- Reader Case: Struggling to Get to FI with a Special Needs Child - June 5, 2023
- Why HomeExchange Beats Airbnb - May 22, 2023
- Let’s Go Exploring! Da Nang, Vietnam: The Next Digital Nomad Paradise? - May 8, 2023
Since it’s been FAR too long since I ranted about housing (aka 3 whole days), I’m going to break that dry spell with a case study from a reader in Montreal (post has been edited for brevity):
“I have been in the housing market for nearly a decade, moved from Edmonton to Montreal, and owned property in both cities. My employer recently threw down the gauntlet and said “hey, we need your skills at the mothership – please move to Toronto.” I am likely to move because the opportunity is interesting, and I am in the process of negotiating the package. The core of my dilemma is this.
I am virtually mortgage free in a downtown Montreal loft, living a car free existence, walking to work. If I move to Toronto, I have zero intention of buying property in that effing-ludicrous market. Assuming I move, I will rent in Toronto, and am struggling with what to do with my condo? Do I sell my condo and invest the 325K and enjoy both market appreciation and dividends, or do I become an absentee landlord, hire a property management company, and enjoy a passive income stream of rent (which is more than I could generate with dividends)?
Condo market value is 325K. The mortgage balance is 50K at 2.19%. I essentially consider it paid off because I have 56K in cash earning 1.75% in a TFSA. I know that’s not an optimal position to have all that cash, but I figured I was just going to pay the whole thing when it comes due next October. I struggled between having an emergency fund and paying off my mortgage faster, so I was willing to bear the opportunity cost of a 0.44% spread to have the best of both worlds.
Current costs are:
$254 per month condo fees
$187 per month property taxes
$42 per month school taxes
$36 per month owners insurance
$60 per month for hydro
My mortgage payment is $318 per month ($172 principal and $142 interest), and I max out all prepayment privileges every year.
When I had the assessment done, I was advised I could rent it for 1400 per month unfurnished or 1600 per month furnished.
What should I do?”
–MontrealDilemma
Well MD, I gotta admit that is some NICE debt murdering. You murdered the SHIT out of that debt. I would wager you are the MURDERIEST MURDERER who ever MURDERED a…
Aaaaand now the RCMP just emailed me saying we’re both on their watch list. Sorry about that, buddy.
Anyhoo, onto your question. To hold and rent or sell and invest? The age old question, which we shall answer by…
MATHING THIS SHIT UP!
Okay, so MD has 2 options to choose from:
1) Keep the condo and rent it out
2) Sell the condo, invest the proceeds
Scenario 1: Keep the condo and rent it out
Costs = $254 + $187 + $42 + $36 + $60 + $318 = $897/month
Wow! That’s as low as our rent was in Toronto. Pretty good deal right? Okay, let’s see what happens if he rents it out.
Rental income is $1400/month – $897/month = $503/month or $6036/year. And since the condo is worth $325,000 and his home equity is worth $275,000, that’s a return-on-equity of $6036/$275,000 = 2.19%
Yeesh. Considering the high interest rate savings account we’re currently using pays 2.25%, that’s pretty shitty. So if he actually SELLS the house now and shoves all his money into a savings account, he’d get better returns.
Now, we also know that he has $56K sitting in cash…enough to pay off the rest of the mortgage. So what happens if he does that?
Costs = $897 – $318 (principal + interest) = $579/month
Rental income = $1400 – $579 = $821/month or $9852/year.
Cap Rate = $9852/$325,000= 3.03%
So paying off the mortgage dropped his monthly cost by $318, pushing up his cap rate to 3%. But is that good? I mean that 3% would still get taxed as rental income, which isn’t taxed as favourable as investment income. And we haven’t even taken into account the cost of hiring a property manager! Which MD will need since he’ll be living in Toronto and won’t be around to deal with the tenant.
So already we’re looking at returns of 2.25% – 3% (depending on whether he pays off the mortgage) and we still have to subtract the costs of a property manager. Not good.
Let’s see what happens if MD invests instead.
Scenario 2: Sell the condo, invest the proceeds
If MD were to pay off the mortgage and sell it, he’ll need to subtract closing costs:
Real-estate agent: 0.05*$325,000= $16,250
Lawyer fee: $500
Closing costs: $16,750
Total earnings after fees would be $325,000- $16,750 = $308,250
Assuming a conservative average return of 6%, that would be $18,495/year. Comparing that to his rental income of $9862/year, that’s almost double!
Even if you were to ignore the capital appreciation and only focus on the dividends, his assumption of “enjoy a passive income stream of rent (which is more than I could generate with dividends)?” holds as much water as a submarine with a screen door.
