5 Questions to Ask Before Becoming a Landlord

There are a fair number of people who believe that owning property is the way to build wealth. Books have been written about it. Gurus have made fortunes touting it. And there are people who have been successful playing Monopoly for real. But it’s not a strategy for the faint of heart. And it’s not “easy” and so many flogging the idea would have you believe.

When Antony and Maria decided to buy a bigger home, Antony convinced Maria that the best way to do it would be to take money out of their first home as a downpayment on their second and then rent their smaller home. It was in a good location and Antony had been watching some late, late night TV and thought is made sense. Maria wasn’t so sure. She was pregnant with their second child and headed off on maternity for a year. While she liked the idea of having more space for a growing family, she’d thought that putting all the money from the first house into the second would mean lower mortgage payments.

When she wrote to me asking if this was a good idea my response was, “I can’t tell until you show me whether the rental will cover it’s costs and your cash flow can manage the higher mortgage payment.” So Maria and Antony had to do some work.

Question 1: Would the property carry itself or would Antony and Maria have to kick in money? When they worked out the mortgage payment plush other carrying costs like property taxes and maintenance for the “rental” the number was higher than Antony initially thought it would be. He’d been looking only at the mortgage and property tax payments, with no thought to covering maintenance and potential periods when the property sat empty. Making an allowance for just 1% of the value for maintenance and a three-month fund to cover costs if the property was empty, they would have to rent the property for $2,800 a month, slightly higher than the going rate in the neighbourhood for a similar home.

Question 2: Could their cash flow manage a larger mortgage payment if they were only making a 20% downpayment on the new home instead of using all the equity they’d built up? Here’s where Maria almost flipped a kidney. It turned out their mortgage payment would be $670 a month higher if they did not use all their equity. Antony suggested they just cut back on some of their savings since they were building equity in two properties. Maria asked me what I thought. Which lead to…

Question 3: Are you happy to have all your assets tied up in one type of investment. In the world of investing “diversification” is the key to managing risk. Having all your eggs in one basket – real estate – means that while markets are doing well so are you. But if there’s a shift and markets turn south, your entire portfolio is at risk. Maria was concerned but Antony felt they had more than enough time to ride out any ups and downs. “At some point in the future when things are on an upswing we could sell and rebalance, couldn’t we?”

“That’s absolutely true. As long as you have the stomach and the time,” I said.  “You do know that being a landlord requires a significant amount of work, right?”

Question 4: Are you willing to do the work to find tenants, deal with maintenance issues, respond to complaints or concerns and everything else that comes with owning rental property.

Maria sighed. “Antony is a whiz with a drill and saw,” she said. “It’s one reason he’s so unwilling to give up the old place. He put so much sweat equity into it, he wants to hold on to it for the long term.” Antony just grinned with glee.

“Hey, if he’s prepared to do the work, rental property can work for you guys” I said, “but there is one more question I want you to answer.”

Question 5: What do you imagine will happen in the future? Will interest rates go up or down and how will that impact on your rental property paying for itself? Will you have more children and want to spend more time with them? Is it likely that your jobs will require that you relocate? A little future gazing is a good thing so you have some sense of what’s working now and what will work in the future. Nothing is cast in stone and keeping an eye on what comes next is a good idea.

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Gail Vaz-Oxlade

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16 Responses to “5 Questions to Ask Before Becoming a Landlord”

  1. There are certainly advantages and disadvantages. We started out being landlords way back in 1975. We purchased a duplex and we lived in downstairs and rented out upstairs. That paid our mortgage and we had good tenants. My husband is also handy and we both put a lot of sweat into the place – it was very old and needed a lot of painting and care. However was more difficult when we moved to another home and rented out both units. Bottom tenant was a complainer and no one could please him – calling us all the time (even after we sold property). However, I would do it again as it probably was the only way to buy a house for us at the time – plus we got a big 1500 home ownership grant from gov. at time.

  2. Was an investment that worked out for me for the most part, only having to make two mortgage payments from my own pocket over the coarse of the mortgage on the property. Then divorce hit my family. Paying capital gains on the property when it needed to be sold then was not something I had factored in at that point.

