Common Mistakes When Purchasing an Investment Property (Part1)
With the real estate market on its way to a correction in market values for many parts of Canada, savvy investors who are prepared will have some great opportunities to purchase new assets to add to their portfolios.
If you are new or just starting out as a real estate investor, the next 6 – 18 months may be an excellent time to get your feet wet.
Before you dive into the deep end and blindly buy your first rental, I thought it would be helpful to put together a little 3-part series on common mistakes we see first-time investors often make….
#1: Not Doing Proper Checks on Possible Tenants
Probably one of the biggest deterrents when purchasing a rental property is the possibility of ending up with the world’s worst tenants and having to go through the stressful, time-consuming, and often costly process of eviction.
It’s a very fair concern! It’s a reality for many landlords.
But there’s a fairly simple solution to this.
Hire a property management company.
They will complete all the due diligence for you including credit checks, employment verification, and previous landlord references.
On top of that, they’ll continue managing the property for you by dealing with complaints from the tenant, help with scheduling repairs, and ensure rent is paid on time.
Your next thought might be that it must be costly to hire a property manager, but it’s actually quite affordable.
You see, property managers build their fee based on a percentage of the rent you are charging, generally between 6 – 12%. This helps you scale by being able to budget them into the cost of future investments.
#2: Forgetting to Budget for Rising Rates
If you just recently became an investor during the pandemic, this one might sting a bit.
With the interest rates in Canada being historically low in combination with home values soaring during the pandemic, this created an environment very conducive to real estate investors.
If you made the mistake of thinking that rates were going to be forever low and did not include the cost of your rate and payment going up, the recent rate increase may have very quickly eaten into your ability to cash flow and may even cause you to dip into your own savings. Not really the goal of investment real estate.
Of course you don’t have control where rates go, but there are ways you can protect yourself from it.
It starts with being prepared and thinking of all the risks before you get your keys.
Speak with your mortgage advisor and work with them on different payments based on different interest rates and amortizations, so you know how high your payment could go in the worst-case scenario.
It allows you to run different scenarios and compare them side-by-side so it’s easy to understand. You should have this app ready whenever you go to look at any piece of real estate.
If you need help running these numbers, click here to schedule a complimentary mortgage appointment.
#3: Focused on Lowest Interest Rate, Not Cash Flow
This requires a shift in perspective that can be difficult for those who have only ever applied for a mortgage on a property they are going to live in, as the interest rate is what affects what comes out of your pocket every month so it’s a more direct concern.
But when you are purchasing a rental property you have to remember the tenant will be paying this interest, and it is also an expense you can claim on your taxes (Speak to your accountant).
When looking at investment real estate, focus on your net cash flow – how much you take home after deducting your expenses like mortgage payment, strata fee, property taxes, etc., and not on trying to increase your interest savings as much as possible as this takes away from the overall goal of profiting from your investment.
Of course there is a balance. Too high of interest and the payment can make the investment unrealistic.
But if you can give yourself a lower monthly payment by taking a slightly higher interest rate, this could be the difference between having your rent cover the expenses, and you having to dip into your own savings to cover the difference.
One example of this is increasing the amortization on your mortgage from 25 years to 30.
For example, with a mortgage of $400,000 the difference in payment between a 25 year and 30 year mortgage is approximately $200/month based on today’s rates.
Yes you may receive a slightly higher rate and you will pay more interest by extending your amortization, but you will decrease the out-of-pocket expenses and increase the chances of you being able to put something back into the slush fund.
Remember, you can also reduce your interest costs by making larger lump sum payments later on when you have the extra cash to do so. For now, limit your risk by structuring your financing to give you the lowest obligation month-to-month.
This is part 1 of our series. To move on and read part 2, click here.