At an ROE of only 2.25-3% from paying off the mortgage and renting the condo, that’s similar to the dividends generated by a 60/40 portfolio! And since you have to subtract the cost of a property manager, and dividend income is taxed more favourably than rental income, the spread is even bigger than you think.
So in MD’s case, I see no reason why he would want to keep the condo and rent it out at that rental price. I would need that rent to double to pique my interest, so unless he wants to have shitty returns just for the sake of owning something, I’m going with selling that sucker.
But those are my thoughts. What do you guys think? Chime in in the comments below.
UPDATE: Here’s what MD actually decided to do:
“Thanks for the thoughtful analysis FC. I reached the same conclusion as you, though your calculations are more accurate. I completely overlooked the return-on-investment component expressed as a percentage (duh).
For those that are in suspense as to my decision (yes, the world CLEARLY revolves around me), I have put my condo on the market. What I have had a harder time with (arguably), is the shift in mentality from being an “owner” to being a “renter”. While the numbers make more sense to me, I have become irrationally comfortable in having my equity tied up in a piece of real-estate, because I can live in it, touch it, and marvel at the exposed brick and roof top terrace with a downtown view. My financial psyche is still influenceable by emotions, even though I know that is anathema to financial success.
I have started focussing on some of the positives in making this choice:
– Blowing away that piddly mortgage I have means 0 debt. Period.
– Enjoying a Montreal-metric-shit-ton(ne) more flexibility than if I kept owning. I can pursue other opportunities – either with my company or along another venture – at my own pace with a lot of financial runway.
– Greater liquidity than with real-estate, which is important to me in case that Montreal-metric-ton(ne)-of-shit should hit the fan. The mental cushion of a relatively liquid portfolio is comforting.
I was also able to work out an equitable arrangement with my employer when it comes to relocation that keeps me whole, especially because they asked me to break up with the city I love. I know a lot of corporate cultures mistreat/underestimate their workforce, particularly millennials, but I count myself part of the lucky corporate whores out there: I am well treated, well compensated and am truly engaged in my work, all while building my portfolio. Yes, this is a business relationship and one day my employer and I may part ways (either voluntarily or involuntarily) – this emerging liquidity makes taking this career risk a lot easier to deal with despite moving to stoopid expensive Toronto.
Wish me luck guys!!”
Hi there. Thanks for stopping by. We use affiliate links to keep this site free, so if you believe in what we're trying to do here, consider supporting us by clicking! Thx ;)
Build a Portfolio Like Ours: Check out our FREE Investment Workshop!
Travel the World: Get covid-19 coverage for only $45.08 USD/month with SafetyWing Nomad Insurance
Multi-currency Travel Card: Get a multi-currency debit card when travelling to minimize forex fees! Read our review here, or Click here to get started!
Travel for Free with Home Exchange: Read Our Review or Click here to get started.
Earn 15% Cash-back: Earn an extra 15% back for a limited time with a Tangerine World Mastercard! Click here to sign up!
As usual you have a solid analysis. However, I just want to point out that diversification can include things like real estate – particularly if it carries rental income. The financial samurai is a big proponent of diversification like this and he calls it diversifying income streams.
So while your argument is really good, its hard to evaluate the risk of only being in the stock and bond markets. I suspect that even in a poor economy a Montreal Loft would be rentable and thus give you some shelter from having to cash out your market positions at low prices.
Fair point, but you can use REITs (which Financial Samurai also advocates) in your portfolio for real-estate exposure.
Also, $325K is a big chunk to be invested in real-estate, especially if it’s performing poorly at only 2.25-3% return. After subtracting the property manager’s costs, he could do just as well in a savings account, without even investing.
Why take a risk for so little gain?
I would sell and invest in solid dividend stock and etfs. Still you have another house which provides diversification.
It’s a tough one. The long term numbers clearly show that selling it and invest is the best choice. But considering the current extensive stock and especially bond market, I’m not sure about that. If I take CAD 1400 as the rent, it means that the price to rent ratio of the condo is around 19, which is a bit high, but not crazily high like I’d expect from the stories I hear about Canada.
I’d personally keep the condo for at least a 1-2 years and rent it out. By that time MD will see how she likes at the new place (who knows, maybe he wants to return), plus I think there will be better timing to invest 325k at once than it is now. This is only my personal humble opinion…
PR ratio is actually not as accurate as ROE in this case, since it doesn’t take into account the cost ( $579/month after mortgage is paid off, and property manager’s cost) that has to be subtracted from the 1400.
I think there’s one more question that needs to be asked. Does MD plan to move back to Montreal at some future point? If the answer is yes, than it might make sense to hang onto the condo: it sounds like MD likes the location, there was no mention of problems with neighbours or condo board (not to be under estimated!!!) and the price is incredible. If MD moves back to Montreal, what are the odds of finding all that again? If the odds are good, than, yes, sell. If not, than I would be tempted to rent it out on the basis that a good place to live is hard to find.
