The Ultimate Mortgage Guide To Buy Rental Property in Canada

27 January , 2022

“If you are considering buying your first or next rental investment property – then, Congratulations!”

Buying income properties has long been one of the most rewarding and secure investments for Canadians. Use our mortgage guide to buy rental property to help you in your journey!

In According to the Globe and Mail, one in three Toronto condos are investor owned. Last quarter (2021), 25% of the all purchase activities were rental properties.

Our “Ultimate Mortgage Guide to Buy Rental Property in Canada” was put together to help you become a successful real estate investor! You will learn:

How you can qualify for a rental / investment property mortgage
Most Asked Questions when buying s rental property
Four reasons why you should buy an investment property
How to pick the right rental property
How to find under-valued property
How to grow your rental portfolio

Let’s get started! Let’s talk about what you need to know first…

Qualify for a Rental / Investment Property Mortgage

Get prepared to qualify, here’s what you need to know…

Down Payment

A rental property requires at least 20% of down payment with a major bank or a B lender. However, private lenders may approve the mortgage with 15% down payment or even 10% down payment depending on the property.

Rental Income

The more income you earn from your investment property, the easier it is to qualify for an investment property mortgage. Typically, lenders will take into account 50% – 85% of your rental income when qualifying you for a mortgage. Our experienced advisors can help you select the best mortgage lender based on your rental income.

Debt Service Ratio

Debt service ratio measures your ability to meet your monthly expense and debt obligations based on the income you earn. To qualify for an investment property, lenders will look at your personal income and expenses, as well as take into account the income and expenses from the investment property.

Maximum Total Debt Service (TDS) ratio is 44% for most of the bank lenders, but can go up to 60% with B lenders. Private lenders do not have any limit on TDS.

Here is the high-level formula lenders use to calculate Total Debt Service (TDS) ratio:

For Principle Residence (*PITH Stands for Principle, Interest, Property Taxes, and Heating)

TDS = (PITH* + Other Monthly Debt Payments)/Income

For Investment Property, the formula changes into the following:

TDS = (PITH of Principle Residence + PITH of Rental Property + Expenses of Rental Property + Other Monthly Debt Payments)/(Employment Income + Rental Income)

Documents You Need to Provide

To qualify for an investment property mortgage, you will need to provide the following documents:

Proof of Personal Income (T4, Notice of Assessment (NOA), etc.)

Proof of Rental Income (lease, bank statements, Schedule T776, etc.)

Market Rent Assessment – a new investment property requires a market rent assessment
Proof of Sufficient Down Payment – note that some lenders do not allow gifted down payment for rental properties

Most Asked Questions When Buying A Rental Property

Being able to get financing is the most important factor to your journey to become a successful real estate investor.

Whether you can get approved for rental property mortgages is the difference between being able to own 1 rental property vs 10 rental properties.

Let’s examine a few key things to understand when financing a rental property.

What is an Investment or Rental Property from a Financing Perspective?

An Investment Property is a real estate asset that is purchased for earning rental income. Plain and simple. Mortgage lenders consider it to be a “rental property” when you need to use rental income to qualify. If you are buying a second property but do not need the income to qualify, you can get a mortgage using a standard/non rental program.

Can I Live in a Part of My Rental Property?

Yes. If your property has more than one self-contained unit (think of a basement unit that has its own kitchen and bath room), and you plan to live in one and rent out the rest, the property is considered “owner occupied” as opposed to “rental property”. In this case, the part that’s rented out is a “rental suite”. Standard qualification Rules for owner occupied properties apply to rental suites.
The upside of renting a part of the property is that you can add your rental income from the rental suite to your employment income to help you qualify for a bigger mortgage. Lenders typically consider only 50% to 80% of discount to the rent earned from a rental suite in order to account from vacancies and added expenses.

Rental property mortgages are complex. Fortunately we have mortgage advisors at the Effortless Team who specialize in rental properties. They can help you structure your deal to get you approved.

Wonder if you can afford multiple investment properties? Keep reading to find out!

How Many Rental Properties Can I Finance in Total?

