Articles
2008-06-05 - Buying A Rental Property? - Some Facts
It may take you some time to locate a good income producing property, and you don’t want to be pressured into buying a property, or building a property, which is close to your goals, just because that’s all you have found so far. You want to make sure that you are making the informed choice, and to do that the following 10 tips can assist you in doing just that.
1. The property should be visually appealing or have the potential to be appealing with a few cosmetic improvements.
2. The property should be close to public transit or have its own parking. It should also be located near other apartments. You want to anticipate problems, like resist the temptation (even if permitted by the city) to build student housing among single-family homes.
3. The property should be zoned for the number of rental units that you have, and the construction should be done with the necessary permits.
4. The property’s major systems should be working properly, and make sure you put a condition in the offer to conduct a building inspection. Make sure you have easy access to key parts of the heating or electrical system, for example they are not in tenant’s apartments. Some important questions that you need answered include: Does the heating system use a boiler or forced-air gas? Is the plumbing copper or galvanized? Is the wiring aluminium or knob-and-tube, which could be a safety hazard?
5. The property should have a hydro inspection and a fire safety retrofit, which should be included in your offer.
6. Try to meet the tenants when you visit the property, and ask them if there is anything that needs repair or anything they don’t like about the building. A conditional clause about repairs can also be placed in an offer, and this will help protect you from unexpected demands from tenants after the deal closes.
7. Really go over the numbers to make sure you are getting a good return on your investment. As a tool, you can calculate the capitalization rate (cap rate), which is the building’s net operating income divided by its purchase price. From the buyer’s perspective, the higher the cap rate, the better the deal. In Toronto today a 6% to 8% cap rate is considered good, compared to an 8% to 10% cap rate, which in past years was traditional. This is due to the appreciation in real estate values.
8. Ask the seller to participate in the financing. Use only borrowed money, with a line of credit on you home for the down payment. You can negotiate with the vendor to take back a small second mortgage, worth 10% to 15% of the purchase price, amortized over 4 to 6 years. At a 10% cap rate, you can make this work, and once the second mortgage is paid off, your monthly income will increase.
9. Buy one property a year, and once the second mortgages are paid off, in 4 to 6 years your monthly income will increase each year.
10. Get a second opinion. By bringing someone you trust when looking at the properties, such as lawyers, tax advisors, investment analysts or even family members, simply to obtain another perspective.
Data compiled from The Toronto Star, February 5, 2006.