Correct, and then it would be a lifestyle decision, based on feelings instead of math. So if you make a decision and ignore the math, that’s fine, but then why bother doing the analysis in the first place?
Well, there’s a little bit of math. The cost of selling and then re-purchasing if you plan to come back.
Actually, I thought about moving back to Montreal in the future – even though I LURVE this city, I don’t think it is in the cards with the centre of gravity being around my mothership. I have even contemplated being extremely bourgeois and keeping the condo as a pied-a-terre, but I honestly cannot justify letting that equity sit unproductively and fork over the carrying costs just to have a sweet pad for weekend getaways. If I have to move again for work, the next centre of gravity is likely the US.
I’m also against property ownership, but to be a little fair, you guys forgot to take into consideration the average increase in value on his property.
He will not only get the rent, he will get whatever his house appreciate/depreciate plus the rent.. So the combined annual return will be higher than this.
An astute observation. Except we didn’t forget inflation. The reason why inflation is not in the equation is because inflation happens on both the housing price AND the rent. So if you have:
Cap Rate: $9852/$325,000= 3.03%, with inflation that becomes $9852 * 1.02 ^5 / $325,000 *1.02 ^5 over 5 years for example, so the 1.02^5 at the top and bottom cancel each other out.
In fact, one of the downsides to renting out is that your property value could increase more than 2%, but your rent can only be increased by 2%. As a result, you end up with a bigger denominator, causing your Cap Rate to be even lower. So you can’t increase your return on investment, even when the underlying asset has gone up.
The only way to capture that appreciation is to sell, at which point you get hit with closing costs. And not only that, as reader “Tara” pointed out below, if he sells it later AFTER renting it out, it becomes a rental property, which makes the capital appreciation TAXABLE. If he sells now, he gets to keep the gains tax-free because it’s his primary residence.
There are lots of good REIT’s out there, true diversify the portfolio, and have some Real Estate, as there are lots of times where it is good to have. Right now in Victoria, the rental market is crazy, Morguard REIT, is building an 18 story high rise to take advantage. You don’t have to incur all the expense, and Risk by owning Real Estate, there are lots of other Property Linked investment vehicles out there… Commercial Property always beats residential because of a thing called Triple Net, ROI is much better.
Good work FC, ya to make a decision, you gotta math the shit out of it… and then just do what the wife tells you to do anyway…
D.
D.
“you gotta math the shit out of it… and then just do what the wife tells you to do anyway…”
Ha ha. Or sometimes your wife is the one telling you to math the shit out of it…
I think you are misleading people here – maybe I have misread something in your comparison?. I know you are very anti-property, but you can’t really take into account the capital appreciation of the shares and not the capital appreciation of the property for a fair comparison. The long term return on shares is 6-7% (source: Warren Buffet – capital and dividends).
What’s interesting here is that property increases in capital value vary enormously by city and area within cities. So I think the bottom line would be, how good is the capital return on property likely to be in Montreal and how good an area is their flat in?
We live in London and return on property there over the last 10-15 years has been way higher than the stock market. Annual growth in capital values is 10.6% (excluding rental), and have risen 420% over the last 15 years. I also know of properties in parts of Washington DC that haven’t recovered their 2008 prices.
Clearly London is a special case – a conservative property capital value increase in a year might be 4% – that would make the returns from each approach similar – although using a property manager might just tip in in favour of selling. BUT it really depends on their local property market.
I think from memory you don’t like leveraging, and it’s certainly a risk; but if the return is good in both places and interest rates are much lower than the return they expect to achieve and they can fix the mortgage rate; they could extend their mortgage and keep the investment in the house (using the rent to cover this) AND put the money in the stock market. Much higher risk strategy, but still might be interesting to compare the returns this way. This works well in the UK because mortgage payments can be set against rental income, reducing tax (although rules are about to change).
Looking at a mortgage of $325k at 2.19% would give a payment of $593 a month (just interest), that’s close to being covered by the rent (including costs) but doesn’t allow for anything else (tax, managing agent) – but obviously they’ll get capital returns from both the flat and the stock market and dividends from the stock market and it takes the selling fees of £16k out of the equation. It may well not be worth it depending on what the tax situation is like and what managing agents charge in Montreal vs the capital return on properties there.
Of course that doesn’t allow for a short term wobble in either market (and the US election could easily provide this!!) hence the increased risk.
Hope this helps.
“You can’t really take into account the capital appreciation of the shares and not the capital appreciation of the property for a fair comparison.”
