Buying a rental property for the wrong reasons...

One of my specialities is helping people build their their real-estate-investment portfolio. Because I'm in the business of owning and managing rental properties myself, most of my clients appreciate the fact that I have first-hand experience of what to do (and what not to do).  I've made several mistakes over the last ten years where I've lost money, but I have also had several success.  I'm proud to say that I'm finally making a decent profit.

I love Don Campbell's quote from the Real Estate Investment Network (REIN), "Real estate is not a get-rich-quick-scheme, it's a get-rich-slow-and-steady strategy". 

Here are some typical reasons people give for buying a rental property, that may be the wrong reason for purchasing (I'd love your feedback):

1. I want to supplement my income now. If you purchase a rental property and need to put a mortgage on the property to 80 per cent of it's value, you're likely not making more than $500/month on it.  I'm referring to the marketplace which I know best KW, Cambridge, Guelph, Brantford, and Niagara.

2. You want passive income. Owning a rental property is not a passive business.  There's allot of work that goes into managing a property and making money.  Depending on the property, it should take you an hour each week BUT you need to do some work each week per property.

3. You're retiring in a year. If you're retiring shortly and you're looking for something fun to do, then a rental property may be the way to go.  I've also helped retires buy properties to leave a legacy for their children.  If you have money to invest and want to make a "dividend" or supplement your monthly income, investing in a private mortgage is a good alternative.

Implications of new mortgage-lending guidelines...

With little surprise in Canada, the Minister of Finance has finally made a formal announcement that there will be significant changes to mortgage lending. The main changes are a decrease in maximum amortizations from 30 to 25 years and a maximum loan-to-value refinance amount for your primary residence to 80% of the home's value (down from 85%).

What are some of the practical implications?

1. For first-time home buyers (especially in Guelph or the surrounding area), it's difficult to find a detached, suitable home for under $260,000. The shorter amortizations will decrease a person's borrowing capacity and purchase price by approximately $40,000. The exact date of the changes is unknown yet; however, if someone has been pre-approved for a mortgage 4 months ago, be sure they call their mortgage broker and speak to them about their maximum purchase price.

2. Qualifying to purchase a rental property has tightened in the last 6 months.  We have seen most lenders go to sticker uses of how rental income is used in qualifying someone for a new mortgage loan. The shorter amortizations will also limit one's ability to purchase rental homes.  In Guelph, we've seen a surge in prices for rental properties.  The change in shorter amortizations may cool rental property prices.

3. Refinancing to only 80% of the value of your primary residence will limit one's ability to take equity out of their home to pay-off debt, or to purchase other properties.  For example if a home is worth $350,000, under the new guidelines, the individual will have access to $17,500 less equity.

Here's one way to pay-off your mortgage if you have rental properties

This week I met Sam who has been an astute real estate investor over the last 7 years. He's been strategic about his real estate purchases, focusing on good locations and positive cash flow.

Although he's retired, Sam still has a significant mortgage of $250,000 on his primary residence and carries a secured-line-of credit (SLOC) of $70,000.  Don't be surprised at this debt level, because more and more baby boomers are not paying-off their mortgages before they retire.  In this case, Sam went through a divorce almost 10 years ago where his assets where divided, which is the main reason he still carries a mortgage.

The great thing about Sam's situation is that he has a stable teacher's pension and he's done a good job at managing his real estate investments.  He has enough equity in his real estate investments to pay-off his secured line-of-credit. This SLOC could be an issue in the future, given that rates on SLOC's show a 10-year historic average rate of about 6%.

Sam's meeting with his accountant this week to determine how to minimize the tax implications of this restructuring.  But I'm a big believer of using the equity in your real estate to help your personal finances, while still maintaining a positive cash flow on the properties.

Here's a good link from a recent story in the Financial Post on how to manage SLOC debt.

Should you buy a house even if you have consumer debt or student loans to pay?

In the last week, I've see three clients in similar situations. All three clients had good paying jobs, where in their late 30's and had over $20,000 of consumer debt outside of traditional car loans. Should they be considering buying a home? Here's my opinion...if you have any comments on this topic, please share them on my blog!

A home is one of the only appreciating assets you'll own. The trouble with these particular clients is that they have kept waiting to pay off their debt and are now almost 40 years old and still do not own a home. My recommendation would be to review their family budget with them and find a monthly mortgage payment that will help them get into a house, while also developing a plan to pay down their debt.

If they had savings to put as a down payment they could also look at paying their debt down with their savings and getting a cashback mortgage, which gives them the money for the down payment. Remember that you can withdraw up to $25,000 from an RRSP the year you buy a home under the RRSP Home Buyer's Plan.  That money does not need to go to the down payment, it could go to paying off debt.  Now that's a good idea!