Real Estate Talk:
Investing in income property

A sound alternative to stocks, bonds or funds for investment and retirement

By Joseph Marovitch

Updated 28-11-2018

For many people, income property is a wonderful alternative to stocks, bonds or funds for investment and retirement. The stock market can be very volatile and profits can come and go quickly. However, an income property, fully rented and in a good location, can produce income for years to come on a consistent basis. The most successful real estate investors rarely sell their income properties. The only reason to sell a profitable income property is to purchase a larger income property or retirement. In many cases the income properties are passed on to children or partners.

The stock market can be very volatile and profits can come and go quickly. However, an income property, fully rented and in a good location, can produce income for years to come on a consistent basis.

Definition

An income property can be 2 or more units providing income to the landlord via rent from the lessee (Tenant) to the lessor (Landlord). An income property containing less than 5 units (apartments) is considered a chiefly residential property and is subject to different tax implication and bank restrictions than a property containing 5 or more units (apartments). When purchasing a property of 5 or more units, I always recommend creating a corporation first, and purchasing the property within the corporation to reduce personal risk.

It should be understood that residential leases fall under the jurisdiction of the Régie du Logement, which governs the rules and regulations of the landlord and tenant. The Régie serves to protect both parties.

There are rules the landlord must follow:

• Whatever is included in the lease (i.e. heat, hot water, electricity, appliances, etc) must be in good working order at all times.
• Should an appliance break down through no fault of the tenant, the landlord must replace or repair the appliance in a reasonable time period.
• Should a serious problem occur, such as a power failure in the middle of the night in -40 degree weather, the landlord must respond immediately.
• Should the landlord wish to visit the apartment, the tenant must be notified 24 hours prior to the visit.
• A landlord can request the tenant vacate the premises if the landlord or a member of the landlord’s immediate family intends to move in. However, the tenant must receive six months and one day’s written notice prior to the end of the lease.

These are just a few of the obligations of the landlord.

When searching for an income property consider the following:

• Location – Determines the type of tenant
• Condition – Does the property require repair and to what extent?
• Type of units (i.e. 1 bedroom, 2 bedroom, 3 bedroom) – Properties with only one bedroom apartments may not be eligible for CMHC financing since they are considered rooming houses and are higher risk for insurance.
• Cap rate or capitalization rate – rate of return
• Financing – Is there a mortgage? Must it be assumed? What is the percentage rate of the mortgage?

‘… an income property, fully rented and in a good location, can produce income for years to come on a consistent basis.’

Capitalization Rate

An income property value is based on the capitalization rate (Cap Rate) or rate of return. The cap rate is determined by a formula: Net Income / Purchase Price x 100 = Cap Rate

Example: The asking price for a 20 unit building is $1,500,000
The net income (income after all expenses) is $75,000
Net Income / Purchase price x 100 = Capitalization Rate
$75,000 / $1,500,000  x 100 = 5

In your search for an income property, if the asking price of the property with 5 or more units creates a cap rate of 4 or less, you can adjust your offer to create a cap rate of 5 or higher. If the vendor refuses to adjust the purchase price, then the property may not be worth purchasing, barring other factors such as ability to raise rents or increase units.

The cap rate in Montreal today can fall between 1 and 12. A cap rate of 4 or less would indicate a duplex or triplex that is just covering expenses but will generally create a gain or profit upon selling. A cap rate of 5 or higher would indicate a property of 5 units or more and is providing a profit.

An income property provides gain in two ways:
1. From the rent, after expenses
2. When you sell the property – Capital Gain

A duplex is a wonderful concept since you are living in one unit and renting the other. The income for the 2nd unit can generally cover your expenses, and in effect, you are living expense free. When you sell the property you will have a capital gain on half the sale that is taxable at a reduced rate.

‘A duplex is a wonderful concept since you are living in one unit and renting the other. The income for the 2nd unit can generally cover your expenses, and in effect, you are living expense free.’

A property of 5 units or more is an excellent investment since you are receiving a profitable income from the property and, as time passes, the equity (Value) of the property increases. Eventually when the value of your property increases enough, you can take part of that value in the form of a bank loan and purchase your next income property.

Next article: the promise to purchase offer for an income property of 5 units or more and ways to protect the buyer.

Should you have questions or comments, please refer to the comments section at the bottom of the page. As well, to view past articles, go to the search link and type in Joseph Marovitch.

Have a great week!

State of the market

There is this idea that young couples are purchasing condos in Montreal because there are a shortage of single homes, causing prices to be too high to afford, and prices will continue to rise. This is partly true. However, there is a shortage of condos developing as well. New construction of condos and singe homes in Montreal are expected to drop from the previous year. So where are people moving to if not downtown?

The suburbs is where. Couples with children do not really want to push baby strollers up Metro steps and have no good park space for their children to play in. Suburbs such as Blainville, Laval, Lachine, Vaudreuil-Dorion and more offer full 3-bedroom, 2 full bathrooms and 2-garage homes with finished basements for a 1/3 the cost of a similar property downtown where space is running out.

There is a movement towards the suburbs which will eventually cause prices to rise more and more.

The next best opportunity is beautiful homes and condos in the suburbs.

Image: Andrew Burlone

Read also: Real Estate Talk: Purchasing a Country Home