Major financial institutions finance between 5 and 20 rental properties per owners. The more properties you have, lenders impose stricter qualification ratios making it tougher to qualify for more mortgages.

Can I Buy an Investment Property with Friends and Family?

Yes. Because investment properties can be lucrative, you may choose to team up with friends and family to co-invest and share the benefits. If you are contemplating this option, here are a few things to think about:

Create a co-ownership agreement. Owning a property together in some ways is like being married. Everything looks great in the beginning, but you may have disagreements from time to time. There is also the possibility of a break-up (sorry for being syndical but life happens). So, it’s important to set the ground rules such as what happens if one party wants to sell, who handles the maintenance, etc.

Each of you is responsible for 100% the mortgage regardless of how much of the investment property you own. No, I’m not kidding. If your co-owner fails to make the mortgage payment, the Lender can foreclose on the entire property and go after your wages if the Lender is unable to recover the entire mortgage amount from the sale (in certain provinces).

Can I Purchase an Investment Property Under a Name of a Corporation?

A Personal Holding Company (“Holdco”) can be an effective structure to purchase and hold investment properties.

A Holdco is an extension of a person and can not be running an active business. Immediate family members must hold all shares of the holding company. This structure provides you a certain level of protection against potential liabilities and some flexibility for tax planning. Therefore, it can be especially beneficial for people who have more than one investment properties.

Many lenders require additional documentation when qualifying mortgages for a personal holding company.

If you have specific questions about financing a rental property through a Personal Holding Company, one of our Advisors would be happy to answer your questions.

What are Some of the Key Product Features for Investment Properties?

Amortization: An Investment Property mortgage can have amortization up to 30 years.

Mortgage Default Insurance: Since you need to provide more than 20% of down payment, Lenders do not require you to purchase default insurance.

Financing a rental property is very different than getting a mortgage on your primary residence.

The two most important things are the Total Debt Service Ratio (TDS) and down payment.

The more income you earn from your rental property, the more favourable your TDS ratio will be, the easier it is to get approved for a mortgage. Our experienced mortgage advisors can help you plan ahead and ensure your numbers work before you commit to an investment property purchase.

Four Reasons Why You Should Buy a Rental / Investment Property

1) Stable Cash Flow

With the low vacancy rates across Canada and high demand of housing, rental properties are one of the most reliable ways to generate cash flow.

Below is the vacancy rates last year. The average vacancy rate for Ontario markets is 3.2%. One really importance thing to point out is that “low vacancy rate” is not just limited to the bigger cities like Toronto. Now we see even lower vacancy rate in smaller markets such as Brantford and Guelph.

This is why rental income is one of the most reliable and risk free cash flow income you can have. Low vacancy means you can be certain that 97% of the change the rental unit will delivery the income you expect to earn. There is no other income stream that provides such certainty.

Now, let’s take a look at the average rental income across Ontario markets.

You can see that the difference in average rent for a one bedroom apartment in Ontario is not that large. Sure, it is more expensive to live in Toronto.

The average rent for one bedroom apartment in Toronto is $1,536 per month. However, one bedroom rent in smaller markets are not too far behind. Ottawa is a close second at $1,379 per month and Barrie has the 3^rd highest rent rate for one bedroom apartment at $1,346 per month.

This is great news for aspiring real estate investors. You do not need to be able to purchase a $1.5 million dollar duplex in Toronto to earn significant rental income. The median sale price for one bedroom apartment in Ottawa is $350K and the median sale price for townhouse and row units are around $550K.

Let’s compare that to Toronto – the median sale price for one bedroom apartment is $638K while the average townhouse is selling for $800K in Toronto).

Let’s look at the numbers. While the Toronto one bedroom apartment rent is 11% higher than Ottawa, the home prices in Toronto is 80% higher for one bedroom apartment and 45% higher for townhouses.

Though the Greater Toronto Area remains one of the most desirable locations for rental property; there are tons of opportunities to earn stable cash flow across Ontario.

As your rental income helps you to paydown the mortgage, rental properties are excellent sources to create the passive cashflow income stream that allows you to make money in your sleeps.

