# Buying residential income property in Montreal



## mtl83 (May 23, 2011)

Hello all,
I've been reading through all kinds of questions about real estate here. I've already ordered a couple of books about being a landlord suggested by people here.

I'm not very sure about what to do, I have like $200K and my salary is around $75K, I have stable position and I actually have some offers for better salary.

I live in Montreal, and I rent an apartment. I need to decide what to do next: to buy a condo (lots of them are being constructed), to buy a house, to buy a duplex/triplex or to buy a residential income property with like 10 apartments for rent.

One of my main goals is to buy something that more or less close to my work (within 5km range, so that I would be able to ride bicycle to work at summer time, to keep myself in shape . Initially, I found a condo at L'Acadie/Henry-Bourassa, I went for the most expensive one, then before buying it, I went to check out options, I ended up almost buying a penthouse condo in Bois-Franc for almost 500K. Then it looked quite too expensive: I'm sure that I'd be able to live in that penthouse for 5 years or so, and when entire construction is over I'd certainly be able to sell it for more. I talked to people, everybody said that I won't lose, but I'll have to make heavy payments for 4-5 years and I'm not very comfortable with that.

So, I started to look out for alternatives, and I found a few residential rental properties. I asked some friends (who owned 10-unit apartment buildings for more than 10 years) and it was quite clear that it's best for me to get that residential apartment building, one of the good reasons was that I have a few good friends who actually do all kinds of renovations in this guy's buildings, plus I'm not afraid to do renovations myself (I've been through all kinds of dirty jobs myself while studying at university).

So, I have four properties on my radar, I went to check them out personally (without calling the agent), simply drove there to check around the neighborhood. All of them meet my criteria: withing 6.5 km from my work, and all of them are within 200-300 meters from a metro station and the neighborhood isn't bad. I looked for them on duproprio and mls, all of these properties were listed for quite a while (for more than 30 days, so that potentially may indicate that they aren't killer deals).

I'll give details on the 4 properties in the order of my choice, please give your comments/thoughts about these:
1) $850K, 1960, 9 units (6 x 4.5 and the rest is 3.5), assessment (2011): $450K + $185K (lot). Heated by gas/hot water, paid by the owner. Yearly costs (municipal/school taxes, insurance, heating): 14K.
2) $820K, 1965, 14 units (almost all of them studios, only a few 3.5), assessment (2011): $390K + $220. Heated by electricity, paid by the owner I guess (because of high energy expenses). Yearly costs: $17.5K. Rent paid: 74K/year.
3) $640K, 6 units (I guess these should be 4.5 or 3.5), assessment: $400K. Taxes: $4.4K
4) $640K, 1950, 10 units, all are studios, assessment: $400K, taxes: $4K, heating+insurance: $7.5K


The first building is the closest to the metro station (like 100 meters only, there are private houses/duplexes on the street mostly. I did my research and only saw a couple of ads posted in April for 3.5 basement unit availability in July for 550$ (heating included). This building looks better than the others (has modern PVC windows, fiberglass balconies etc), in the backyard there are 4 or 5 parking lots (without roof). Seems like rent for this building is managed by a company, on their web site they still list that this basement 3.5 is available for 550 in July, the rest is all occupied.

The 14 unit apartment building is also very close to metro (150m), all units seem to be rented and the rent price is VERY cheap in this building (350-450 for a studio all included, 3.5 is around 550). That's why 14 units bring "only" 74K/year. This building has old aluminum sliding windows and old balconies, it doesn't look that bad (I didn't see that there is any brick jobs are required for example).

The other two buildings aren't that attractive to me (especially the one with 10 apartments, the building is almost the same as the other with 6 units), they seem to require some more maintenance (balconies, windows; though, I didn't see problems with foundation or walls).

Initially, my choice was the 14 unit property, but then statistically if people moved once a year then I'd need to find a tenant every month and I was told that tenants in studios come with their suitcase of stuff and disappear two three months after without paying for a month or so. The good part is that rent is quite cheap and it's close to metro (and negative part is that it's attractive to all these job less losers who want to rape their landlords). The other building with 9 units is more attractive in that sense: bigger units, rent is higher (the building itself looks better, I wouldn't mind to live there myself). I do not have an agent, the very idea of the agent taking 5% or so out of 900K is the deal killer for me. These properties are all listed by agents for quite some time. I'm thinking to get direct contact info on the owner (through title search) and then if the contract with the agent expires soon, I'd prefer to negotiate the price with the owner directly.


Any your ideas and suggestions are highly appreciated.
thank you.


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## Ziggy (May 16, 2011)

I've also been looking at properties in Montreal but I'm looking at multi-unit Residential/Commercial properties instead of residential only. In my opinion, most of the asking prices are too high by at least 100k but sellers don't seem to want to drop their prices to what I would consider realistic.

You should look at this post and use the spreadsheet to figure out cap rates on those properties. Keep in mind you have to estimate higher tax and insurance cost due to sale price being significantly higher than evaluation.

http://www.milliondollarjourney.com/landlord-math-cap-rate-and-return-on-investment.htm

Most properties I've crunched the numbers for have ended up with negative cash flow at asking price and Cap rates below 5%. One place was asking 299k over bank evaluation!

