A lot of people have thought about getting income properties and never pursued it. Why is that?
Are you interested in getting Rental properties? The benefits of rental properties can be HUGE! Everyone seems to be always talking about having a “diversified portfolio” But what does that even mean?
Having a diversified portfolio is spreading out your investments to lower the potential risk of loss in one area. Basically, don’t put all your eggs in one basket. So why not diversify into rental properties? You’ve heard good things about them, haven’t you? High returns, good cash flow, someone else paying you Money.
What is Income Property?
An income property is any property that you or your business owns that you create income with. Income properties aren’t just Rental houses such as Duplexes or Multifamily homes, Apartment buildings or an Airbnb. There are lots of Income properties you may not have thought about. The income from buying, holding and renting out a property is what’s going to classify it as an Income Property.
So let’s dive right in and look at why Income Properties need to become part of your portfolio.
- Tenants will Pay for Your Mortgage
- Many Different Property Types to Make You Money
- You Choose How Your Property is Run!
- You can get Money Tax Free for Investing
- Your Property Appreciates
- You Can use CCA (Capital Cost Allowance) to differ Paying Income Tax
- Income Properties Create Cash Flow
- You Decide Your ROI (Return on Investment)
- Numerous Tax Deductions
- You Can Get Higher Returns Than the Stock Market for Less of YOUR Money
Tenants will Pay for Your Mortgage
The best part about having a Rental Property is that you don’t have to pay for it. You as the investor place a down payment of normally at least 20% and purchase the property. The rest of the money to purchase the property comes from the bank or lender through leverage.
The most popular mortgage for Income properties is a 30-year fixed-rate mortgage. With a fixed-rate mortgage, your interest rate is fixed for the term you have secured. This percent maybe 3%, 4% or maybe 6% but it won’t change for the term. This allows you to go through numbers based on the property and what your tenant will pay each month for your mortgage.
Allowing you to calculate your return on investment (ROI).
If you purchased an income property for $100,000 with 20% down ($20,000) you would have $80,000 left owing on your Mortgage.
If we assume you have a 5.34% interest rate like TD is offering right now your Mortgage payment would be $443.33 per month.
- Mortgage Amount: $80,000
- Equity: $20,000
- Interest Rate: 5.34%
- Monthly Payment: $443.33 monthly
- Tenant Payment: $1050
In this scenario, you can see right away that the tenant paying $1050 per month will cover your monthly mortgage payment of $443.33 leaving you with $606.67 after the mortgage payment. But that’s not the only expense that comes along with properties. Some people use 5% some 10% but the expense of repairs for the property needs to be accounted for as well as vacancy. Because there will come a time when you don’t have a tenant and the mortgage payments still need to be accounted for.
Therefore if we assume that 10% of our income will go into our repair account and 10% will go toward the inevitable vacancy our profit will go down a little bit. $606.67-$105(10% repairs)- $105(10% vacancy) you would have $396.67 each month in cash profit.
With an investment of $20,000 and generating $396.67 a month in profit is a good return on investment all thanks to the tenant paying for your mortgage. This is a simple example and there can be more expenses to take into consideration but it gives you a good feel for the income you can generate. Making a proper goal will help you to consider all the options available to you.
So Many Different Property Types of Properties to Make You Money
In the vast world of income properties, there are a lot of options to make money. Let’s take a look at how we can break down some of these options. The three biggest categories that can distinguish your properties are:
- Single-unit Residential Property
- Multi-unit Residential Property
- Commercial Real Estate
Single-unit residential property
A Single-unit residential property is one of the most common starting properties for investors. There are very strong incentives to start with a single unit property rather than a multi-unit property. Especially when starting out in income properties, there will be a learning curve. The benefits of starting with Single-unit residential properties is that typically, they are simpler, have less maintenance and are a lower cost than multi-unit dwellings or commercial properties. There are a few different types of single-unit properties and multiple ways to create income.
Single-family home
A single-family home is a single property with a single building that doesn’t share walls with a neighboring house. Being that the house is on its own lot typically the property will have a front yard and back yard. This is a great incentive for a lot of potential tenants as it gives them more space than an apartment. With this type of property being a house on its own it also tends to attract a long term tenant which is great because lowering your tenant turnover is always a plus.
Condominium (condo)
A condominium (condo) is a property that the unit shares one or more walls with neighboring units. These types of properties are normally cheaper than a single-family home because they lack some of the privacy that comes along with having a free-standing building. There are some other potential benefits to having a condo rather than a house though such as:
Some condominium complexes have pools, gyms or clubs that are available to the tenants. Also, a lot of the complexes have HOA’s (Home Owners Associations) which manage the complex and take care of those amenities as well as outdoor upkeep like snow removal, grass cutting, etc.
