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Should you invest in a rental property with five or more units?

15 August 2016 by National Bank
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Are you planning on buying a rental property with five or more units? Here’s what you can expect and what you need to keep in mind, according to Philippe Tessier, National Bank senior manager of multi-residential financing.

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How is purchasing a building with five or more units different than buying a smaller rental property?

It’s in a different mortgage category, because it’s a commercial, not residential, loan. To qualify for a loan, the building needs to be profitable.

We calculate the rental income and expenses (mortgage, insurance, taxes, heating, electricity, janitorial services and management).

Our target debt coverage ratio is 1.25. In other words, cash flow needs to exceed expenses by at least 25%.

The investor’s personal financial situation is also included in our overall assessment, but it is not taken into account in our calculations.

 

Is it better to start out with a residential rental property before investing in a commercial rental property?

A lot of people jump right into commercial real estate – it’s more profitable. But for commercial properties, we recommend starting with relatively small buildings with five, six or eight units.

 

How big of a down payment is required for this type of transaction?

For a building in a city with over 10,000 inhabitants, financial institutions generally require 25% of the purchase price.

But the down payment can be lowered to 15% with loan insurance.

Risk is higher in smaller cities. You could be at the mercy of a factory closure, for instance. So in these cases, the bank will finance up to 65% of the building’s price.

If the building has a commercial space on the ground floor, the same down payment is required, but the debt can only be amortized for up to 20 years, instead of 25 for entirely residential buildings.

In Canada, these rules are the same across the board.

 

What should you look for to make a good investment?

Of course, you want the building to be in good condition.

Avoid buildings with small-sized apartment units. At National Bank, we don’t finance boarding houses. We prefer buildings with units that have at least three rooms – they are more popular with tenants and there is less turnover.

In terms of location, we prefer buildings that are close to jobs and services (stores, schools, hospitals, public transportation, etc.)

 

What’s the key to success in real estate?

You need to take a good look at the financial resources available in case of unforeseen circumstances. Generally, you need to be able to reinvest 10% of the building’s value.

In terms of management, you have to be clever when looking for tenants. A “for rent” sign in the window won’t cut it anymore. Nowadays, everything is online, so you’ll have to understand how classified websites work. For example, if you want your ad to stay in the top results, you’ll have to take it down after a few days and post it again.

You also have to like working with people, you need to be comfortable with conflict management and you need to have time to devote to your tenants. If not, you can always hire a building manager, but it will cut into your profits.

It also pays to be handy. If you need to hire someone every time there’s a leaky faucet, it can add up.

Lastly, it’s important to know the market well and have a good grasp of tenants’ and landlords’ rights and responsibilities.

 

How is real estate different from other investments?

Real estate requires more time and management from the investor. You need to make an effort to make a profit. It also takes longer to sell than a stock option! On the other hand, it’s a tangible investment vehicle, which a lot of people appreciate.

 

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This article is provided by National Bank, its subsidiaries and group entities for information purposes only, and creates no legal or contractual obligation for National Bank, its subsidiaries and group entities. The details of this service offering and the conditions herein are subject to change.

Views expressed in this article are those of the person being interviewed. They do not necessarily reflect the opinions of National Bank or its subsidiaries.

For financial or business advice, please consult your National Bank advisor, financial planner or an industry professional (e.g., accountant, tax specialist or lawyer).

© 2016 National Bank of Canada. All rights reserved. Any reproduction, in whole or in part, is strictly prohibited without the prior written consent of National Bank of Canada.

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This article is provided by National Bank, its subsidiaries and group entities for information purposes only, and creates no legal or contractual obligation for National Bank, its subsidiaries and group entities. The details of this service offering and the conditions herein are subject to change.

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Views expressed in this article are those of the person being interviewed. They do not necessarily reflect the opinions of National Bank or its subsidiaries. For financial or business advice, please consult your National Bank advisor, financial planner or an industry professional (e.g., accountant, tax specialist or lawyer).

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