We did take capital appreciation into account. Since the rent can only be increased by 2% per year (rate of inflation). If the house also appreciates by the rate of inflation (which typically housing has done), the two cancel each other out:
Cap Rate: $9852/$325,000= 3.03%, with inflation that becomes $9852 * 1.02 ^5 / $325,000 *1.02 ^5 over 5 years for example, so the 1.02^5 at the top and bottom cancel each other out.
If you assume the house appreciates by more than 2% a year, that makes the cap rate even worse because the denominator would be even bigger.
That doesn’t take capital appreciation into account. If the property appreciates faster than 2%/year, then you let your renters’ lease expire and sell the condo at the fully appreciated value.
Ontario’s 2% rental increase cap is pretty whack (fortunately we don’t have such a thing in most of the US), but even so, from my understanding the Canadian gov’t isn’t saying they will keep it at 2% for all future years are they?
I agree though that if someone believes real estate will assuredly continue to appreciate faster than inflation, then they’re simply betting (speculating?) on a higher return / higher risk investment.
I’ve been (what I consider) pretty lucky. I bought the condo 3 years ago for 285K and it has appreciated by 5% per year, so I will recoup a return above inflation when I sell it. With all financial things considered, there are a few intangible benefits that I am learning to love:
I have been typically pretty risk averse being a bachelor – if I break my face, I don’t have a spouse to help mitigate reduced income – so I like higher liquidity of investments versus real estate.
Renting gives me more flexibility. You think I would have learned after the first piece of real estate I sold to move to Montreal that I cannot predict where life will take me. Renting allows me the peace of mind that “I don’t own this place and if the trade winds take me to Kuala Lumpur, I am not anchored to T-dot by real estate.”
Actually one of our readers pointed out something that we ALL missed. Once he rents it out, the property is no longer his primary residence. That means any capital appreciation will be TAXED. If he sells now, he’ll be able to keep his capital appreciation since it’s still currently his primary residence.
No, it does not.
The way it works is you file a change in use for this year and lock in your capital gains at this time via an appraisal and you get up to four extra tax exempt years given he is moving for work.
Going forward there would be capital gains on 50% of the gain from the post two-year point.
If he doesn’t file the election he still gets to claim a pro-rated portion of the gain as exempt for the years he lived there and up to an extra four years given he is moving for work.
That aside, a paid off home as a rental without a secondary suite at this price point is probably not advantageous even if it continues to appreciate at 4%.
Without leverage he will have more cash flow as the interest payment disappears, but less ROI and he will also have more taxable income (with supporting cash flow). Have to know more about RSP and TFSA room to see how much better off by investing, but given his desire not to keep the place and perhaps move to the US selling is probably better imo and his (it seems :))
http://www.taxplanningguide.ca/tax-planning-guide/section-2-individuals/principal-residence-rules/
Damn I wish I had stumbled across this 8 years ago . Just sold the house and taking your strategy I mathed that shit. Would have been 250k ahead instead of 100k loss. I did the math on my website maybe you can take a look and see if it looks right. Life of chill.com
Ouch. That sounds bad. Sorry to hear about your 100k loss 🙁 (I checked the math on your post and it’s correct).
On the plus side, now that you’ve dumped that ball and chain, you can turbo charge your investments. Thanks for sharing your story so others can learn from this experience.
I like your ‘math it out’ approach. That said, if appreciation is overlooked in the equation, owning real estate is commonly less attractive than other investments. While real estate generally does not become more valuable over time, it does hold its value and appreciates with inflation. Rent will also rise with time impacting the formula. Discounting these qualities of real estate is not sharing the entire story.
One alternative, if you felt confident in your market returns, is to keep the property, refinance at low interest rates on a shorter term loan (pulling out no more than can safely cover costs but enough to avoid taxable income) and invest that in your conservative 6% options.
“While real estate generally does not become more valuable over time, it does hold its value and appreciates with inflation. Rent will also rise with time impacting the formula. Discounting these qualities of real estate is not sharing the entire story.”
Since the rent can only be increased by 2% per year (rate of inflation). If the house also appreciates by the rate of inflation (which typically housing has done), the two cancel each other out:
Cap Rate: $9852/$325,000= 3.03%, with inflation that becomes $9852 * 1.02 ^5 / $325,000 *1.02 ^5 over 5 years for example, so the 1.02^5 at the top and bottom cancel each other out.
If you assume the house appreciates by more than 2% a year, that makes the cap rate even worse because the denominator would be even bigger.
The problem here is not capital appreciation. The issue is the low rent, ownership costs, and cost of a property manager which is not giving him a good return on his investment.
