BUYING A RESIDENTIAL INCOME PROPERTY – A Primer
With the Ontario real estate market demonstrating continued resilience, many people are still putting their confidence in real estate as an investment option across Ontario. These people are buying income properties such as student housing, multiplexes, apartment buildings and mixed-use residential/commercial properties.
An income generating property is one that results in a positive cash flow for the investor. This means that the rents and other incomes (such as laundry, parking or even an advertisement billboard) are exceeding the overall expenses to carry the property. Expenses can vary; some of the biggest and most typical include mortgage payments, realty taxes, maintenance, repair and insurance. Other expenses often overlooked include management, pest removal, accounting and miscellaneous. A quick way to determine whether an income property is a good investment is buy calculating the cap(italization) rate which is done by dividing the net annual revenue by the cost (or value) of the property. The higher the cap rate the better the investment.
With the purchase of an income property the buyer will often assume the existing tenants. When residential tenants are assumed, the agreement of purchase and sale should always be carefully crafted to ensure that: the seller provide any leases and assignments thereof; directions to tenants to forward rent payments to the buyer after closing; the seller to provide all rent deposits on closing; and for the seller to stop accepting payments from tenants at a certain time. The buyer should also make sure that: the seller is not subject to any notices or orders of the residential tenancies tribunal; the seller does not rent vacant units for equal or lesser rent; the seller to continue professionally operating the property; and conditions on positive inspection reports from fire safety, environmental, building, elevator, electrical safety and zoning.
Financing for income properties is more stringent than for personal properties. The reason is understandably that the borrower’s property is dependent on a third party (the tenants) to meet debt obligations. Therefore these properties are a higher risk to lenders. However, there are financing options available and lenders will often ask for a further security such as a general assignment of rents registered against title and and a PPSA (Personal Property Securitization Act) registered against the borrower personally, entitling the lender to all of the rental income should the borrower default. To ensure a positive cash flow, a borrower should always look to get the lowest interest rate in order to minimize mortgage expenses.
Once the property is owned, a prudent owner will make sure to increase rent rent as per the residential tenancies guidelines every year in order to generate more income from long term tenancies. Of course, a owner should also famaliraize themselves with the Residential Tenancies Act, 2006 in order to properly deal with tenants.
Buyers should also consider properly organizing their affairs through incorporation(s), co-ownership, partnership, and trust agreements in order to take advantage of tax strategies, limit liability and have their interests protected.
If your buying one of these properties, the lawyers of Levy Zavet PC can assist you in determining whether an income property is a sound investment both from a business and legal perspective and can advise on the most productive strategies to maintain your investment.