Investing in real estate has been one of the most reliable ways to build wealth for centuries.
Not only is it essentially recession-proof, but it’s also relatively simple in concept: buy a home, someone else lives in it, they pay rent every month, and you use that money to pay off your mortgage.
But, just because it’s “simple,” it doesn’t mean that you don’t have to plan. Just like you would before investing in a stock, you need to do your due diligence. A critical part of that process is projecting your cash flow and ROI:
Cash Flow:
This is your monthly income minus expenses. While having positive cash flow isn’t the only path to building real estate wealth, it is a determinant of your ability to make payments and hold your property long-term.
Return on Investment (ROI):
This is a measure of how much money you’ve earned in a defined period of time (often calculated yearly) compared to how much you’ve invested – something every investor needs to know:
ROI = net income ÷ costs
Errors, Omissions…and Inaction
While these concepts are relatively straightforward, many prospective investors get the math wrong for two reasons:
- They haven’t accounted for all expenses
- Because there are a lot of variables and calculations involved, it’s easy to make mistakes and, ultimately, get inaccurate cash flow and ROI projections
When you can’t get a quick, clear, and accurate snapshot of your rental’s potential, it becomes more difficult to move forward — even if the investment is sound.
On the flip side, those investors who do proceed despite their miscalculations can find themselves, unexpectedly, in the red each month.
How to Get the Numbers Right (Fast!)
We’ve removed this issue of miscalculations with our handy online ROI calculator which projects your monthly cash flow and forecasts your one, five, 10, and 15-year ROI – in seconds!
This tool accounts for all of the various expenses you could incur as a property owner to ensure there are little to no financial surprises after taking ownership.
Not only does this help you make sound decisions fast, but it also removes ongoing mental effort from the equation, which promotes a more passive investment.
Getting Started
While you can access the calculator here at any time (bookmark it for future use!), we thought we’d first outline the inputs that you’ll need to have ready — or, at least, estimated — to get the most accurate results.
Here’s what you need to account for:
The Big-Ticket Items:
- Purchase Price: This is what your property will cost to acquire, and also how you’ll calculate your down payment.
- Down Payment: With an investment property, your down payment will be at least 20% of your purchase price. The higher your down payment, the lower your monthly mortgage payments will be (assuming the same mortgage rate and amortization). And, as your lump-sum investment, it’s also a key component of your ROI calculation.
- Mortgage Amount, Rate, and Length: The greater, higher, and longer these are, respectively, the more interest you’ll pay (and vice versa).
- Purchase Costs: Closing costs are common — particularly land transfer tax as well as fees for legal and other professional services.
Monthly Costs:
Aside from your monthly mortgage payments, there are other expenses you need to account for:
- Hydro, Water, and Gas: We’re lumping these together because, in many cases, the tenant covers these costs month-to-month based on their consumption. In this case, you’d enter a “0” into the calculator for each.
- Property Taxes: You’ll need to pay taxes to the municipality, often monthly or quarterly.
- Insurance: Just as you need to insure your principal residence, you’ll need to carry insurance on your rental.
- Condo Fees: These fees aren’t exclusive to apartment-style condos. Many townhomes and even some singles have common elements fees that cover waste removal, snow removal, and general maintenance.
- Property Management: You don’t need to hire a property management company, but they almost completely remove your day-to-day involvement in your rental by collecting payments and handling all tenant-related issues for you. When calculating, budget at least 5% of the rent (more if you’re using them to find you a tenant).
Long-Term Cost Considerations:
There are costs that you can’t predict but often arise over time. For that reason, you should factor them into your cash flow calculations:
- Vacancy: Unless you get that magical tenant who stays and pays forever, you’ll at some point have tenant changeover. Often, when this happens, you’ll have a month or more where the property is vacant (which is a great time to deep clean, paint, and freshen up!). The amount you should budget for this depends on your local market. Speak to your agent about local vacancy rates but add at least 5% vacancy to be safe.
- Repairs & Maintenance: This one really depends on the type of property you purchase. An older home is bound to have higher repair costs than a new build or a condo where you’ll likely avoid significant repairs.
- Inflation: You need to add 2-3% inflation for your costs to make sure your projections keep up with the cost of living.
Once you have your monthly expenses in line, you can start adding in the fun stuff:
Income
- Rent: It’s what you charge your tenants each month. Again, generally speaking, you’ll want to enter a number into the calculator that at least covers your costs. You should also speak to your Realtor about prevailing rents to ensure you’ll be able to charge enough rent to break even.
- Appreciation: In addition to potential monthly cash flow, you’ll want to understand how your overall investment could grow over time — and increase your ROI. In our calculator, by adding an appreciation multiplier, you’ll get a clear idea of what your equity position could be over the next 15 years. We recommend a conservative multiplier, between 3-5%.
A Note on Income Taxes
While not in the calculator, it’s important to keep in mind that your rental income is just that: income. As such, you’ll need to pay income tax at the end of the year. On the flip side, you’ll also get to claim expenses such as mortgage interest, property management, and more. Consult with an accountant familiar with income properties to learn how you can best position yourself at tax time.
Make Better-Informed Decisions — on the Fly!
As you’ve seen in the Waterloo Region real estate market and markets across Canada, timing is everything.
But, when you understand the variables and have the tools to quickly translate them into easy-to-understand projections, you’ll be able to evaluate different opportunities with crystal clarity and make better-informed and more confident decisions that set you up for long-term success.