2% growth on a $325k property value would be an additional gain of $6500. That should be added to the $9852 for a total one year gain of $16,352. In your scenario selling still wins. The assumption of gains is at the heart of the analysis. Where does your confidence lie… will property values increase at 2% or will your investments return 6%? With these numbers I would not pay off the 2.19% loan and instead would invest that at 6% for a return of $3000. This would reduce income but increase net gain with numbers like this …
$6036 rental income
$6500 growth in property value
$2064 in equity from paying $172 in monthly principle
$3000 from investing $50k at 6%
$17,600 total return- We are narrowing the gap.
Another option is to refinance at low mortgage rates pulling out enough to eliminate all income and invest that at 6%.
What are mortgage rates in Canada now?
Nice number crunching. That said, reader Tara noticed something we ALL missed. The fact that once he rents it out, it’s NO LONGER his primary residence. Which means his capital gains will be taxed when he sells. So not only would he be dinged for the appreciation going forward, he will have all his existing capital gains clawed back as well. But if he sells now, he can keep all the gains tax free.
And your idea of borrowing against the equity to invest is called “the Smith Manoeuvre”. I have heard of it being done before, but it does increase his risk. And as MD mentioned in this comments below, this strategy is “too high maintenance and risky” for him.
Unless rules have changed. He would not be taxed on capital gains for years it was his principle dwelling. When you sell you are taxed on number of years you rented.
You are right. So he would be taxed on the future capital gains and rental income, but it wouldn’t be retroactive on the existing capital gains.
What if someone took out a mortgage of say 80% of the cost of a home. Then rented it out. Assuming the rental income will cover the cost of mortgage payments (quite possible given the low rate environment), then that person basically pays the downpayment while the future tenant(s) pay for the rest of the equity of the house. The return on the 20% invested in the form of the downpayment will be the 80% equity that the tenants will pay through rent. Plus with inflation, rent will increase while the value of the mortgage payments will decrease (I.e $2,000 in mortgage repayment will have less purchasing power in 1999 than in 2019). Does this logic make sense?
Ugh – welcome to Quebec. I honestly have no idea if the rules in Ontario about rent being increased no more than 2% apply to Quebec. I know there are regulations around renters managed by the Régie du logement (yup, some Western Canucks speak French) and honestly, laws are tilted even more in favour of renters in Quebec. I wouldn’t surprise me if there are extra hidden headaches in renting my condo in Montreal than Toronto.
What about the fact that (from what I’ve read) Montreal and other major Canadian cities’ condo markets are ridiculously saturated and unlikely to see much gains? How does that factor into the equation?
BTW love the detailed case analysis, it’s a great way to apply what we’ve been learning from you in REAL situations with REAL numbers.
Thankfully Montreal is not (yet) as bad as Toronto or Vancouver, and it’s not that those markets are not seeing gains – quite the opposite, they are red hot – its that everyone is waiting for the bubbles to burst. Vancouver just had a 15% foreign buyers tax levied by the government and sales have dropped in turn. It will be interesting to see what happens to overall property value in Vancouver.
There are only recent indications that the Montreal market is starting to raise eyebrows with the CMHC and are typically we are left out of the current mainstream discussions around crazy real-estate markets. Toronto and Vancouver are the locus of those discussions… at least for now.
I’m keeping speculation of housing price out of the equation (because who knows which way it will go) since we are evaluating whether the Cap Rate makes it a good investment or not. In this case the rent is way too low and the costs too high.
And thanks! Glad you like the real life reader case. I’ve got A LOT of them piling in my inbox…good thing my weirdo brain finds math fun…
How long until this buble pop?
https://plot.ly/~jasonkirby/1747.png
Sell now to buy after the pop 🙂
I may have missed this but I didn’t see mention anywhere here or past posts about homeowners mortgage write off?? It’s a major deduction for me and for many every year in the US. I don’t know about the UK or Canada.
Sadly, we cannot write off interest on our mortgages in Canada – you guys get a great deal in the USA!
Canadians cannot write off their mortgage interest. We do get the luxury of the principle residence capital gains exemption (and now with recent changes, we may have to prove our principle residency), but the only way to write off mortgage interest is use the Smith Manoeuvre: use your residence as collateral to borrow money to invest in the market, thereby making the interest of the loan a tax write-off. I am pretty hands-off and am trying to cultivate a low maintenance life – the Smith Manoeuvre is way too high maintenance/risk for me.
Agree with you on that one. Smith Manoeuvre is one way to get the equity out, but definitely need to consider the risk.
We dont get a mortgage deduction here in Canada, what we get is that when we sell our primary residence the proceeds are tax free. But the mortgage deduction in the US isnt really that great, for most people it wont make that much of a difference unless that the interest is greater than standard deduction, and gets smaller as the mortgage goes down. So the deduction is better for people with large mortgages (ie expensive houses) and I think most people dont even itemize.
In the US, he could sell it now as a primary homeowner tax free. If he waits and rents it for two years, and then sells, it will become investment property and profits are taxed. Maybe Canadian law is different?
