When Being A Landlord Can Pay Dividends

To me, the idea of becoming a landlord and owning a real estate empire sounds better in theory than practice.  I can barely look after my own home maintenance, let alone having to manage another property.  There’s also a major lack of diversification when you put all your eggs in the real estate basket – an asset class that’s awfully expensive in Canada.

Related: Borrowing to invest – how it works

That’s why I was intrigued when I read about a different type of landlord strategy.  In his book, The Smart Debt Coach, financial author Talbot Stevens explains why a dividend landlord approach could make sense for those who’d rather avoid having to manage and maintain a rental property.

Here’s how it works:

With the dividend landlord strategy, the investor borrows an amount he or she is comfortable with, say $50,000, and uses that money to buy dividend paying stocks.  The interest expense is tax deductible when you borrow to purchase an investment that has the potential to produce taxable income.  Not only can the dividend income pay for most or all of the tax-deductible interest, dividends from Canadian companies are taxed less due to the dividend tax credit.

The lowest cost of borrowing is likely through a home equity line of credit, or HELOC, which can be obtained today at a rate between 3 and 4 percent.  The investments would need to be held in a non-registered account in order to make the loan tax deductible, and to be eligible for the dividend tax credit.  That means you can’t use this strategy in your RRSP or TFSA.

The dividend landlord opportunity was born after the financial crisis hit in 2008, when interest rates dropped so much that the average dividend payout of companies listed in the TSX became higher than the prime rate of borrowing.

Related: Is your investment loan tax deductible?

It’s now possible to be the owner and landlord of dividend paying stocks and have the dividend “rental income” cover the cost of borrowing to invest in them.  One example shared in the book is that you could go to any of the banks, borrow the bank’s own money to buy its own stock, and have the dividend income more than cover the interest cost.

Benefits of becoming a dividend landlord

When you consider that the interest cost of borrowing is fully deductible and the dividend income is taxed less, many investors can be cash-flow positive even when their dividend income is less than their cost of borrowing.

By purchasing quality blue-chip stocks that you’d want to hold for the long term anyway, being a dividend landlord can be an effective no- or low-cash-flow strategy that is much less work than a rental property.

Related: Is it time to say goodbye to dividend investing?

The other benefit to this approach is that if you choose stocks in stable industries that have a history of increasing their dividends over time, your “rents” should go up automatically each year.

Downside to becoming a dividend landlord

Borrowing to invest comes with certain risks.  Just as your gains can be magnified, so can your losses.  The author also cautions investors that they’re almost guaranteed not to be cash-flow positive indefinitely.  That’s because interest rates go up and down over time.

The strategy is designed to have the borrowing costs mostly or completely paid by the dividend income.  Still, you should be able to comfortably handle the loan payments on your own, even with higher interest rates.

And just like you might have vacancies or tenants skipping out on rent, there may be times when a company might reduce or suspend its dividend.  You have to be able to deal with those times.

There are also behavioral risks to consider.  If you want to eventually be debt free and own the stocks outright, as with a rental property approach, you need to be careful with what happens with the additional cash flow generated by this strategy.

Related: How the behavior gap affects investor returns

For example, the tax savings from the interest expense deduction and the dividend tax credit should be used to cover the interest costs and pay down the amount you borrowed.

“If this cash flow disappears out the back door and is used for something else, it’s going to be tougher to retire the debt before you do.”

One last thing the author mentions with the dividend landlord strategy – and with any investment debt strategy – is that when you start can make a big difference.  Starting your dividend landlord business when the stock market is down can significantly increase your profitability.

Final thoughts

I enjoyed reading The Smart Debt Coach – it explained strategies on how to use debt to increase your investment portfolio, and how to think in terms of before-tax and after-tax dollars in order to maximize your returns.

I’ve already used one of the strategies in the book when I used a top-up loan to boost my RRSP contributions.  I like the concept of the dividend landlord approach – certainly better than being a traditional landlord – but I’m not too excited about starting while the stock market is at its current high level.

What are your thoughts on the dividend landlord approach?

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  1. Ed Poletto on March 3, 2014 at 6:13 am

    Interesting outlook on borrowed money. Not for the faint of heart.

    • Money Saving on March 4, 2014 at 1:59 pm

      Exactly 🙂 Sound like an interesting idea, but seems extremely risky.

      • fiscally fit on March 4, 2014 at 6:55 pm

        How so?

        Stupid question… I know haha but it depends on how you define risk. Volatility? probability you will end up with $0? liquidity risk? interest rate risk? Risk you will not have enough assets to retire?

