August 29, 2011
Real estate investment: Is the gain worth the pain?
It has been said that investing in an income property was a good way to start your investment portfolio? This may in fact be true, however there are certain criteria for evaluating a property that you should be aware of prior to proceeding with your purchase. It is imperative that you do all your due diligence to ensure that your investment is not only sound but that it fits your needs.
Let us look at the reasons why people say that purchasing a revenue property is a good investment. The three main reasons are as follows. You intend to live in one of the building’s apartments and the rents received from the other tenants will help you pay your mortgage loan. Oddly enough, what often happens when purchasing a revenue property is that you will qualify for a loan which you would have been turned down for, if it was purely a single family home. The fact is, that in the case of an income property, the banks take into account a certain percentage of the revenues as income which basically ensures your ability to repay your mortgage loan.
The second reason, which is of particular interest to young people and self-employed individuals, is that an investment in real estate allows for the creation of a pension fund. Over time, providing that you keep your income property, your mortgage loan will be totally paid off by the time you retire and most likely well before that. The rents you receive will be pure income aside from any maintenance and repairs, which need to be done from time to time. The deal is basically protected against a downturn in the economy, because even in a case where, your property has lost value, as long as you will have tenants who pay rent, the lost of money will be identifiable only on paper, because you will continue to get incomes through rents. When investing in an income property to build up a pension fund, the goal is not the capital gain, but the income that you will get during your retirement.
Finally, the third reason why it may be advantageous to buy an income property is that it is a good starting point to build up a portfolio in real estate investment. Once your term expires, you can refinance your mortgage and use the money to purchase another rental income property. Using this technique, you will reuse the down payment invested in the first building, thus you can purchase a new property without having to spend any more money.
On paper, these arguments seem very convincing, but keep in mind that you must always assess the disadvantages which may affect your everyday life. Indeed, owning such a property is very demanding and can become a source of anxiety. Think about tenants, for example. You will have to learn how to select tenants and how to manage the bad debtors or those which are unpleasant. You will also need to learn the laws and payments established by the Régie du logement, which may help you better manage difficult situations. Fortunately, several owners associations exist to help you. Feel free to ask them any question! Remember one very important point when planning your budget. You must base any budgeting on your actual income and not on your anticipated income thus avoiding any nasty surprises.
Another disadvantage of owning an income property is that you must attend to the maintenance of the building and make all important repairs. Despite the fact that the normal maintenance of a building must be done whether it is a one family home or an income property, remember that if you have an income property, you have to do the repairs for each of the tenants as well as your own repairs. Maintenance is less expensive in the long run since it could prevent more serious problems which ultimately will cost you much more to repair. This of course requires a greater investment of your time as well. Moreover, think about the fact that there may well be tenants that call you on weekends or weekdays evenings to ask you to make some minor repairs or to report a troublesome tenant.
If these disadvantages do not scare you, and you want to go forward on this adventure, here are some criteria to evaluate to help you make better choices. For example, carefully choose the site where you want to buy a multi-plex. A functional rental unit is one that has storage facilities and is close to close to public transport and shopping centers. These will be much easier to rent than an isolated rent in a residential area which is only partially served by public transport. As the old adage goes “The most important thing is location,location,location”.
To see if you can afford the purchase of a particular building, you can rely on the coverage ratio of debt because the lenders partly base themselves on this criterion to grant you a mortgage loan. To calculate this ratio, subtract your potential loss of rental vacancies (usually from 3 to 5 % of your income) and your operating costs (taxes, heating, and maintenance) from your potential earnings. Take that amount and divide it by the amount of your mortgage payment. You should get a ratio of at least 1.10 – 1.20 for the loan application to be accepted by lenders.
Also, remember to assess the revenue from the property. According to the rules of the Régie du logements, you are limited in the amount that you can increase the rents. If a tenant has been living in the apartment for many years, he may be paying well under the market price, which could affect the total of your income at the end of the year.
To help you buy an income property, it is advisable to consult a professional. He will be better equipped to help you find a building at a fair market value.
Finally, property values tend to increase over the years, which make us think that real estate is a sound investment. In general you will not suffer long-term losses in real estate. On the other hand, the best advice that can be given is: diversify your investment types. You will be better able to absorb losses from any particular area.