Investing in property? Mind the pitfalls
WE all wish for a decent standard of living in retirement. There are many ways to invest for retirement, but a wise investor will study the pros and cons of putting funds into real estate.
Most people, just by living in their house and owning their home, have the majority of their money already invested in the real estate market, says Scott Ward, financial adviser with Edward Jones. If you’re looking at buying a second property as an investment... you’re not diversifying — especially if you’re going to reinvest into the same market.
If you and your financial adviser decide you have enough diversity in your portfolio to buy more real estate, the next step is to decide how involved you want to be in managing your investments.
“(These people) should certainly be aware of what work is involved,” says Lois Volk, mortgage broker with Invis. I get a lot of people that buy the property, and end up wanting to get rid of it within a year or two.
Ward agrees investing in real estate may not be an option for the more passive investor.
“Owning a property and renting it out, it’s really like having another job,” Ward says. “It may be an investment that generates cash flow for you, but you are still working. Hiring a property management firm is an option, but that will add to costs.”
Volk says financing requirements have been tightened up for investors.
“The CMHC guidelines state they have to qualify based on their own income plus 50 per cent of the rental income,” Volk says. “If they have a mortgage of their own plus the cost of the investment property, they have to be able to carry those debts within 40 per cent of their income.”
New rules for investors mean a minimum down payment of 20 per cent will be required to finance small (one-to four-unit) non-owner-occupied residential rental properties, up from the previous five per cent minimum.
Volk says the most popular types of properties for renters, and therefore investors, are those close to public transit and popular areas.
When it comes to taxing those returns, an investment property receives different treatment from your principal residence.
When buying an investment property, you will need to identify what percentage of your purchase covers the land, the building and any fixtures inside the building. The cost of the property cannot be deducted when determining net rental income, but Canada Revenue Agency allows for the depreciation of the property over time through a capital cost allowance claim. Depreciation is the loss in value of an asset — in this case your investment property — over time, due to physical deterioration and age.
The land cannot be depreciated, but CRA will allow you to depreciate the building, the fixtures and furniture. The CRA website explains how much you can deduct for which type of property (cra-arc.gc.ca/tx/bsnss/tpcs/slprtnr/rprtng/cptl/dprcbl-eng.html). The depreciation is treated as an expense on your tax return, but it would be wise to have an accountant go over all potential expenditures and deductions.
Once you have acquired it and are renting it out, you need to report the rental income and then from that you can deduct any of your cash expenses, says Myron Knodel, a tax and financial planning expert with Investors Group. These items include any utilities not paid by the tenant, maintenance costs, insurance and taxes. In addition to that, you are eligible to deduct the capital cost allowance.
As with any investment, values go down as well as up.
“You really need to be careful about stretching yourself too far (borrowing against the investment property) because interest rates go up, and the next thing you know, you can’t carry the cost and you’re forced to sell at a loss,” Ward says. “The real estate market doesn’t always go up — as 2008 showed us. Interest rates go up, property values go down, and you could be at the bad end of a bad investment.”
— Canwest News Service