Is there ever a bad time to invest in a rental property?

Fabio Campanella, Special to Financial Post  May 22, 2012 – 10:48 AM ET

Record low interest rates coupled with an overly extended bull market for Canadian residential real estate has some investors questioning the validity of investing in a rental property.

Current economic indicators support these fears: mortgage rates scheduled to rise, a global economy not yet out of the recessionary trenches, residential real estate prices in Canada that have clearly outpaced increases in general earnings over the last decade.

This all paints a compelling picture supporting the hesitation some investors have when dealing with rental properties. But is this hesitation legitimate? Is there ever really a good or bad time to get into the real estate rental market? The answer is yes, and also no; it all depends on your current financial situation.

If the Toronto residential market is used as a barometer we can see that residential real estate has treated us quite well over the past 20 years. During the period from 1992 to 2011 the average sale price for a home in Toronto increased from $214,971 to $465,412 according to the Toronto Real Estate Board (TREB).

That’s a 116.50% ROI over 20 years or 3.94% compound annual return, and that’s just the price increase not including any potential rental profits. In fact, over the last 20 years we have only seen four years of negative returns in the Toronto market and they all fell between 1992 to 1996.

Assuming you were to have purchased an average single-family Toronto rental property in 1992, put 25% down, taken a mortgage for the rest, and found a tenant who’s rental payments covered only your property’s basic operating expenses, taxes, maintenance and the interest portion of your mortgage (leaving you to cover the principal portion yourself) you’d have achieved an 11.40% annualized return on investment as at the end of 2011.

Not bad considering that the TSX would have given you 8.69% over the same time period. Using the same assumptions in the previous example on rolling 20-year periods from 1966 to 2011 the average investor would have achieved annualized compound returns of 13.96%.

In fact even if you were to have purchased a property at the bull market peak just before the infamous GTA real estate crash of 1990 you would still have achieved an 8.94% ROI if you held the property with a decent tenant until 2008 even though the value of your investment would have dropped by 25% over the first 4 years.

So what’s the point? Are rental properties a good investment and is this the right or wrong time to make a move? The answer is yes but only if you’re in it for the long-haul and only if your current financial position allows you to do so. Novice investors tend to follow market momentum and stretch themselves thin. They see prices increasing year over year then go out and take massive amounts of leverage to get in on the action “before it’s too late.”

What often happens is they buy more than they can handle, they don’t do proper due diligence on their tenants, and they get caught with a dud investment that they can’t support with their personal cash flow. This frequently leads to panic selling in order to raise funds to pay off large amounts of debt consequently resulting in losses.

Smart investors take their time. They seek out properties in desirable neighbourhoods, scrutinize their tenant’s ability to make rent payments before they take them on, manage the property with a keen eye, but most importantly they do not over-extend their leverage. Smart investors realize that there may be times that tenants can’t make rent or that markets may temporarily turn south.

Even if the original intention for a real estate investment is a short term flip, the smart investor will not purchase a property they aren’t able to hold over a long period of time should price momentum not go their way in the short run.

Direct investment in real estate is not like buying a passive investment such as a mutual fund. It requires a time commitment, experience, and patience but the long-term results can be superb when done properly.

Fabio Campanella CA, CFP, CIM is a partner at Campanella McDonald LLP. Fabio@CampanellaMcDonald.com