Three reasons to invest in rental property
Depending on your goals and your local market, investing in rental property can provide a solid return. It's a particularly attractive investment when interest rates are low, the stock market is volatile and house prices are on the rise.
Most people invest in rental property for one of three reasons:
- To generate monthly income
- To create a capital gain
- To diversify their investment portfolio
Let's look at each of these.
Generate monthly income
This is an appealing reason to invest, especially when it comes to funding your retirement. Regular monthly income from a rental unit can go a long way to supplementing your retirement savings or pension.
But how long you have until you retire is important to consider. Because of the costs, it can take a few years for a rental property to generate a stable and positive cash flow.
Of course, any loss you face at the start can be used to offset your other income, and this can be a beneficial tax strategy for high-income earners.
But it's important to remember that if there is no reasonable expectation that your property will ever make a profit, your losses may be denied by the CRA. It's therefore crucial to keep accurate records and consult with a tax expert for guidance.
Location, amenities and vacancy rate all play a role in how much rent you can charge and therefore, how much income you can generate. But if you have five or more years until you stop working and are up to the challenge, the right property can start to generate positive cash flow before you retire.
Creating a capital gain
Creating a capital gain is another popular reason to invest in rental property. Leveraging your existing assets can help. The more you can leverage, the lower your capital outlay and the more substantial a rental property you can afford.
This also frees up more of your cash to pay off your non-deductible debt or add to your other investments.
But you must make sure you don't over-extend or your debt commitment may force you to sell. Panic selling due to poor planning often leads to a loss.
Rental property is also not a liquid asset. If you need cash, it can take time and may be difficult to sell. The real estate market faces long up and down cycles, and if you're forced to sell in a downturn, you may lose on your original investment.
It's also important to remember that any gain you realize will be taxed. In Canada 50% of your capital gain is taxed at your marginal tax rate.
Diversify your investment portfolio
Finally, rental property can be used to diversify your investment portfolio. When interest rates are low, the stock market volatile and property values are on the rise, rental property can be an attractive investment.
It's also a hedge against inflation because your rent will likely increase over time, but with stable or falling interest rates your mortgage payments will not.
However, buying rental property is not risk-free and you must consider your opportunity costs. A substantial down payment of 20% or more is typically required, and you will likely face unexpected expenses.
While diversification is important, your expected returns should be equal or greater to your other opportunities to make the investment worthwhile.
A financial partner can help
No matter what your goal, finding a financial partner that will help you maximize your investment is crucial. Rental homes are often perceived to be riskier by lenders and some may have higher borrowing rates and stricter qualification rules.
Look for a financial institution that takes into consideration all your assets, as well as your income and credit situation, and will work with you to make financing as affordable and accommodating as possible.