2) Tax Write-Off

While rent is considered passive income, it still comes with all that good stuff of owning a business. You can deduct all sorts of expenses related to the property to reduce your taxable income. Let’s look at a few examples:

** Your Mortgage Interest Is Tax Free **

This is probably THE biggest deduction you have against your rental income. Keep in mind that this is not your entire mortgage payment. It’s only the interest part of your mortgage payment.

Using the following mortgage statement as an example. Your monthly payment is $2,461.74, which includes both principle and interest payment. Over the course of 2021, for this mortgage, a total of $29,540 mortgage payment was made. Out of that, $12,893 is the interest cost, which is how much you can include as interest expense on your tax return.

Maintenance costs

Don’t underestimate how regular fixes and maintenances can add up. From smaller fixes like a leaky faucet to bigger fixes like replacing a furnace, you can write everything off as long as you keep the receipt.

** Here’s a tip for news landlords… **

Often times you might be tempted to pay your contractor cash to save the 13% HST. Remember, rental income is considered “passive income” and it’s taxed at the highest income tax rate. By saving 13% on HST, you are foregoing the opportunity to save 50% on taxes. Always get the receipt as opposed to paying cash.

And a lot more…

Here’s a list of other spending to keep track of as a landlord

Fire and Flood Insurance
Advertising cost to rent the unit out when there’s a tenant turn over (such as Kijiji and Facebook marketplace ads)
Property tax, hydro and heat… of course
(part) of your phone bill and transportation costs to travel to the property
Property management – this is if you have a property manager. You cannot charge for time you spend yourself to manage the property
Cost of new furniture if your unit is furnished
Amortization of any major renovation and improvement

Here’s the link to the Canada Revenue Agency website for a full list of rental expenses you can deduct.

The key is to keep good records of the expenses. When well planned, you can write off most or all of rental income and pay very little tax on the income.

3) Appreciation and Leverage

Appreciation is one of the most powerful ways to grow your wealth through real estate.

As of the end of 2021, Canadian home prices reached an average of $720,850, representing a 20% year-over-year increase.

2021 was an exceptional year, not an average year. As much as we all want to have a 20% year-over-year gain on our investment, this is not the normal rate of growth. To be conservative, we will use a 3% annual appreciate on average.

3% per year doesn’t seem to be a very high rate of return. However, that’s before considering leverage. Leverage is the secret weapon of investing in real estate.

For primary residence, i.e. not investment property, you can put as little as 5% down payment. It means you can leverage your money 20x (i.e. 1/5%).

For Investment Property, you need 20% down payment. It means you can leverage your money 5x. That alone will change the 3% Year-over-Year (YoY) return into a 15% YoY return.

Let’s compare it to the stock market returns.

In the past 25 years, the S&P index returns on average 8.45% on an inflation-adjusted basis, and 10.74% without adjusting for inflation.

If you compare the housing price index chart above and the S&P index chart below, the pattern is similar.

If you invested $50,000 in an S&P Index Fund in 2005, that investment would have increased to $275,000 by the end of 2021.

Say if you bought a house in 2005, and you bought it for exactly the average price for a single detached house at the time, $250,000. To purchase that house, you would have had to put down $50,000 or 20% down payment.

By 2021, the property would have been worth $800,000. Your mortgage would also have been paid off (assume 25-year amortization). Therefore, your initial $50,000 investment would now be $800,000. That is 3x the return you get from investing in the stock market.

If you are one of the lucky ones who bought a property at the lower point of the market, such as 2018 and 2019, you would have seen almost 15% YoY gain per year in the past 3 years. This translates into almost over 100% return per year assuming a 5x leverage.

The best part is that real estate investing is one of the true passive income streams that requires very little time needed. And market appreciation will keep working hard to increase your wealth even when you are not : )

4) Build Equity

Not every rental property can be cash flow positive. It doesn’t mean they are not great investments.

You might ask, why would someone buy a rental property when they need to pay out of pocket to service the property? Appreciation is one of the reasons. The other reason is to build equity.

For your primary residence, you need to pay for your mortgage use your AFTER TAX income dollars. And the mortgage interest CANNOT be deducted against your personal income.