Very good point! I completely forgot about that. In Canada, the rental property capital gains would get taxed, same as the US.
So he would actually lose out big time if he sells later. See, this is why people lose money in housing so often. It’s so easy to forget about all these extra costs !
You would want the rent to double before the scenario would pique your interest, however I don’t think you considered property appreciation in the calculations . If his condo appreciates in value by $10k/year wouldnt that be a phenomenally great investment to hold? That alone is more than 6 times the rent.
If he rents it out, it is no longer considered his primary residence. So not only would he get taxed on any future appreciation, he would get his existing gains clawed back. If he sells now, he can at least keep the capital appreciate tax free.
It sounds like he’s lived all over. If the condo is absolutely amazing and there’s a chance of moving back for the long term, keeping it could make sense. Otherwise sell!
Thanks for the thoughtful analysis FC. I reached the same conclusion as you, though your calculations are more accurate. I completely overlooked the return-on-investment component expressed as a percentage (duh).
For those that are in suspense as to my decision (yes, the world CLEARLY revolves around me), I have put my condo on the market. What I have had a harder time with (arguably), is the shift in mentality from being an “owner” to being a “renter”. While the numbers make more sense to me, I have become irrationally comfortable in having my equity tied up in a piece of real-estate, because I can live in it, touch it, and marvel at the exposed brick and roof top terrace with a downtown view. My financial psyche is still influenceable by emotions, even though I know that is anathema to financial success.
I have started focussing on some of the positives in making this choice:
– Blowing away that piddly mortgage I have means 0 debt. Period.
– Enjoying a Montreal-metric-shit-ton(ne) more flexibility than if I kept owning. I can pursue other opportunities – either with my company or along another venture – at my own pace with a lot of financial runway.
– Greater liquidity than with real-estate, which is important to me in case that Montreal-metric-ton(ne)-of-shit should hit the fan. The mental cushion of a relatively liquid portfolio is comforting.
I was also able to work out an equitable arrangement with my employer when it comes to relocation that keeps me whole, especially because they asked me to break up with the city I love. I know a lot of corporate cultures mistreat/underestimate their workforce, particularly millennials, but I count myself part of the lucky corporate whores out there: I am well treated, well compensated and am truly engaged in my work, all while building my portfolio. Yes, this is a business relationship and one day my employer and I may part ways (either voluntarily or involuntarily) – this emerging liquidity makes taking this career risk a lot easier to deal with despite moving to stoopid expensive Toronto.
Wish me luck guys!!
Why not take advantage of low interest rates take out a 50% LTV Mortgage and invest the proceeds? Would provide diversification, the interest is tax delectable and allows for prudent use of leverage not possible with stocks and bonds.
This is the Smith Manoeuvre that MD mentioned in his comment above. Too high maintenance and too risky for him. I would agree with that assessment.
Should you take off 2% for inflation off the 6% return making it 4%?
As a landlord, I wouldn’t invest 325,000 in real estate to rent for 1400, especially if condo fees needed to be deducted on top of other expenses. I recently invested 297,000 in real estate which brings in 3100 in rent. Utilities paid by renters. I pay taxes and home insurance, and water heater rental. If the reader decides to invest in real estate there are definitely better properties to hold.
If the reader does keep property. I would suggest managing himself. In condo properties, much is cared for by the strata. Usually the only issues you are looking at are appliances.
“Should you take off 2% for inflation off the 6% return making it 4%?”
No, because 6% already takes inflation into account. Historically, the S&P 500 has returned 8-11%. So when you subtract 2% inflation from 8%, that’s 6%.
Keep in mind that you get paid dividends of 2-3% regardless of which way the market goes, so 6% is actually pretty conservative, since it includes the dividends of 2-3%.
“I recently invested 297,000 in real estate which brings in $3100 in rent.” How much do you pay for taxes, home insurance, and water heater rental? Also how much do you pay for maintenance? If the cost of ownership doesn’t eat away too much of the $3100 rent, then your ROE is really good.
Where do you live that rent costs $3100 but houses are only $297K? Wow.
The rentals are in London Ontario. Bought one house for 157000, rents for $1250. Bought another with a basement suite for 140,000. Upper rents for 1100. Lower for 750.
Thanks for explaining the 2% question. I’m a bit chicken when it comes to investing…other than real estate. So I’ve been trying to educate myself through your blog. Thanks!
Sorry just realized I didn’t answer your question. Taxes are 2200 on each property. Water heater 50 every three months. Insurance approx 800$ per year. These prices are per property.
You scared me for a second there! I originally thought you were quoting cost per month!
