well. So, if you were to put a budget on that renovation imagining it will need a new kitchen, new flooring, a little drywall work, maybe a little plumbing…we’ll round that up to be about a $100,000 renovation budget for this example. And, that budget you plan to add into the mortgage to finance it. That means instead of needing a mortgage for the original purchase price less your down payment ($188,000) you’ll need a mortgage for $268, 000 instead. Because you’re adding money to the purchase price to pay for the renovation, that means your down payment goes up as well. So, instead of $47,000 down, you’ll need $67,000.
Now, when you sell that home after you’ve renovated it you’re hoping that your $100,000 renovation investment in the property pays off and that you can relist the home to sell for about $450,000 given the current real estate market. Whereas the home you were thinking about renting, it has two rental units, one in the basement and one on the main floor. Given the current rental market in the area you’re thinking you can get about $1,800 per unit, so approximately $3,600 per month in rental income.
Which is more profitable in the long run? Let’s do the math.
The home you plan to flip by selling it after you’ve renovated….
Purchase price: $235,000
Renovation loan added into the mortgage: $100,000
Closing costs: $10,000
Total = $345,000
Upfront investment = $67,000
Actual mortgage amount: $268,000
Monthly cost including CMHC and property taxes is approximately: $1,400 per month
Profit monthly when sold for $450,000 less realtor fees (approx. 6%): $98,700.00
The home you plan to rent 2 units in…
Purchase price: $400,000
Closing costs: $15,000
Total = $415,000
Upfront investment = $95,000
Monthly cost including CMHC and property taxes is approximately: $1,600 per month
Profit monthly is approximately: $2,000 a month or $24,000 a year
Which is in fact more profitable? That depends on what your goal is, of investing, to begin with.
If your goal is to create an additional revenue stream for yourself to use to fund extras like a boat, a new car payment, or to zonk away into more RRSPs, perhaps a rental unit makes sense for you. However, if you’re wanting to create a nest egg for retirement, a lump sum you can put down on another property, or to fund a 6 month hiking adventure across Europe, perhaps flipping homes makes more sense for you. Whichever you decide, creating a long-term financial plan is essential to holding on to that wealth you’ve worked so hard to create. That’s where I come in. As your mortgage broker and your financial partner, I’ll help you review the options and define an investment plan that makes sense for you specifically. Give me, Darren Robinson, a call at 705-315-0516 and let’s talk. You’ll rest easy knowing that I’ve crossed the t’s and dotted the I’s to make sure you can lock down the lowest mortgage rates, the flexibility you need in terms of cash flow and that your best interests have been considered from all sides today as well as in the future.