When you have an investment property, your renters are paying for your mortgage with their AFTER TAX income, and the Mortgage Interest CAN BE deducted against the rental income. The math cannot be clearer.

Even without appreciation, after 25 years, the house will be paid off and you have accumulated the equity without using your hard earned after tax dollars to service the mortgage.

For example, for a $500,000 mortgage, over 25 years, your renter would have paid approximately $216,812 in interest and the entire $500,000 mortgage principle, which is the amount of the equity you accumulated simply through principle paydown.

There are a ton of other reasons why you should start investing on real estate, today.

Real estate investing is not a get rich fast scheme, but it is the most simple and sure way to create wealth and financial security.

Now let’s take a look at an important aspect of real estate investing…

How to find the right rental property…

Pick The Right Rental Property

FIRST! Determine how much effort you would like to put in…

Are you ready to put in some work to fix up a property? Or would you rather purchase a turnkey property and rent it out right away?

How many hours would you like to put in managing this property?

These are the questions you need to ask yourself to determine the type of rental property that is right for you.

Let’s look at the level of effort required based on the type of property:

Teardown

Typically, these properties are in rough shape. These properties typically have structural issue and need a full demolition before you can rebuild on it. When you purchase a teardown property, you are pretty much buying it for land value.

You are looking at minimum of 12-18 months to rebuild it depending on where the house is located and the local building permit processes.

Teardowns can be really profitable for experienced builders who are able to efficiently navigate the permitting process and control the costs.

It is not for the faint of heart! If you are a first time real estate investor, this type of property is not for you. To finance for a teardown project, you may require a construction loan.

Major Renovation

When you see the “as is” description in a realtor.ca listing, it typically means the property requires major renovation.

These are types of properties with “good bones”, but in need of some “immediate care” before they can be rented out. Examples include replacement of roof, wiring, clean-up of water damage, or simply redoing the entire interiors of the house. Some refer these types of renovations as “gut job”.

These types of properties are great opportunities to “create value” for your rental properties. However, it does require rigorous budgeting on what needs to be fixed and how much it costs to complete the renovation. You may also need a building permit for major renovations depending on local zoning rules.

Photo description: Gut job vs. teardown – unlike a teardown, when you are doing a major renovation, the foundation and exterior walls of the property are usually untouched.

Minor Renovation

These are the types of properties that simply have “dated” interiors, such as properties with a new shade of paint, new cabinets, refreshed sinks, etc.

These properties are excellent choices for real estate investors. Due to lack of staging or “polish”, these properties are often overlooked by homebuyers who are searching for their “dream home”.

That means there will likely be less bidders on offering night, which creates a great opportunity for real estate investors to snatch it at a value below the market price.

Take one of our return customer, Jackie as an example, she and her family had been looking for an investment property for months, but kept being out-bid by other buyers. The found a property located in the highly sought after Leslieville neighbourhood in the east end of downtown.

It was a traditional Victorian house with 3 units and was listed for $990,000. The problem was that the MLS listing photos looked awful. Clothes were all over the floor, the paint on walls were peeling, and the rooms looked dark and small.

However, when they went and viewed the property, it turned out to be a nice, south-facing triplex with 11 ft ceiling and large rooms. Due to the poor staging and the facts that tenants remained in the property during that time, the property was significantly under-represented.

When similar properties were getting 10+ offers, Jackie was able to purchase this one by only competing with one other registered offer, which was unheard of in that neighborhood.

Jackie spent $5,000 to re-paint the entire house with fresh white paint. She was able to rent the three units out for $7,000 per month in total!

Photo description: Nothing can’t be fixed with a fresh coat of paint. Look beyond the staging to find value in rental properties.

Turnkey

Turnkey properties are the ones that are ready for tenants to move in right after closing. There is typically no immediate renovation needed.

The downside of turnkey properties is that there is very little room to add value and build equity right away.

However, it is a worry-free option to purchase your first investment property.

Find Under-Valued Property

The key in finding “under-valued property” is to understand the “true value” of the property. This might be a little difficult with Turnkey properties – if a property is nicely renovated, staged and marketed, it’s more likely than not you will be paying the market value on them.

