Rental Properties - The Break Even Scenario

As I mentioned in my previous blog “Should I buy a rental property”, the first step to getting into the rental property game is to figure out why you want to buy one in the first place.

Now I want to take it a step further and assume you’ve determined why you want to buy a rental property and have decided to take the plunge. Let’s examine the steps you’ll take to get there and why the “Break Even Scenario” may be something to consider after all.

Step One: You go to see your local mortgage professional and they have concluded you are qualified to buy a rental. This should always be your first step. Always. Mortgage rules are constantly changing and evolving over time and the recent mortgage rule changes have made it even more difficult for consumers to qualify. With rental properties becoming harder and more complicated to qualify for, going in this blind and not knowing if you can afford a rental is unwise. Even if you make $200k a year running your own business and that whip you drive is the latest BMW. That may mean nothing in the way of an approval these days. Since you have an accountant that ‘works wonders’ and is able to get the income you claim on your taxes down, it may mean you can’t qualify despite your booming business. There are so many factors to consider which is why it’s imperative that you seek advice from a professional. Knowing your numbers and having an understanding of what you qualify for will save you a lot of potential hardships down the road.

Step Two: You contact your Realtor and begin your search for the perfect property. Buying a home with the help of a realtor is extremely important. Remember, you don’t pay a realtor a dime to help you find a house. It’s a free service and you will get expert advice and more accountability from the seller and their agent. I can’t recommend enough that you use their service!

When you find a property that you like, you run the numbers only to find out that after all expenses, you are only breaking even or even losing $100 per month if you purchase this property. Now, if you were in it to make monthly income this may be a deal breaker and you may pass on the property and the hunt continues.

To you, the lack of monthly income generated is a deal breaker, but to me, I’m not so quick to pull the plug. We see the same investment differently, and that’s ok. Possibly it’s because our reasons for owning Real Estate in the first place is different, and that’s ok too. There are no wrong answers. My ‘why’ is to build up a Real Estate portfolio over the course of several years since I don’t have a pension and this will act as my retirement. Regardless of our ‘why,’ here’s my perspective on why you may still want to look at this property as an option.

Consider This: To me, if the home is in a great area, has great rental potential now and in the future, possibly the zoning is beneficial for a change in the property’s usage down the road, and the market is allowing me to get this home at a decent price, even though its losing $100 a month, II may jump all over it.

So, here’s the math:

Home Purchase Price – $400,000

Let’s assume the home you passed on in this example yields a 4% increase in value year over year. Some years will be 2% and some years may be 6% increase in value,but statistically it will rise – so let’s stick with a conservative 4%. 4% on $400,000 is $16,000 in value its increased in one year.

Now, in order to buy, we needed 20% down for a rental property, which is $80,000 plus about $6000 in closing costs (where I am we pay roughly 1.5% in legal fees and closing costs on a purchase) for a total investment of $86,000.

As for the mortgage, you needed a $320,000 mortgage. Let’s say the rate is 3.1% over a 25 year amortization. You will have paid down the mortgage roughly $9000.

$16,000 increase in value, and $9000 decrease in the amount owed on the mortgage. That’s $25,000 I earned this year.

Although it’s actually $25,000 LESS the $100 per month you were losing on the expenses vs rental income = $1200. So You NET $23,800 on your $86,000 investment or 27.67% interest.

Say what now?

(I realize their are variable expenses as well owning a rental but these are the same whether you are making a profit monthly or not) Now, multiply that by 5 years. You gained $119,000 on an initial $86,000 investment.That is essentially a 19% return on your money year over year…

Now, for fun, let’s compare that to contributing that $100 per month (the amount you were losing and act as if you simply were contributing) to your RRSP or mutual funds at a fantastic yield of 7% with the same initial $86,000 investment. You would have $127,000 after 5 years.

And to think, you passed on it because you couldn’t make any money.

This is just one example of course, but the reality is, it can be that simple. Imagine if you had more than 1 property? Well, you just may be able to retire a little sooner. But Wes, you say, ‘How can I possibly get the money required to buy MORE than 1 property’?? Well, that’s a topic for another day.

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