  2. Dan @ Our Big Fat Wallet on March 3, 2014 at 7:26 am

    That’s an interesting way at looking at dividend investing. Sounds like a solid strategy, so long as the cash flow is used to pay down the debt as mentioned. My only concern along with any other leveraging strategy would be rising interest rates. Right now it doesn’t seem like an ideal time to start a strategy like this because the markets are high but hopefully we will see a correction soon

  3. Echo on March 3, 2014 at 8:28 am

    @Ed and @Dan – Definitely not for the faint of heart. If I recall, the Smith Maneuver strategy hit a feverish level back in ’07-’08. Many investors couldn’t stomach the fact that their leveraged portfolio declined in value by 30 percent or more. The ones who stuck with it are doing okay now, but I’m sure many wish they’d never heard of Smith after that experience.

    • Don on March 3, 2014 at 4:36 pm

      You mean that Abbot…er..Brian Costello wasn’t telling us how hard it was? 😉

      Actually, from what I recall of Brian’s advice, he wasn’t even promoting the Smith Maneuver correctly, he would just tell you to cash in investments, pay off your mortgage, then take out a loan for investments. Something the CRA had already ruled a “sham transaction”.

  4. Addison @ Cashville Skyline on March 3, 2014 at 9:36 am

    Thanks for sharing! I had never considered this approach, and I’d definitely be hesitant to give it a try for the reasons the other commenters shared. I agree that being a traditional landlord is anything but passive, and I’d like to learn more.

  5. David W on March 3, 2014 at 3:12 pm

    I wish I had done the Smith maneuver years ago and not relied on the so called “bank financial adviser” who when I decided to buy an investment property “advised” the best way to go was to just increase my home mortgage although I did mention to him that there should be a more tax efficient way of doing it…………
    When at a later date when all was done and dusted I found the Smith and took it to the bank they had no idea about it!!!!! Obviously wasn’t a buck in it for them.

    • Don on March 3, 2014 at 4:47 pm

      You actually don’t need the Smith Manoeuvre for rental property. Even if you increase your home mortgage, you can just apportion the interest you pay to the amount you took out on your investment property. The Manoeuvre is actually only required for people that have existing securities that are held without a loan against them.

      • David W on March 3, 2014 at 6:16 pm

        Hi Don,
        that was what I was telling him in addition to the Smith but as he was not a tax expert he probably would or could not advise???
        It all turned out OK as in 7 years the property tripled in value, sold it off, rolled all the capital gains into RRSP’S as we had the room, paid off the mortgage and got some money back from the tax man…& retired…….

        • Don on March 4, 2014 at 7:33 pm

          I’m glad it all worked out for you.

          I’m guessing that these employee was merely a loan officer, and only knew how to spell “tax”. Still, he should have been familiar enough to provide you some reference material or given you advice on who to contact.

          • David W on March 4, 2014 at 10:13 pm

            Hi Don,
            No he wasn’t a loan officer he had, according to him been a broker at an investment house before he came to the bank. He later went back as a broker. That is a worry !!!!but all’s well that ends well.

  6. fiscally fit on March 4, 2014 at 12:27 am

    I am a big fan of leveraged loans when the strategy is constructed properly. I spoke to Talbot Stevens three years back and he presented some interesting ideas.
    In today’s environment, a closed system works best. All dollars generated stays in the loop and isn’t used to pay down non deductible debt. Although not as efficient as a debt swap in that regard, it is easier for the investor to “stay the course”. The goal should not be capital appreciation, but the efficient generation of monthly cash flow to cover a principle and interest payment. This solves the “market timing” aspect of the investment loan. As the hurdle rate in todays economy is quite low, this should be achievable over a 20 yr amortization of an investment loan. If you are able to pledge additional dollars against the loan, you can build in a margin of error for when the rates increase. Again, not the most efficient but the most likely to produce a good outcome.

    For my own leveraged account I chose an income fund with a solid mandate and good management (I am lucky enough to have met the managers and the analysts). I pay 1.5% MER with 0.5% of that tax deductible and the loan is 3.75% over 20 year amortization. The distribution is approximately 6%. And just for context (worse case scenario haha), if I used this strategy starting jan 2 2008 for this fund relative to today, the NAV would have went up about 5% with the 6% distribution never adjusting

  7. Penny pincher on July 13, 2014 at 12:41 pm

    Thanks for sharing. Just wanted to say this post got me thinking awhile ago about this strategy and I finally decide to start it.

    I was also a bit concerned about the current market’s high valuations but I’m going to keep investing a couple thousand every quarter to make sure I’m not buying at a market peak.

    I believe I’ll have the will to stay the course if there is a correction. I managed to keep investing throughout the last correction.

    Thanks for the idea!

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