If you read Hardbacon, you know that a lot of the richest people in Canada have diversified into real estate holdings; names like Greenberg, Thomson, Rahi, Apostopoulos, Azrieli, and Goldhar. Some inherited their wealth, others built in from hard work and diversified risk. They did it and you can too.
It is a mistake to think that you have to sell one property to finance another. If you leverage the equity in your current primary residence, you can start your own real estate investment portfolio.
Equity is something you already have
What is equity? Equity is the current value of your house that is greater than what you owe on it. If you can manage your current payments, calculate if you can handle more debt on the house. Rates are low but be warned: rates on investment properties are slightly – slightly – higher than on principal residences. According to the CMHC, an investment mortgage will be higher than a conventional rate but your tenant will absorb the cost.
That positive margin between your house’s value and its remaining mortgage is the down payment for the investment property. There are two ways to access it depending on your personal risk tolerance.
If you are outgrowing your house, if you don’t like the neighbourhood, or if you just want change, you can move to a new place and take the mortgage out on your current property and subsequently rent it out. The biggest risk is the time that it takes to find tenants to move in and begin paying rent. The tenants’ monthly payment should cover your costs, which include mortgage, all taxes, insurance, and utilities if it is part of rent.
Another option is to take the mortgage out on your principal residence and finance an investment property that already has a paying tenant. You save some costs by not moving and you don’t have to worry about finding a new tenant quickly. The tenants pay the mortgage, taxes, and costs regardless. It may be easier to qualify for a mortgage since the tenants are in place.
Don’t quit your job yet
You are just starting your real estate portfolio, and for the first few years, it might be a source of taxable passive income. You’ll probably still need a steady income to live comfortably, pay for your own lifestyle, and to qualify for the investment mortgage.
Quitting your job doesn’t have to be the goal. Real estate investment can be another income stream, and one of many. The more investments returning a positive cash flow, the faster you would get to being independently wealthy.
Financing that is right for you
You don’t have to go to a traditional bank to get the mortgage. You can hire a mortgage broker to do the research and outreach to find the best rate for you. Brokers have access to all of the retail banks and specialized companies. A broker is not for everyone, but you can still get the right mortgage yourself by doing your research. Your real estate agent has a network of mortgage specialists ready to help you too.
Financing is the critical factor. Remember that equity is your house’s value minus any debt on it? Well, it’s the lender that determines its value, not a real estate agent. The bank or mortgage company will determine how much equity you have and balance it against your debt level and total income. In some cases, the lender will finance up to 80% of the value of the rental.
At last! Some tax relief!
Real estate investment is just that – an investment – and the Canada Revenue Agency looks at your new mortgage in a different way. Once you declare a property as a rental investment, the interest portion of the mortgage on it and any other expenses, including city and school taxes, are tax deductible. The principal owed on the loan is not tax deductible, but the amortization period pays interest first, meaning that it can be well over 50% of your monthly payments that goes strictly to interest payments.
Once you pay off your investment mortgage, the costs of improvement or upkeep are still tax deductible and that protects your profits from a bigger tax bite.
TFSA is another way to protect your portfolio
Even better, you can take your after-tax rental income and put it in your Tax-Free Savings Account or TFSA, if you have room. According to Brad Wise, an investment advisor at Manulife Securities Incorporated, the term Tax Free Savings Account is a misnomer. “It should really be called a Tax-Free Investment Account. The money in it should go toward investing.” Why? Because interest on TFSA investments grow tax free. Do you have money your TFSA already? Use it to build your real estate portfolio. It’s money you don’t have to pay back, and it can help build equity in your new business. That’s right – your portfolio is your own small (or not so small) business.
Are you ready?
Owning an investment property is a financial commitment that is very different than buying shares in an REIT or real estate stocks. You have a physical asset that you control. Only you know if you are ready to be a real estate investor involved with your own portfolio of buildings or units.
You are building wealth for yourself and diversifying into something that can lead to your financial goals. As someone once said, in your golden years, “you cannot eat your house.” Rental income can fund a lifestyle that doesn’t rely on selling your principal residence. Selling a property at the right time and for the best price is never guaranteed. If you have increased equity now and want to get into the real estate investment, this might be the best time to make your move.