Buying-to-rent involves a very different approach to real estate than buying a primary residence. Most matters of personal taste and preference go out the window; what it boils down to is the financials: the ROI (return on investment) and Cap Rate. ROI calculates the percentage of profit that will be made in respect to the amount of capital invested, while CAP rate measures the rate of return on a real estate investment property based on the income that the property is expected to generate along with the appreciation. Accurately projecting ROI and CAP rate is the key to success for any real estate investor, whether dealing with a single unit or a large multiplex.
How do you spot a good real estate investment?
There are two key points to look out for when scanning the market for promising opportunities:
1. Properties that are listed below market value.
Look for repossessed properties and properties listed below their municipal evaluation. Consider joining a mailing list for investors to receive handpicked deals in high-demand neighbourhoods. Lastly, always ask your broker to provide you with a comparative market analysis before putting in an offer on a property.
2. Properties that offer positive cash flow, or as close to positive cash flow as possible.
An investment brings ‘positive cash flow’ when the monthly income generated through rent is higher than the total carrying costs, including mortgage costs, bills, taxes, and other expenses.
Use a mortgage calculator to determine your carrying costs, while consulting with your broker about rental averages and vacancy rates.
How do you calculate ROI?
The best mortgage conditions for R.O.I are with a downpayment of 20-25% (thus avoiding mortgage insurance costs) over a 25 year amortization.
Let’s take as a case scenario the typical purchase of a $250,000 (2 bedroom) condominium in St Henri.
To calculate the ROI over 5 years:
- Downpayment of 20%: $50,000
- Total Acquisition costs = (Downpayment + Closing costs and fees) = $55,000
- Mortgage amount: $200,000*
- *Interest rate of: 2.29% (current lowest)
- Mortgage payments: $875/ month
- Property Insurance: $50/month
- Municipal taxes: $166/month School taxes are $40/month
- Condo fees: 100/month.*
- *based off the average taxes for $250,000 condos in St Henri
Total carrying costs: $1231/month
A semi furnished 2 bedroom condo in St Henri can be rented out for an average of 1300/month.
Net profit = rental income – carrying costs.
In this case, this condo brings in a profit of $69 / month.
The net income after all expenses will be positioned between break even and positive cash flow.
Rental net income after carrying costs over 5 yrs = ($69 x 60 months) = $4,140
Now to consider the additional equity gained through appreciation over the years:
A conservative average of appreciation rate in Montreal is 2% per year.
Value appreciation (assuming 2% on base price p.a non-compounding) = ($5000 x 5) = $25,000
Over 5 years the market value of a $250,000 property will increase to $275,000.
After 5 years, the mortgage balance left to pay will be: $180,212
Mortgage appreciation = initial mortgage – current mortgage = (200000-180,212) = $19,788
Total Gains = Rental net income + value appreciation + mortgage appreciation
Total Gains = $48,928 (total gains p.a = $8785.6)
ROI= Total gains / capital investment * 100
ROI = (48,928/55,500)*100
ROI = 88.96% over 5 yrs
ROI per year = 17.7%
To secure a high ROI investment, the different points to look out for are:
a) Low asking prices
b) Favourable mortgage terms (high downpayment and low interest rates, if possible)
c) Low condo fees and other carrying costs
d) Properties in locations where the rental value is high and vacancy rate is low
e) Locations where the appreciation rate is high or growing
What other factors should you look out for?
Other than the financial factors which will contribute to ROI, here are some general points to consider when shopping for a rental property:
- Look for properties which have a garage or are very close to public transportation, as they are easier to rent out.
- Consider buying a duplex or multiplex. They require more capital and maintenance, but they bring higher returns over the long run.
- Location, Location, Location! Invest in a part of Montreal where tenants are easy to come by.
- Stage your fully furnished rental according to mass market preferences, to secure the best profit margins and occupancy rates.
- Check the co-ownership rules surrounding short and long term rentals
and most importantly,
- Work with an experienced broker with good knowledge about the investment market as well as the rental market.