  3. My father is a property manager and handyman for several people who own investment property. While they usually have good tenants, it does happen that you get one who is not so good. One house, the tenants stopped paying rent. It took two months (with no rent coming in) to have them evicted. Then, they left almost all of their belongings in the house… It took multiple trips to the dump and quite a few dollars to get rid of all of that… Then they had to repair the damages. Four months without any rent, plus the costs of disposal and repair, before they could look for a new tenant. I love the idea of having a rental income but I am also concerned about being able to cover the mortgage for six months and pay for repairs in that time…. And don’t even ask about the tenants who don’t take care of the place….

  4. If any of these people actually sat through and did the math, for the average investor, buying a rental property is not going to make you wealthy. People never budget for things like taxes, maintenance, insurance, property transfer taxes, lawyer fees when buying and selling and all the time and energy it takes to manage a property. Capital gains turn out to be less than half of average annual compounded returns compared to a diversified index fund which will pay you a dividend. And with that, there is no stock picking, you buy, hold and collect dividends. You ride out the market highs and lows. As gail said your net worth is tied up in one or few assets, all subject to one local market.

    Download a future value calculator and do the math. Stocks (the index) have on average gained 8.4% average compounded annually while real estate gains about 4% (before all your fees). Fees on a low cost index fund is less than 0.2% while it’s negligible if you manage a diversified portfolio of dividend paying stocks as I do (10 dollar trades, and I trade minimally). As far as providing a steady income stream, dividend stocks or index funds that also give a dividend provide a steady income stream. I’ve worked for five years since finishing med school and residency, and I now make about 15% more annually than what I did when I started because of dividends! I keep reinvesting that money and through the magic of compounding my wealth will grow exponentially. And there is absolutely no headaches with having to manage a tenant, having to fix things, find tenants and meet with total strangers, etc. Just money in my pocket.

  5. avatar nadjam123 Says:
    March 17, 2014 at 2:33 pm

    My hubby and I currently own 2 income properties. We had 3 and sold one last year. These are not typical “rent and hold” properties, but rather, we invested using a rent to own strategy. It worked beautifully with the first tenant – she purchased the home off of us 1 year ago. Our 2nd tenant was on track, but they have needed a bit more time to secure a decent mortgage. The 3rd one…they are our problem tenants. With all 3, we were dealing with people whose credit wasn’t good. The whole point is for them to do rent to own while building up their credit. In 2 of 3 of our cases, it has worked. With the 3rd – not so much. We will likely be evicting them soon, and then we will sell the property. That will cost us, as the real estate in that area has decreased in value, and they have not treated the house well at all.
    All this to discover that the “romanticism” of being real estate investors didn’t pan out to be what we thought. Even rent to own, where you are very “hands off” is still too much work. We have discovered that we are just regular people who are lazy (well, not really…I work my butt off at my regular job!), but too lazy to manage the properties. We value our free time way too much to spend it chasing tenants down for rent or to resolve other issues. So…we learned a bit lesson…we are not RE Investors…and we will never do this again. I will be happy when we are out of this business…hopefully by mid-2014. Had we asked ourselves some very hard questions and been really honest with ourselves, we likely wouldn’t have gone down this road. The lure of making money swayed us…it really does take the right kind of person with a certain risk tolerance to get into RE investing. That said…we are both happy we did it, as we learned a lot about ourselves.

  6. I am a landlord and real estate investor.

    One thing I’d add to this is that from a management and mitigation of risk point of view, it’s usually better to invest in a property with more units. Most people get into landlordship by renting out a single home or single condo because they want to start small. The difficulty with that is that it’s more labour intensive (the numbers don’t usually justify hiring a superintendent to deal with the little stuff when it’s just one unit) and you are much more dependent on keeping that single unit rented. A larger property that has more units can usually carry if there are a couple of vacancies. Likewise, in something that is a purpose-built apartment building, things tend to be standardized between units. Makes for simpler maintenance.

    Granted, such properties are often (though surprisingly not always!) more expensive, so it’s a bigger chunk of your investment portfolio tied up in real estate. But if you can make it work, it helps to mitigate some of the management hassle and the vacancy risks.

