Weekend Reading: Let’s Talk About Rental Properties Edition

A new report issued last week by condo research firm Urbanation Inc. shed light on a problem that has plagued real estate investors for years – the vast majority of rental property owners are bleeding cash flow.

According to the report (G&M subs), which looked specifically at new condo investors in Toronto, more than 80% who took out a mortgage to buy newly completed condos this year were cash flow negative and losing an average of $605 a month.

Perhaps these investors had no intention to close on the pre-construction condo and instead would look for an assignment sale. But with pre-construction condos being priced nearly $100,000 higher than existing condos on the resale market (and there are a lot of them), new investors are understandably taking a pass.

That leaves buyers on the hook to close the deal and take on the expenses of owning a rental property, which will cost them hundreds of dollars a month more than what they can get in rental income.

Therein lies the dilemma for real estate investors. A cash flow negative condo was tolerable when the rental property appreciated in value by 10-20% per year. Stick it out long enough, sell, and make a tidy profit.

But now we’re in a situation where housing prices are sky high and the cost of ownership is sky high, leaving investors in a bind.

This is not uncommon.

I’ve met with countless real estate investors (or wannabe real estate investors) from across the country over the years of running my financial planning practice. Most lived (or owned property) in big markets like Toronto and Vancouver, but there are plenty of investment property owners in Calgary and Edmonton, and in smaller markets like Lethbridge and Regina.

Most didn’t really have a plan. They either bought a new house and kept their old condo as a rental. Or they heard success stories from other property owners (their parents) about how real estate is a great investment and so they decided to buy a property to rent out.

Here’s a reality check. If you own property in an expensive market and have a mortgage you’re going to be cash flow negative when factoring in all expenses. Even if you manage to break even or turn a small monthly profit, you’ll need to set aside a reserve fund for future maintenance, vacancies, etc.

There is no guarantee of price appreciation. Even in more reasonably priced markets, like Edmonton, investors who bought 15 years ago have seen their properties depreciate in value (yes, you read that right).

Related: My house was a lousy investment (or was it?)

With those factors in mind, what is the end game? Hope you can sell for a profit down the road? Ride out 20-25 years of negative cash flow until the mortgage is paid off?

One young couple owned a rental property (a condo they previously lived in) that had appreciated in value by $300,000. The property cost them $300 per month more than they received in rental income. 

Meanwhile, the couple was struggling to save meaningfully for retirement, and had an upcoming parental leave to fund.

The solution was staring them right in the face. Sell the rental and use the ~$250,000 in after-tax profit to boost their retirement savings and set-up an emergency fund to cover their parental leave.

Another couple, closer to retirement, owned a rental property outright. Did they plan to own the house indefinitely? Not sure, they said.

Delving deeper, they didn’t love being landlords and managing tenants. The property was aging, and they figured it would need a new driveway and a new roof at some point soon.

We came up with a plan to sell the property the year after they retired, but two years before they planned to apply for Old Age Security. That way they could get rid of the property, use the proceeds to shore up their retirement savings (and take that bucket list trip), and take the capital gain at a time when they had no other income. They even had some remaining RRSP room to use up and reduce the tax hit.

All of this to say, think carefully about buying a rental property today. No doubt there are successful real estate investors out there. But this is not your parents’ real estate market. Most investors are bleeding cash flow, and there’s no guarantee that prices rise like they have in the past decade or so.

This Week’s Recap:

We’re back from a wonderful three-week trip to Europe, highlighted by an incredible Taylor Swift concert in Zurich, a glorious five-night stay in Varenna (Lake Como), and a new favourite destination in the Lauterbrunnen valley in Switzerland. We will definitely be back for a longer stay in the future.

I did not take any foreign currency with me this time, just as an experiment to see if it was possible to get by with just a credit card. I brought my Wealthsimple Cash debit MasterCard with me just in case I needed to take out cash (and not pay any foreign currency conversion fees or withdrawal fees), but I didn’t use it.

Even shopping at a hand-made market in Bellagio, the sellers all took credit card or in one case took payment via PayPal. All good!

I used the Scotia Passport Visa Infinite for all of my transactions. I like the Scotia cards because they also don’t charge foreign currency conversion fees, but also because I received an email immediately after every single transaction with the amount charged in Canadian dollars.

This was helpful for me because I like to stay on top of our budget during our travels. 

Even public transit in Switzerland and Italy could all be booked online or via mobile app (including the bus in Varenna). I appreciated this, because I hate having to fumble for exact change on the bus.

So, it is possible to visit London (pound sterling), Paris (Euro), Zurich (Swiss Franc), Lauterbrunnen (Swiss Franc), Lake Como (Euro), and Venice (Euro) without bringing any local currency with you.

Finally, while we didn’t use our American Express Platinum cards for any transactions on this trip, they still came in handy for airport lounge access in Calgary, Venice, and Montreal. Your Amex Platinum card gives you and a guest free access to 1,400 airport lounges in over 500 airports around the world. 

My wife and I each have our own Amex Platinum cards, so that gets all four of us into the lounges. If you figure it costs $50 per person, per visit, then we got $600 worth of value out of our Platinum cards this trip.

Weekend Reading:

At the Humble Dollar blog, David Gartland explains why real estate investing is not his thing.

Our house has become a retirement nest egg. But if we cash out, will our kids ever own property in Toronto?

For mortgage seekers, a good broker is paramount. Rob McLister explains how to find one.

Rebalancing your portfolio can reliably reduce risk, but it doesn’t necessarily improve returns.

Here’s why you shouldn’t give up on international investing:

“The owner of foreign stocks has not only faced devaluation versus the US, but currency devaluation. So, the underlying investment is now a lot less expensive than say a US counterpart. And you’re able to buy those investments using undervalued currencies. So, looking forward, you have a double positive: underpriced stocks using underpriced currencies.”

One is not enough. Why you should diversify beyond an S&P 500 fund.

Private credit is promoted to retail investors for its high yields and stable returns, but as you can probably guess, Ben Felix is skeptical:

A Wealth of Common Sense blogger Ben Carlson explains why a balanced portfolio always comes with regrets.

Here’s Ben Carlson again on how much money you need for retirement.

A taxpayer was penalized for a TFSA over-contribution after relying on My Account information.

Finally, Gen Y Money shares a long overdue break-up story – goodbye Telus, hello Public Mobile.

Have a great a great weekend, everyone!