If you are looking for a property that you can add value right away, there are the steps:

Decide which city/neighborhood you would like to purchase the rental property in. We recommend to select the city based on proximity, appreciation potential, and vacancy rate. If you are not yet sure, ,we have some recommendations : )
Determine how much is the maximum purchase price you can afford. You can do so by getting a pre-qualification from one of our experienced mortgage advisors. To illustrate how this works, let’s say your budget is $600,000.
Decide the type property you are purchasing. Is your budget enough for a condo, townhouse, semi-detached, detached, or multiplex?
Now reduce your budget by 15% to get to the upper limit of the listing prices for your “search”. In this case, if we reduce the $600,000 by 15%, we get to $510,000. This is to leave you room in case of a bidding war.
Talk to your Realtor or go to Realtor.ca and filter by city, type of properties, and maximum listing price (in this case, use $510,000)
Now you need to put in the work and scroll through the listings. Pay special attention to the ones that are less polished and less staged – these are the opportunities!
Once you narrow down on a property, estimate how much would it cost to “fix it up”. Let’s say the property you found is exact $510,000 needs about $20,000 for a new paint job and some renovation in the bathroom. The total cost for you is now $530,000 to get this property ready to live in.
Last but not least, work with your Realtor to compare the Total Cost of $530,000 with similar properties with updated interiors in the same neighborhood to determine if you are getting it at a “good price”. For example, if similar properties are selling for $580,000 with similar finishes after you do the paint job and the bathroom reno, you have instantly created $50,000 value through the purchase and renovation.
Repeat this process until you find the right opportunity. It gets easier to spot a good deal the more you spend time looking and buying.

We do send out list of investment properties that are deemed “under valued” with great returns. Email us at info@effortlessmortgage.ca to be added to our mailing list.

Grow Your Rental Portfolio

Follow the “BRR” model – Buy, Renovate, Refinance

This model is simple:

Buy a rental property with 20% down payment (for less than 20% down payment options, talk to us). Using the previous example, you need to put down $102,000 as down payment, and take out a $408,000 mortgage.

Renovate the property and increase rent. Pick and choose “high value” renovations that create the most equity for your home, such as kitchen and bathroom. Use the example from the last section, after purchasing the rental property at $510,000 and spending $20,000 renovating the property, the property value increased to $580,000.

Refinance the property to take out more money. You can refinance up to 80% of the property value. We generally recommend you wait for at least 12 months before refinancing. Refinancing too soon may be raising questions for lenders. Let’s look at the numbers:

Say after the renovation and 2 years have passed, your property increased 5% each year, and is now worth $650,000.
By refinancing up to 80% of the market value (i.e. 80% x $650,000 = $520,000), you can increase your mortgage balance to $520,000
During the 2 years time, your tenants helped you paid down about $20,000 mortgage principle. This reduces your mortgage balance from $408,000 to $388,000.
Therefore, you can take out approximately $132,000 equity (i.e. $520,000 new mortgage – $388,000 existing mortgage balance). Now you have the down payment to start this cycle all over again!

Build a team around you so you can keep buying.

Whether you are planning to purchase your first rental property or you are looking for ways to keep expanding your rental portfolio, it is imperative to spend the time and effort to find the right partners to help you purchase, renovate, and refinance your properties.

With 30 years of experience in the industry and a team of dedicated Mortgage Advisors specializing in investment properties, Effortless Mortgage can be “your team” when it comes to an investment property mortgage.

To Sum It Up

The recent and long term trend is the renter households growing at a faster rate than owner households offering landlords a big advantage in the rental market.

Investing in real estate is a true passive income stream that with less effort than other investment streams builds your wealth, significantly.

The key to success as a beginner rental property investor is learning how to assess the value of properties, choosing the right rental property and the right location, understanding market conditions, and MOST IMPORTANTLY, GETTING QUALIFIED FOR THE MORTGAGE you need to purchase the rental property. If you meet these criteria, you can be better prepared to reap the benefits of owning rental property.

We hope that “The Ultimate Mortgage Guide to Buy Rental Property” in Canada offers you actionable advice to ease and support your real estate investment journey!

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