*Phew* Okay, so that means your cost is only $6400/year for both properties, rental income is $37,200. Since you didn’t mention mortgage, I assume they’re both paid off, so that means you’re getting a 10.4% Cap Rate. Well done! In your case, real-estate investing makes more sense, though you’d still have to take into account the taxes on the rental income. Hopefully you are either income splitting with a spouse or have low enough regular income that you can minimize the taxes.
What are the vacancy rates like in London, Ontario?
Yes you are right, no mortgage. We previously had property near Brampton, but the value of the house compared to rental income, (though both insane to me) wasn’t great. So we made a switch to a different market. So we have held these properties only since January, so take that into account as you read my response. Because we have had rentals for a number of years, we also ended up with surplus building materials which we have used to improve new rentals. My hubby does maintenance. So far other than a few initial improvements, there hasn’t been any. We usually take one months rent a year to put back into property. For example the two dwelling unit needs new windows on upper unit. We will plan for that next year. Vacancy rates…we rented our places with our choice of tenant within days…. With renters wanting to move in sooner than we expected. I’m not sure if having Western university so close…makes rentals for non students rare? We have noticed that many who can work remotely are moving from Toronto to London, already noticed quite a jump in house prices, comparable houses near our rentals selling for $200,000. (With our cash offers no conditions, we got houses way under assessment)
Taxes on rental income…we income split so half of our rental income gets us in a category of no taxes. Of course this year we have a capital gain from selling a property, but with rrsps income splitting, retroactive medical expenses, capital losses, donations our accountant assures us we are ok.
Heading to Australia in February, have you been there yet? Any recommendations?
Awesome! Sounds like you know what you’re doing 🙂
Enjoy your trip to Australia! We haven’t been there yet, but my sister-in-law went 2 years ago and loved it! She stayed in Melbourne and Tasmania and had a blast.
So i have a friend in the similar in Toronto for 1 bedroom condo. The price of the condo is of course higher and so is the maintenance fees. Let’s assume he’s in the same scenario for mortgage payment, so would the cap rate be lower considering maintenance fees are much higher and total initial investment costs are also higher? The rental income is also higher in toronto , it’s about $1700 per month.
It depends on how much higher. If you can get the actual values (how much it’s worth, how much he paid into it, costs of ownership–mortgage, condo fees, insurance, etc), we could all “math that shit up” right here in the comments as a fun exercise 🙂 (just don’t tell the cool kids)
Down here in Texas you can buy a house (3/2) for about 75K and rent for $1000-$1200 a month. Most of these deals will come through the investing community but they are out there.
If someone had 150K to invest in this type of market which way should they go? Real estate or stock market?
That’s actually ridiculously cheap. I don’t know how much the cost of ownership is so I can only guesstimate, but let’s say it’s $500/month if you don’t have to pay a mortgage. Assuming you bought with cash, then Cap rate=(1000-500)*12/75,000= 8% Now that’s a good cap rate and worth considering buying over investing in the market.
But don’t forget to consider vacancy rates in the area, re-sale value, taxes on the rental income. Highly recommend you read “affordanything.com” on real estate investing.
Thanks. I keep sitting on the fence about this exact thing because I am starting to over analyze. I want the rentals to have a cap rate of 10-12% when 8% is perfectly fine. My plan is to have 4-5 of these rentals first (currently have 1 but have the money saved for 2 of these) THEN start investing in index funds (Vanguard). I like the cash flow from rentals to give me some lifestyle independence now and the index funds for retirement.
If the reader changes the usage of his home (from a personal residence to a rental property), there’s a deemed disposition at fair market value at the time of that change. Assuming he has no other properties, he can claim the principle residence exemption for the appreciation from the date of purchase until the date he starts renting it out.
You’re right that, going forward, any (realized) capital gains would be taxable – but it isn’t retroactive, and the gains he’s earned so far would remain tax-free.
Okay good to know. So it wouldn’t be as bad as I thought, but he would still be taxed on the capital gains and rental income going forward. So on top of the property manager costs, taxation on the rent, and taxation on any future capital gains, that makes the “keep and rent it out” scenario pretty unattractive, considering how he’s only getting a 2.25-3% return from the rental income.
i think the numbers are slightly different for us US folks? For example, as a landlord we get to write off mortgage interest, prop tax, utilities, maintenance/repairs, depreciation which all go on Schedule E (i think), but then we also get to start claiming the standard deduction which wasn’t available when itemizing deductions…i will be in a similar situation regarding whether to sell or rent my SF house.
i’m not sure we can count on getting 6% over the next decade (many smarter than me also agree…bogle for one).
also us US folks only need to have lived in the residence for 2 out of the last 5 years so i believe i could rent it out for 2yr 11 mos and then sell and keep the first $500K tax free (though i know waiting til the last month isn’t smart/realistic).