  7. I agree with Zonal. Landlording isn’t bad if you have more units. DH and I own a 6-plex. We’re hands-on and prefer it that way. We’ve had only one difficult tenant and with the others, a very cooperative relationship. We’re organized, reresponsive, and respective of our tenants. And we built a reserve fund to weather the unexpected issues already discussed.
    We chose this type of investment because our citizenship status(dual CDN-US) limits our investment options without onerous tax reporting. Honestly, I don’t mind landlording. But you have to work at it.

  8. Sorry– Sonal. Darn autocorrect!

  9. My husband and I own 9 rental properties. We have been landlords for over 10 years now. It is a lot of work! Our houses all cash flow, but we reinvest a lot of our profits into maintenance and upkeep to keep our taxes low. When we first started, we also had very good jobs to cover any losses should any of the places not rent. Carrying costs can be expensive and the rental market can be very competitive! So I would caution anyone to not buy a rental property if any of the following apply to you:
    1. You are having trouble figuring out the math of all the different costs involved
    2. You are in a tight financial situation already
    3. You are not good at sales and cannot afford a property manager or real estate agent (at least 1 month’s rent+)
    4. You are going through a life change like having a baby, or don’t handle stress well

    If you are financially stable, you’ve done the numbers and you can actually afford to carry the rental for a while while you find good tenants, then Go for it! It’s been a very rewarding experience for us. I

  10. And let me guess Gail, you didn’t even have the heart to tell them they’d have to pay tax on their rental income!!

    Back to the drawing board for these two…

  11. If you own your rental property in your personal name, yes, you will pay personal income tax on the net income. If you own the property under a corporation, you will pay corporate income tax on the net income, which is usually a lower rate. You’ll have to pay more in legal and accounting fees to own it through a corporation, but for a large enough portfolio the tax savings often justify the additional cost.

    That also means you can’t just take money out of the corporation without considering the tax consequences of doing so, but hey, if it’s a long-term investment, you probably don’t want to take much money out. Likewise, it depends on how you take that money out, whether drawing from your equity (no tax so long as you have equity), taking it as a dividend (lower tax), or drawing it as salary (highest tax.)

    The other thing is that you can write off all your expenses including your mortgage interest and depreciation on the property. People often overlook depreciation, but it can wipe out your on-paper profit such that you are paying little to no tax on the rental income. (Yes, like everything, check that out with an accountant.) I say on-paper because it’s not a “real” expense in that you don’t pay the depreciation bill every month, but you are permitted to write off a portion every year, and that goes a long way to reducing taxes.

    With a bit of research there are smart ways to manage the taxes, but yes, some professional advice plus a good working knowledge of taxes and accounting is important.

  12. We rented our first home too, and because of capital cost allowance (depreciation) and all other expenses, we paid next to no tax on the income.

    While most tenants are reliable, if you are putting a rental property on the market for the first time, be prepared to get a disproportionate number of undesirables. You have to be really business-like and get a credit check and employment history. Past rental references are usually useless.

    Sonal is right. I was told by my insurance agent that if you are going to have one tenant, you might as well have a 100. Should have followed his advice.

  13. Spinal, there are no tax advantages to owning rental properties in a corporation. There was a money sense article about this.

  14. Feel free to post the article.

    But there are also non-tax advantages to own within a corporation. For one rental house or condo, it’s almost certainly overkill, but if you’re dealing in larger properties, multiple properties, have partners, etc., it can be useful.

  15. Sonal – Rental income within a corporation is considered passive income for tax purposes and thus taxed at the highest corporate tax rate (around 45% depending on your province). So it is not at all taxed preferably, however you are right there are other advantages that are not tax related.

    You also need to be careful with depreciation because it can come back to bite you. Depreciation decreases your adjusted cost base on the property so when you come to sell it it will create a larger capital gain. It’s not a bad thing, just one more thing you have to take into account.

  16. Hi there colleagues, fastidious piece of writing and good
    urging commented here, I am actually enjoying by these.

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