Townhouse
A Townhouse is a mixture between a Single-unit residential property and a condominium. Each house has its own area and a lot of times will have a smaller front and back yard for the tenants but will also share one or more walls with neighboring houses. Along the same lines as a condo, there are a lot of times an HOA that will take care of the outside of the complex while the tenant or landlord will be required to take care of the inside. Being a hybrid of the two types of townhouses tend to be larger than condos but smaller than single-family homes.
Multi-unit residential property
A multi-unit residential property is an income property with 2 or more units. Some owners will live in one of the units and rent out the rest of the units to tenants thereby paying for their mortgage as well as their living situation. These properties will normally have higher maintenance costs and purchase price in comparison but they also have more tenants to offset the cost of repairs and the mortgage. Being that there are more tenants you have greater potential for higher ROI. (Return on Investment)
Commercial real estate
Commercial Real Estate is normally overseen and purchased by more experienced income property owners because it will tend to be the most expensive and potentially can have more risk than residential Properties. Finding tenants who have businesses can be difficult in some areas and the buildings are normally much larger than a single unit.
There are different rules and zoning that affect commercial properties as well as potential renovations to suit tenants’ needs such as retail, offices, industrial or manufacturing needs.
Finding the right Property for you is what’s going to make the difference. There are a lot of types you can get into but they all have something in common.
You Choose How Your Property is Run!
Being that this is your own property you get control over what is going to happen with it. You are the one that will decide the rent. You decide who and what can or cannot be done inside or outside. All of which you can write up in a lease agreement and hold the tenant responsible.
If you want to hire property managers you can they can help a lot especially since they will take care of any calls or problems that may arise during the not so great times to be getting phone calls like at 3am. Property managers will also have a good non-bias screening for tenants to make sure you don’t have any problems.
Sometimes especially being the property owner if you need a tenant your own judgment may be swayed a little bit to find someone to start renting fast. With a non-biased outside manager, they can better suit the needs of your property by making sure a potentially bad tenant doesn’t get a chance to cause problems in the first place.
You also get the options of how to run your property in more detail like running an Airbnb, renting out a room rather than the whole property, the number of tenants or if dogs and cats are allowed. The list of options to make your property fit you is endless.
You can get Money Tax Free for Investing
This may seem like a silly idea but it’s true. If you’re thinking “how could you possibly get tax free money? There’s no such thing.” I wouldn’t blame you. But without realizing it most people already have tax free money and don’t even know it.
Tax-free money comes in the way of a mortgage. When you get a mortgage the bank is giving you money to purchase the property and even if its $500,000 you don’t have to pay tax on that $500,000 but, you do have to pay back the loan. This is where your tenants come in.
The coolest part about getting tax free money to invest with is that for most mortgages you will need at least 20% down. But, in only having to put a down payment of 20% you get 4 times as much money tax-free to invest.
So in our scenario from before the $100,000 property had a down payment of $20,000 and the mortgage left owing was $80,000.
$80,000 divided by $20,000 is 4.
4 times the money invested tax-free to increase your ROI. (Return on Investment)
To make a quick comparison, the Stock Market typically can grant you about a 7% per year return on your investment. So if you invested the $20,000 and had a 7% return, you would make $1400 in one year. Now with our rental property from before we were making $396.67 a month. $396.67×12(months) is a total return of $4760.04 a year.
$4760.04 is significantly more and it’s all because you got tax free money to purchase an income property.
Your Property Appreciates
Getting the profit from your income property every month isn’t the only benefit you get from properties. Your property also appreciates in value over time. The average appreciation is around 4% per year. So what this means is if you purchase a property this year for $100,000, in 1 year that property will be worth $104,000.
Appreciation is the direct result of inflation and supply and demand. Luckily for us, property prices continually appreciate and are worth more tomorrow than they are today. This also gives you options that you can use like borrowing against the equity of the house if you needed to for repairs or purchasing another income property.
Another great benefit to appreciation is that you don’t pay tax on the appreciated value until you sell the property and even then it is taxed as capital gains and receives special tax benefits.
You Can use CCA (Capital Cost Allowance) to differ Paying Income Tax
CCA (Capital Cost Allowance) or Depreciation as it’s called in the US is a tax befit of owning income properties. With our $100,000 rental unit, we had a cash income of $4760.04 a year. The government still wants there share and will tax that as income.
Investors can use CCA as a way to defer paying taxes by a certain percentage of property value each year. Properties wear out over time and this will cost the investor money. The CCA or Depreciation allowance is to help compensate for this loss but can only be used on the building because land doesn’t depreciate. So our $100,000 property will be split to perhaps $85,000 in building and $15,000 in land value.
In Canada, the CCA is 5% of the total UCC (Undepreciated Capitol Cost) meaning of your $100,000 property 5% of the building value ($85,000) can become a write-off against income.