If you had the money 10 years ago, investing in a Rental property was a much better deal.


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## mtl83 (May 23, 2011)

The other question I have is about profitability of buying residential income property.
As one of the posters mentioned about REITs, the dividend income offered by most of them is far better than most of residential properties that I evaluated. If I bought with cash, most of the buildings would return at best around 6%/year if all apartments were occupied at all times and there were nothing to fix. Most of the REITs offer around 6.5-7.5%. Which is great comparable to regular residential real estate, considering that you have nothing to worry about and you can always sell your shares for cash.

So, the question is, what's the point to buy residential property when there are better RE investment options like REITs? I wanted to understand that myself, and I have only explanation to buy property myself: if I buy 200K worth of REITs I'll be getting approximately 7%/year dividends and associated capital gain on the property portfolio of the trust (in case if I sell REITs), but if I buy residential property, the math is a bit different: I'll put down 200K for 1M dollar property, I'll be getting, let's say, 5% on the 1M property (50K/year), but I'll have to pay to the bank 3% for the mortgage for outstanding principal amount. So, essentially, I'll get 5% on my 200K plus I'll get around 2% on the remaining 800K. Obviously, this works well as long as mortgage interest rate is lower than cash flow that the property can give.

So, in short, as I understand the math of buying property myself is as follows:
200 * 0.05 + 800 * (0.05 - 0.03) = 26K, which means that it's more than 10%/year. If I buy residential, I'm betting that mortgage rate won't go over the roof and that occupancy rate will be over 90% and that I won't have crazy problems with the property (either with tenants, or repairs).

Please correct if I'm wrong somewhere about my guesses!
Another question: can I take mortgage of 800K with 200K down payment to buy 1M worth of REITs? I read somewhere that owing REITs is identical to owing property, can I get mortgage to buy REIT then? In that case managing residential property doesn't make sense at all; it would only make sense only if the seller priced it close to municipal evaluation price, which never happens for well positioned properties.


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## mtl83 (May 23, 2011)

Ziggy said:


> I've also been looking at properties in Montreal but I'm looking at multi-unit Residential/Commercial properties instead of residential only. In my opinion, most of the asking prices are too high by at least 100k but sellers don't seem to want to drop their prices to what I would consider realistic.
> 
> You should look at this post and use the spreadsheet to figure out cap rates on those properties. Keep in mind you have to estimate higher tax and insurance cost due to sale price being significantly higher than evaluation./QUOTE]
> 
> ...


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## Ziggy (May 16, 2011)

The banks are starting to ask for 35% down for investment properties so you might not be able to get a 1M dollar property with a downpayment of 200k. You also may want to keep 10 to 25k in reserve for welcome tax, notary and other unexpected expenses. So it might be more realistict to look at investment
properties under 600k.

You should download the CAP rate spreadsheet found on the page I previously linked. It will let you fill out all the income and expenses for a building to estimate the CAP rate. I'd suggest trying it on several buildings with several scenarios to get a feel for how the numbers work.

If you look at the spreadsheet you will see that you need to save a portion of the income for building maintenance, property management and vacancy rate. This can use up over 20% of the rental income. You might be able to save a it on property management cost but you can't avoid building maintenance if you want to keep a good resale value.

Taxes on a 1M residential building is probably around 10k and insurance is going to cost at least 2000$. So out of your initial 50k revenue, that would drop your profit down from 26k to 12k and then building maintenance, property anagement and vacancy rate drops it by another 10k so you are down to 2k profit on 200k investment. 

Generally you can not take out a mortgage out to buy an REIT unless you actually own a property that can be mortgaged. You should look up the Smith Maneuver.

http://www.milliondollarjourney.com/the-smith-manoeuvre-a-wealth-strategy-part-1.htm

With repect to evaluation and taxes, if the evaluation doubles you can expect the tax to double. The same deal with insurance cost. Residential apartment insurance is more expensive than owner occupied insurance due to the higher risk of damage. I don't know how heating factors in. Commercial space is also taxed at 4 times the residential rate but commercial rent as far as I know does not have any rent control restrictions.

Given all the factors and current market conditions, 200k in REITs does seem a lot more tempting then owning a income property.


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## mtl83 (May 23, 2011)

I'll read on that Smith maneuver.
Off course I read all that info from the link you sent, I spent like 4 hours yesterday reading it.
From the two properties, the one with 14 studio units will yield better results on that spreadsheet list because with identical cost (sale price difference is only 40K) the 14-unit building brings around 14-15K more of gross revenue. However, 14 studios could mean that I'll need to find on average 2 tenants every month if each of them stays for half a year. The good part is that all these units are rented for VERY cheap (I didn't know that rent could be that cheap) and because it's close to metro I estimate it should not be a big issue to find tenants. The low rent price isn't because this building is in the shittiest neighborhood or because it's crappy building, it's probably because units aren't that big and nice (it's 1960 building after all). There are some properties in some places in the city that I would simply never even consider, just like jean-talon/l'acadie area infested by Indian population. Not that I care personally, but I have a few reasons not to ever go to this area. 1) I have a greek friend and his parents because of rapidly growing indian population now hate their property in that neighborhood where they have been living for decades already. 2) my friend who has apartment buildings said about one case where he admitted indian family as tenants in one of his 5.5 apartments and that same year he lost 4 other big families that used to live for years in that building since he bought it. The place started to smell like indian food and he eventually decided to get rid of it; most of new families that came for visit were asking about WTF it's smells like indian restaurant and all refused 

