Today’s topic is income properties – are they a good thing, and what about considering them for first time home buyers? Richard Woodbury from Halifax is a freelance writer who contacted me a couple of years ago about a feature article he was writing for Metro newspaper.
Here are the questions Richard asked me and the answers I provided. It’s just as relevant today, though it’s very hard to find a pay-for-itself rental inside the 416 area code, and mortgage lending guidelines are tougher today for rentals than they were in 2012.
I like this idea. It’s a great way to accumulate wealth at reduced cost and risk. You are building an asset over time, while servicing the associated debt load and operating costs from rental income. It’s very important to choose the property wisely. Talk to people who are doing it already, learn what works and what does not, and consult knowledgeable realtors to select home type and location.
You need to select and maintain your tenants with great care. A good tenant is worth their weight in gold. Unfortunately, many investors have had negative experiences where their investment properties are in disrepair when the tenants move out.
You are not guaranteed a monthly income from the property – if the rental market slows down, or just for the times when you are in between tenants, you will have to cover the operating costs from elsewhere. Unlike your principal residence, where any gains upon sale of the home are tax free, an income property can trigger taxable capital gains upon disposition.
Also, in recent months, many mortgage lenders have turned a cold shoulder towards investment properties – in some cases, it may now be easier to qualify for a mortgage on a rental property as a first time buyer, than as a homeowner who wishes to invest in additional real estate.
I’m not sure they have a greater risk tolerance – arguably it’s less risky than simply owning outright. In my experience, investors in income properties have a certain hunger for maximizing their dollar, and they work harder than others in looking for ways to make more money from their limited resources.
Unlike buying a principal residence, mortgage lending guidelines are tougher when you are buying a pure income property. You can forget about 5% down – normally you’ll need at least a 20% downpayment. And your income from all sources must be able to service not only the rent-adjusted mortgage on the income property, but also your existing home costs and any other debts you may be servicing. Many investor/homeowners take out a home equity line of credit on their principal residence, and use that money to come up with the down payment on their income property.
That said, some people who do not already own a home may buy an income property for as little as 5% down if they choose to live in it too. Example, maybe they will live in the basement and rent out the upper floor or vice versa. Then it’s quite possible the lenders would look at this as a straight home purchase.
As long as they have their downpayment and closing costs and some contingency funds on hand these resources should be sufficient.
In my experience, not many first time homebuyers do this – the desire to live in and own their own home seems to outweigh the practical financial advantages. If you are a first time homebuyer and you do this, you may be giving up privacy and your perceived independence. Having said that, I know several of my clients who have done this in one way or the other, and in each case it has worked out very well. I see it more often with single people than couples and families.
For some buyers, it might be the only way they qualify for a home purchase, since many mortgage lenders will allow you to include a percentage of the rental income in your income – thus qualifying them for a mortgage when their salary alone is not enough. I have one client who bought a four bedroom home in Richmond Hill five years ago as a first time buyer, and rented out three bedrooms and the basement. She lives there rent free, and she has converted equity of $30,000 into $250,000 over this period of time.
Another client bought a triplex in Waterloo four years ago, and she lives in one of the units rent free, while renting out the remainder of the house to students. Her gain is over $100,000 so far.