This means you will be able to write off $4,250 (5% of $85,000) come tax time.
The next time you go to do taxes though you will only be able to write off 5% of $80,750 ($85,000-$4,250) because CCA only allows 5% of the total Undepreciated Capital Cost.
When you use CCA to defer taxes you keep more money in your pocket and can reinvest into other assets creating more value.
Income Properties Create Cash Flow
Purchasing income properties is an amazing way to create cash flow. Every month your tenant is paying you to rent for the property you own. The cash profit from this transaction is your cash flow. Just like going to work you get a paycheque every month, your income property will be paying you every month that you own it.
If you build a large enough income property portfolio, you can have a cash flow of thousands of dollars a month and you won’t have to invest a lot of time like you do going to work for 40 hours a week. This can allow you to start saving or investing more (but which one is better?)
With the $100,000 property, our monthly Cash Flow was $396.67. If you had 10 properties creating that much cash flow, you would be generating an additional $3,966.70 a month or $47,600.40 a year.
That’s how people start living off of their rental income. Slowly increasing the number of units you own and by using cash flow, you can be free to do more and still have passive income coming in from your rental properties.
You Decide Your ROI (Return on Investment)
Your ROI is a very important number to consider when you are making investments. Each Income property can have a different ROI but you get to decide on how much. Different factors affect your ROI such as how much money you use for your down payment. By having a smaller mortgage you will have a smaller payment every month which can increase your cash flow returns every month.
You can also add more value to your income property and be able to increase rent which will increase your ROI. For example, if you owned an apartment building and you added a laundry service to your building. You could increase the rent that all the tenants pay per month for access to the facility. The tenants will be happier that they no longer have to go to a laundry mat and you get the benefit of increased monthly income from the same property.
Another option would be for parking having tenants pay a fee associated with a parking lot can increase your income as well and help with the maintenance costs for the area like snow removal or fixing potholes. There are so many options available that you can use to increase your returns even before you purchase the property like having a bigger down payment or renting rooms to multiple students rather than a single-family. Being creative with your property can benefit you for years into the future.
Numerous Tax Deductions
Just like CCA, Tax deductions are the name of the game. The less money you pay in taxes the more money stays in your pocket. Lucky for you, you own income property.
CCA which is writing off the depreciation of the building, the legal fees associated with the property, taxes on your mortgage, repairs made to the property or renovations for the tenant’s needs. All of these are tax-deductible.
So by reinvesting into your property, not only do you increase the value of your investment but you also don’t pay tax on it. Depending on how you have your rent set up you will also be able to write off heat, hydro, your property taxes and all the other expenses that will take away from your income.
You Can Get Higher Returns than the Stock Market for Less of YOUR Money
Investments are all about making money and having good returns on your investment. No one wants to invest in something and lose money as Warren Buffet said:
“Rule No. 1: Never lose money. Rule No. 2: Never Forget Rule No. 1”
Warren Buffet has spent his career investing in the Stock Market and has accomplished amazing returns on his investments. He has significantly beaten the average Stock Market Returns for years. The average return on the stock market is around 7%.
So in our investment scenario where we are investing $20,000 what kind of returns would we be getting from each investment?
Let’s try and figure out what kind of ROI we can get from a potential Stock Market investment. If the average return on the Stock Market is 7% then we can easily conclude that your $20,000 investment would produce $1,400 a year.
Now, there are ways you can increase that return spending more time choosing a really good company to invest in can produce higher returns. So let’s imagine you are getting a 10% return our investment is now going to make you $2,000. Not too bad, but you want more, a higher ROI. Let’s chose a stock that pays out dividends. We will find a stock with a dividend payment of 4%. Now we make $2,000 from the Stock value increase and a dividend payment of $800 ($20,000 x 4%) giving us a return of $2800 in a year.
So to calculate the ROI we take $2800 divided by $20,000 and have an ROI of 14%. That’s double the average return on the Stock Market. Now let’s look at our rental property and see what the ROI is on it.
By investing the $20,000 into our property and using the bank’s money we are creating a cash flow of $4760.04 every year. Already we have created a higher return than the Stock Market and that doesn’t even include the equity created through mortgage payments. Just the cash flow alone will create an ROI of 23.8%
Putting It All Together
No matter how you invest your money there are options out there. If you don’t already have a rental income coming in, you may just want to start talking to some people and working to put rental income into your portfolio today.
By adding income properties to your portfolio you can take advantage of the better ROI the tax advantages and allow for a stronger diversification to your portfolio that not everyone gets to take advantage of.
Income Properties can also be a great investment for your retirement plan. Allowing you to relax and still make money. They are part of how my retirement plan is safer than yours.