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Investing in real estate not an impossible dream
By Peter Kinch
Real estate investment has become a popular topic around the water cooler and dinner table these days. The more turmoil we see in the stock markets the more Canadians begin to look for a safe harbour to safeguard their hard earned money. In times like this, investors tend to shift their capital to hard assets such as gold. The other obvious choice for an investor seeking less volatility in their investments is real estate. Yet surprisingly, real estate investors in Canada still represent less than 5% of home purchasers. So it begs the question; if the majority of people think investing in real estate is a good idea, why aren’t more Canadians doing it? I think the answer is fear. An individual may intrinsically believe that buying real estate is good but if the thought of doing so intimidates them because they’re not sure how or what to do, it results in no activity. It is easier for most people to do nothing than to venture into unchartered territory that is wrought with fear and false information.
The solution to overcoming fear is knowledge. Equipped with the proper information it becomes easy to debunk some of the myths and misconceptions and begin your investment career with confidence. Here’s a look at some of the most common myths that hold people back from moving forward:
I need to make $100’s of thousands of dollars to be able to afford buying multiple properties.
This is one of the most common misconceptions that I see. The fact is — you don’t. You’d be surprised to see how the underwriting process at a bank works to help you accomplish your investment goals. Although every lender has their own internal way of calculating the rental debt, they all generally follow a variation of the following formula:
Calculate 40% of your verifiable income (if you’re self-employed, that would be 40% of the 2 year average of line 150 on your tax return). I call this number your Debt Service Limit (DSL) – which is the maximum amount of money that a lender wants to see you pay towards servicing your Personal Consumer Debt (PCD).
Next calculate your PCD.
Your consumer debt includes, but is not limited to: your principal residence mortgage, your property taxes, any car loans, leases, monthly credit card bills or any other personal consumer debt that is on your credit bureau.
If you are looking to buy a rental property with break even or positive cash flow and your DSL is higher than your PCD, then you will be able to qualify for a mortgage on that rental property.
As you add more properties to your portfolio, the lender can simply offset the rental income against the cost of the mortgage and consider your rental portfolio as a stand alone entity that services itself.
What many fail to realize is that, using this formula, if you qualify for one, you would qualify for multiple properties without having to increase your personal income. The key is to work with a broker or lender that understands how to build a portfolio.
This leads to a second common myth or misconception:
2. My banker told me that I shouldn’t buy any rental properties or that they cannot offer me a mortgage on a rental.
This is a classic case where many Canadians fail to understand that not every loan officer at every bank is an expert in real estate investment portfolios. You will recall that I mentioned earlier that less than 5% of Canadians purchase real estate for investment purposes. Well, the same statistics hold true for bankers and brokers. Less than 5% of bankers and brokers understand how to work with real estate investors. The fact is that not every bank in Canada has an appetite for lending money on rental properties and some are much more investor friendly than others. Each bank has a different way of calculating the rental income and may use a different percentage of the rent to help you qualify for the loan.
The challenge is that if your personal bank is not an investor-friendly one, then you may make the mistake of assuming that would be the same answer everywhere else. Whereas, simply choosing the right lender, could allow you to purchase multiple properties without the need for higher income.
Solution: Work with a Mortgage Broker who understands the rental policies at all the banks (not just one of them) and can help you build a portfolio that suits both your short and long term goals. (Tip: A good broker who knows how to work with investors will offer you a consultation to review your long term goals and work with you to develop a portfolio rather than focus on a single transaction).
3 I need a fortune saved up in order to buy real estate.
This is a myth that actually has two sides to it. On one hand, many Canadians are not aware of the down payment options available to them, and on the other hand, there are still those who think they can buy real estate with nothing down (usually after watching some late night TV show).
The fact is, since the government rule changes in 2009, you do require 20% down from your own sources for residential rental properties in Canada. However, what many still fail to realize is that equity in your own home or existing real estate is considered your own money and a percentage of that equity can be used for your down payment.
Here’s the formula:
(Market Value of your home x 80%) –(existing mortgage and/or line of credit) = Potential accessible equity
E.g.: Value of home = $400,000
Mortgage = $120,000
No Line of Credit at Present
$400,000 x 80% = $320,000
$320,000 - $120,000 = $200,000
In this example, the homeowner would have $200,000 to invest. If this were to represent a 20% down payment, then the maximum purchase price would be $1,000,000. This could in turn represent the ability to purchase 4 townhouses at $250,000 each.
There are a great number of Canadians today who are sitting on $200,000 of accessible equity in their homes today and are in the position to convert their equity into a million dollars of real estate over and above the value of their principal residence and the only thing stopping them is fear or the lack of knowledge as to how to get started.
Other common concerns or myths that prevent Canadians from taking that critical step forward are:
4 I can’t imagine having to deal with tenants or I don’t want to have to get a phone call in the middle of the night because someone’s toilet won’t flush.
I’ve owned a fair amount of real estate over the years and most of it in a different province. The best money I have ever spent is 6 – 10% of the rental income on a good property manager. Invest in your manager, learn how to manage the manager and never ever worry about the midnight call.
5 What if my tenant skips town and I don’t have any rental income.
Couldn’t I lose a lot of money?
- Two answers to that:
1. Focus your investing on towns with strong and diversified employment. Avoid small towns that would have high vacancies if the mill closed down.
2. Always have a contingency fund equivalent to three-month’s rent put aside for every property you buy at the time of purchase. That way, if you do have a vacancy, you do not have to subsidize it out of your own pocket.
And the biggest concern (or excuse) why most people are afraid to act:
6. What if the market crashes and I lose everything?
The answer to this question is very simple.
Invest don’t Speculate
Speculators look for short term opportunities to make ‘quick cash’. They take risks and gambles hoping to ‘get rich quick’.
Investors buy for the long term and don’t gamble. Real estate investing doesn’t need to be and shouldn’t be a risky gamble. If you purchase a property today at fair market value in a town with a solid tenant base with low vacancies and you have a tenant who is essentially covering all of your expenses and you are planning to hold that property for the long term, then the value of that property between the time you buy and the time you sell is irrelevant. The market can crash three times during the 15 – 20 years I own it and if, in that time, the tenants help me pay off my mortgage, then chances are, I will have made a good profit regardless of what the market did in the interim.
Take the time to educate yourself and seek out good sources of reliable information and replace fear with knowledge. That may just be the secret to going from talking about real estate to becoming part of the 5% of Canadians who are investing in their financial future and using real estate as their safe harbour.
Peter Kinch is the author of The Canadian Real Estate Action Plan and co-author of the Canadian Bestseller - 97 Tips for Canadian Real Estate Investors. Peter Kinch Mortgage Team is located at Unit 201 101 Klahanie Dr. Port Moody BC V3H 0C3 Ph: 604 939 8326 www.peterkinch.com