You guys do have an advantage over us Canucks when it comes to writing off ownership costs on your taxes. So yes, the numbers would look different (especially in SF, where the Cap rate is probably higher since rent is much higher).
As for the comment about getting 6%, that’s actually very conservative, considering how you get paid dividends of 2-3% regardless of which way the market goes (the 6% includes dividends). And if you’re bearish on the economy, that will impact housing prices and rents too. Just as it did in 2008.
Great article! I’m curious where you are able to get 2.25% interest on a savings account?
PC Financial. It’s their promotional rate: https://www.pcfinancial.ca/rate/
Outside of the pure math question, there is one important risk to renting out your place: you could get a deadbeat renter, or an irresponsible one that damages your place, or both. A number of my friends have suffered from this, it’s quite common. In fact, one friend just spend thousands getting rid of a renter who caused all sorts of headaches (the condo board requested he be evicted because he played loud music all night), and in the end left without paying the last two month’s rent. This renter was a professional who works in downtown Toronto and had good references. He did so much damage that my friend had to work for two weeks painting, replacing, and getting cat urine smell out of the floor and baseboards. The worst part is that it’s unbelievably hard to get a squatter out of your place if he or she knows the system and knows how to throw up roadblocks. It took 4 months to get rid of this guy. It’s interesting that everyone who advises making money by being a landlord never mentions this, or if they do they say it can be avoided by careful screening. They are wrong about that. If you are willing to risk it fine, but be aware that your dream of extra income from that condo may turn into a nightmare.
Oh no, so sorry to hear about your friend’s bad experience with renters. With every income stream, there’s always a risk, and in this case, I’m not sure how to mitigate it (since the person had good references). Thanks for sharing the story!
I wonder if it was this guy: http://www.cbc.ca/news/canada/toronto/rent-free-well-dressed-professional-tenant-won-t-leave-toronto-apartment-1.3775136
No, it was another younger guy. We think he has a cocaine problem. And definitely a personality disorder.
Can’t you just get a few guy friends and forcibly remove him and change the locks?
or is that not possible under the tenant act…would be much easier but then he might go really crazy and damage your place more.
Oh no you cannot do that. It’s not only incredibly dangerous but illegal. You could be charged with assault. The process for turfing a deadbeat tenant is arduous and expensive.
Ok, I really enjoy your blog!
Here is my question, What about if one was to buy a house for 300k in Alberta with an income suite live in one unit and rent out the second unit for roughly 1500 per month and essentially live for free?
Brian, do the math lol…no one’s living for free otherwise everybody would do that. and don’t buy in Alberta right now, prices are dropping big time. or have you not heard.
You’d have to calculate the yearly cost of ownership (property taxes, maintenance, insurance, mortgage, etc) and the taxes from the rental income. Then subtract that from the yearly rental income.
Two things people tend to forget is a) cost of ownership b) taxes on the rental income. You can’t evaluate if a decision makes sense mathematically by only looking at the income and not at the costs.
Yes property tax would be 200 / month
gas in the winter 300 / month (less then 100 in the summer)
Water and electricity 100 / month
property insurance 50 / month
internet 75 / month
The mortgage payments would be between 1257 and 900 depending on how much I decided to put down and what the interest rates were at the time…
The idea would be to rent out the upstairs and live in the lower level with minimal expenses and Snowbird for the winter months.
Its not anything I’m planing on doing in the short term, But at the moment I’m living in Vancouver and renting which I enjoy however the Rental market is Extremely insecure here with less then 6 apartments available for every 1000 people looking.
Our rent is reasonable at the moment for 1300 / month however most of these old buildings are getting demolished or renovated and then charging 2300 and up per month.
If we were to get “renovicted” I doubt we’d be able to stay in the city, Even the suburbs have a extreme shortage of rental properties and are not much more affordable price.
For the passed 11 years I have been living the life you guys have just begun, Living and traveling around the world and I absolutely loved it, however now I’m getting a little tired of constantly being on the move and looking for some sort of stability to not have to continuously live out of a backpack and start over again.
Constantly looking for Apartments around the world and making new friends while extremely fun and exciting can also be a bit tiring.
I just wish there were more affordable cities with decent climates in Canada haha
Anyways enjoy your travels!
I lived a couple of times in Malaysia its amazing! Very fair prices and delicious food. If you decide to stay a bit longer look at the local websites for an apartment as AirBnB and Hotels are a bit more expensive compared to the rest of SEA.
This analysis seems to consider the ROE of the rental property to be composed of only rental income (i.e. a dividend); what about the capital growth of the property? In a major city like Montreal, I would argue the overall ROE will be at par (at minimum!) with an index investing strategy. Furthermore, the rental property itself offers a tremendous benefit of diversification to a portfolio, which is far less susceptible to market fluctuations.