The other building that costs 40K more and has 9 big units is managed by some kind of company (the rent ads come only from them for that building), I'm not sure if the company owns or is simply hired by the owner. In any case, that building looks quite better, is taken care of and doesn't look like it will require any investment to improve it other that I'd plant some greens in the front yard to prevent people from passing through the grass and to make it look better. I've looked around there, and I saw tenants from 2 apartments and they look like normal people  I'd rather got that 860K 9unit building cause it requires less maintenance and will definitely have more stable tenants. It's located 150m from metro station door. I'm not afraid to spend some of my personal time on the building, but I don't like to search for new tenants (to get calls from random people at random times and to schedule my time for them to be able to visit), I'd rather concentrate on my main job.
About REITs, I need to make up my mind about what to do. I will definitely need to find another place to live by the end of the year, and it will most like not be a rented place, I'd rather get cheapest new condo and pay the same amount for my own property. 200K available aren't invested in any papers, I take part in friends business and I used this money in international trade (meat, dried fruit), sometimes market goes down so I decided to exit for now because of low returns. Since I cannot take mortgage to buy reits, I'd rather get some mutual funds, I think I could get better returns than with reits. I have another friend who retired already and all he does is managing of his investment portfolio. He was the one who introduced me to investment like 4 years ago, I've been reading investopedia for some time but haven't made any investments.


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## andrewf (Mar 1, 2010)

You may not be able to take a mortgage to buy REITs, but you can use margin.

If you use Interactive Brokers, they offer margin at (effectively) Prime-0.5. They allow 50% margin, but if you don't want to worry about margin calls, you can go with something lower like 33% margin (for every dollar invested, you put up 67 cents and borrow 33 cents). Not as much leverage as is possible with real estate.


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## mtl83 (May 23, 2011)

andrewf said:


> You may not be able to take a mortgage to buy REITs, but you can use margin.


Does that mean that there is a possibility, or you meant to say that I cannot do so? From Wikipedia: "REITs can be classified as equity, mortgage, or hybrid." that's why I was asking if it's possible to take mortgage to buy REITs as if I was buying real-estate. So, if regular people can't get mortgage to buy REIT, then these trusts themselves get financing from banks along with the funds from trustees? and their returns heavily depend on mortgage rate, or they always own property without having to pay any mortgages to banks?


What do you mean by "but you can use margin"? Do you mean that I can use margin with IB?


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## andrewf (Mar 1, 2010)

A lot going on there: I meant you can't get a mortgage secured on REIT units.

A mortgage REIT is a trust that invests (owns) mortgage debt.

REITs are generally fairly highly leveraged, but the degree of leverage depends on their cost of capital. Some REITs have assets that qualify for CMHC insurance and can thus borrow cheaply, even at high leverage ratios.

I do indeed mean you can use margin to borrow against an investment in REITs (a bit like a mortgage, except it's a revolving, callable line of credit). IB offers the margin borrowing best rates I'm aware of--you could feasibly make money with their rates--most other brokerages charge way too much, especially for the (low) level of risk they are taking. You won't be able to leverage up holdings in a REIT the same way you can an apartment complex, but REITs are already levered internally, so it probably comes out in the wash. The benefits of REITs is that they require no work on your part, are much more diversified, have professional management, and are more liquid.

You might be able to add more value to a property if you can find a poorly managed one at the right price and whip it in to shape. Not sure what the Montreal market looks like, but in the Toronto area that's a tall order--valuations are very high). For it to be worthwhile, I'd want to see cap rates over 8%, after accounting for vacancy and your time in property management.


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## mtl83 (May 23, 2011)

Thanks Andrew, it's clear now about REITs.



andrewf said:


> You might be able to add more value to a property if you can find a poorly managed one at the right price and whip it in to shape. Not sure what the Montreal market looks like, but in the Toronto area that's a tall order--valuations are very high). For it to be worthwhile, I'd want to see cap rates over 8%, after accounting for vacancy and your time in property management.


In Montreal it's not much different, I didn't see anything that is close to even 5%, after accounting for vacancy and time in property management. What I see is 5-6% cap rate without accounting for extra expenses or vacancy. I see better cap rates on some dumpsters where a few units aren't yet rented out and these places will definitely require a lot of effort for upkeep. I'm not in the hunt for highest cap rate, since I don't want to make land-lording my second full-time j.o.b. If I end up getting some residential income property, I'll taste it and if I like the taste then I'll see in the future if I want to change it or try something else.
Because of low prime rate, prices are up: for the same amount renters pay monthly for rent they may get a very decent condo themselves. I guess, it should change in a year or two when interest rates go up. But once prime goes up, then cap will be lower than mortgage rate with current asking prices for residential income properties.


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