Make a Sound Investment in a Residential Rental Property

22 March 2021 by National Bank
Rental property investment

Buying residential rental property may be a good idea in terms of investment strategy. But before diving in, it’s important to understand all your future responsibilities. Here’s some advice on investing in real-estate.

By definition, rental property is any residential building purchased in order to generate income. This type of real-estate investment comes with its share of benefits, challenges and rules. 

What are the benefits and responsibilities for a rental property owner?

Some of the advantages:

  • You could earn a return on your real-estate investment as of the very first year if the sum of the monthly rents is greater than your expenses and mortgage payments. 
  • You could pay less tax on your income by deducting certain expenses related to managing and maintaining your rental property. 
  • Your rental property may increase in value over time. According to a recent study of the real-estate market in Canada conducted by, an industry-leader in real estate and finance technology, a conservative estimate of the returns of real-estate investments purchased in the last decade show that today, their returns have increased by an average of 20% to 30%, depending on the area.  

Some of your responsibilities:

  • Managing tenants: You have to be a people person, be comfortable with managing conflicts, and have the time to devote to your tenants. You could hire a property manager, but this will cut into your profits. 
  • Managing revenue and risk: You also have to soundly manage your cash inflow and outflow so you can deal with any unexpected situations, such as urgent repairs or tenants who don’t pay their rent. Plus, to make sure you can handle unforeseen events, we recommend setting aside a security fund worth 3.5% of the property’s sale price. The cash should be easily accessible, so put it into a savings account or a line of credit
  • Maintenance and repairs: Being handy will also factor into your success. If you have to hire a skilled worker every time there’s an issue, the costs will add up. 
  • A strong understanding of the rules: You also need to have a clear understanding of landlords’ and tenants’ rights and responsibilities in your province or territory of residence.     

How do you finance the purchase of a rental property? 

The process for buying rental property is the same as for buying a home or a condo, whether you plan on living there or renting it out. You’ll need to put a down payment on the property and probably take out a mortgage loan. If the rental property has five units or more, that’s when the financing rules change. 

Planning for the down payment 

Buying any property requires a minimum of liquidity. For rental property with four units or less, if you’re renting out all the units, the minimum down payment is 20% of the purchase price. If you choose to occupy one of the apartments, a mortgage loan insurance policy, such as the one offered by the Canada Mortgage and Housing Corporation, helps reduce the down payment to 5% for a duplex and 10% for a triplex or quadruplex. 

Using the Home Buyers’ Plan (HBP)

While some may believe otherwise, you can in fact use the HBP to purchase rental property under certain conditions. That means you can withdraw up to $35,000 from your RRSP for your down payment, as long as you follow certain rules, of course. You’ll have to live in your future rental property, and it has to be the first residential home you buy. Please also note that if you were a homeowner in the past, but not in the last four years, you’re also eligible for the HBP. 

Good to know : It's also possible to use the new First Home Savings Account (FHSA) on a rental property, as long as you live in that property.

Remortgaging to buy new property

When they can, some investors opt to remortgage a property to finance the purchase of another one. For example, if you’ve already reimbursed a good chunk of your mortgage on your primary residence, you can use that initial asset to take out a loan at a more preferential rate than that of a personal loan. The new mortgage loan can represent up to 80% of the value of the building you’re refinancing. This is known as the leverage effect. Your mortgage expert can help you evaluate the advantages of this approach based on your particular situation. 

When buying property, you’ll also have to pay other fees, like the land transfer tax (welcome tax), notary fees, inspection fees, and municipal and school taxes, for example. We recommend setting aside a sum equal to 2% to 3% of the property’s sale price so you can cover these fees. 

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What questions should you ask yourself before buying rental property?

What type of rental property should you buy?

There’s no magic answer to this question. It depends on your goals, your budget, and the time you want to spend managing your new property. 

For example, you won’t have to spend as much time managing a duplex or triplex as you would for a property with eight units and eight tenants. In fact, please note that the rules for buying rental property with five units or more aren’t the same as for buying property with four units or less.

How do you choose the neighbourhood or location? 

To make sure you’re making a good rental investment, you must take into account many different criteria when choosing the location. 

Target properties close to many services like public transit and essential businesses, for example. The prices of rental properties also vary from one neighbourhood to another. Your budget will also guide your decision on where your real-estate investment will be located. 

If you find a property you’re interested in, we recommend doing a pre-purchase home inspection. An analysis of the grounds on which it’s built is also advised in some cases. Contaminated soil may reduce the value of your real-estate investment. 

How do you calculate the building’s profitability?

The simplest way to calculate a building’s profitability is to subtract all your annual expenses (taxes, maintenance, insurance, etc.) from the total rent payments you receive every year. 

To achieve reasonable profitability, have a target income worth 110% of your expenses – so for every $100 you spend, you should make $110. But this is a sliding scale; we recommend talking to an expert to make sure you’re earning enough from your property. 

How do you evaluate rent costs?

The purchase price must not only reflect the condition of the building, but also the rent amounts. A building with apartments rented at sub-market rates does not have the same value as a building with more expensive rent. Establish the appropriate amount to charge for rent based on the building’s type, location, condition, etc., and factor this into the purchase price. 

To get added input for your number-crunching, feel free to ask the seller how long the current tenants have lived there, what the average tenant turnover is, when the latest rent increase was, and so on.

Also, compare the asking price to that of similar rental buildings sold over the past year, all while taking into account the rent prices. A real-estate broker can do this for you. 

Should you be an owner-occupant?

You need to determine whether you wish to live in one of the units or not. If all the units are rented, then from a tax perspective, you are entitled to deducting all current expenses related to the building from your gross income. On the other hand, as an owner-occupant, only expenses for the units being rented are deductible. However, if and when you later sell the building, proceeds attributable to the owner-occupied portion are exempt from capital gains tax.

How much will you be taxed when you sell your property? It depends, because 50% of the gains resulting from the purchase price and the sale price is taxable, and the tax rate will depend on the owner’s overall income, as the gains are added to their other income (employment, investments, etc.). 

Finally, rental property may be a good investment option for you, but you need to be fully ready to put time into it. You need to love managing, have a great deal of patience with your tenants, and be available to address their requests.

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