# Rental or ETF / Stock



## jamesbe (May 8, 2010)

Looking for some input about this.

I have a chance to buy another rental property. Cash investment would be about $40k (20%), Condo would be $160,000

This unit is in the same building as my current unit and is in great shape. I know what my approximate costs would be. About $1000 a month carrying costs.

Rent would be $1,100 a month easily rentable (as I've come to find out with my current unit).

So I'd be gaining $100 cash flow, although yes I know basically after any vacancies if they do happen etc. I'd basically be breaking even. Of course equity in the home would be occurring as well, about another $100 a month from my calculations (30 yr amortization).

Then there is capital appreciation, I'm going to say that is a wash because these units have not gone up in value over the past 3 years, they have been basically flat.

Now my other thought is if I took that same $40k and dumped it into a stock like BCE for example. I'd get a 5% dividend or about $166 a month. Slightly less it seems. But no tenants, no broken washing machines, new flooring or vacancies.

Of course BCE stock could tank... I suppose my rental could burn to the ground as well which would be a problem....

Long term hold of course.

Thoughts?


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## Cal (Jun 17, 2009)

Given the example from you. I would want to know how your net worth was already diversified in regards to RE and equities.


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## jamesbe (May 8, 2010)

This is a good point I didn't even think of. I do have a lot of re although most is in my personal home. Should I be counting that fully?


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## Just a Guy (Mar 27, 2012)

What do you do in 5 years if the interest rates are 6% and your mortgage payment goes up by $100/month for each $100000 and each 1% increase? Assuming 150k mortgage and 3%, means an increase in expenses of $1350/month. 

Real estate, like investments, can be good or bad. I've been buying places in the past year that sold in the past 3 years for over $180k, heck the city assessed them this year at more than that this year, but I bought them at around 80k. They generate around 1250 each and my mortgage is only 80k. 

These are good, long term investments, for you, I'd stick to stocks until you find something better. Either that, or send me your contact information and I'll buy your places in around 5.5 years when they go into foreclosure.


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## jamesbe (May 8, 2010)

That is a good point but 10 year mortgages solve that. Mortgage on my first property is only 100k this would be 120k.

I can float them fully on my income. I could pay off one property fully today with cash.


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## hystat (Jun 18, 2010)

The big benefit of the stock/fund/whatever is the ability to buy it as cash comes in. Servicing a mortgage is more stressful.
Leveraging increases vulnerability. 
Stress has negative value in any equation. Tenants can really make someone's life stressful. But I am not a people person, so weigh your social skills into the comparison. 
If your plans change and you need to sell that condo in the next 5 or 7 years, all gains could be lost when the real estate agents and lawyers and others reach into your wallet. It costs a lot of money to sell a home.


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## Xoron (Jun 22, 2010)

jamesbe said:


> I could pay off one property fully today with cash.


Then unless you're using that money to invest elsewhere, why would you ever carry a mortgage. I understand that the interest is deductible, but carrying the mortgage doesn't make a whole lot of sense unless those funds are deployed making $$$.

And $100 / month net is a cap rate of 0.75% by my calculations (1200 net a year / 160k capital cost). Sounds like a bad deal to me. 

You'd need to be netting $8000.00 a year or ~650 a month with a 5% cap rate.


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## andrewf (Mar 1, 2010)

On a fundamental basis, I think equities are either fairly/slightly over-valued (Canada), fairly/undervalued (EAFE), or overvalued (US). On the other hand, by any objective measure, housing in Canada is overvalued. Unless you can exploit some inefficiencies in the RE market and find properties that are selling below market value, I don't think loading up on Canadian RE is a great idea.


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## andrewf (Mar 1, 2010)

Cap rate is gross rent/value, no?

I get 1100*12/160,000=8.25%.

The leveraged yield is $100*12/$40,000 equity=3%. And that is a highly leveraged investment. A modest correction in RE could cut that equity in half. A full blown correction would wipe it out.


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## jamesbe (May 8, 2010)

All very good points. Thanks you everyone!

This is why I was contemplating this further. First instinct was to buy (as was my mortgage broker's and real estate agent). Then I was thinking in bed last night, I need to run the numbers game here and perhaps there is a better way to deploy the money.

My mortgage broker suggested leveraging the equity in my current rental to pay the down on the second rental. First instinct there is that is a dangerous game to play, but then I had other thoughts about deploying equity from the tax deductible rental property into a non-deductible debt.... I'm going to talk to my accountant about that.


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## andrewf (Mar 1, 2010)

You have non-deductible debt?

You should look into cash flow damming with your current rental property.


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## james4beach (Nov 15, 2012)

lol, your broker wanted you to borrow/buy more ... big surprise 

Honestly, my sense is that everything is overvalued: stocks, bonds, and real estate. There's no easy answer. Sometimes there is NO 'good' investment to be found, especially when low interest rates have been flooding the country with easy money for the last 4 years. That tends to push up the values of everything, meaning everything is a worse deal.


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## james4beach (Nov 15, 2012)

jamesbe said:


> Now my other thought is if I took that same $40k and dumped it into a stock like BCE for example. I'd get a 5% dividend or about $166 a month. Slightly less it seems. But no tenants, no broken washing machines, new flooring or vacancies.


Honestly, from the condo figures you gave, I don't think it's worth your while to buy the property to rent it out for net $100 a month cashflow. For that $100 cashflow you're taking on a lot of debt, a lot of hassle, and an illiquid asset (RE is hard to sell in a downturn).

I'm not saying this is a great idea, but what if you purchased shares in a REIT instead, such as an ETF? You would still have real estate exposure (so you could gain or lose on property values) but now your investment would be liquid, and you wouldn't be taking out a mortgage. Using for example BMO's ZRE fund, you would see a yield of 5.36% - 0.62% MER = 4.74% ... giving you monthly cashflow around $160, all from the cash investment.

Again I'm not saying that's a great idea, but I think it's a better idea than you buying that $160k property for $100 cashflow


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## Cal (Jun 17, 2009)

Just a Guy said:


> What do you do in 5 years if the interest rates are 6% and your mortgage payment goes up by $100/month for each $100000 and each 1% increase? Assuming 150k mortgage and 3%, means an increase in expenses of $1350/month.


Or how does it compare after BCE does a couple of annual dividend increases.


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## jamesbe (May 8, 2010)

andrewf said:


> You have non-deductible debt?


Yes I have a personal mortgage. I talked to my accountant, as I thought what I wanted to do is not really possible, can't take equity from rental and dump it into personal debt (ie, my mortgage) but I can take equity and put in equities/etfs and keep the deductible debt.

Reading up on cash damming, it sounds like what I wanted to do is perhaps possible...


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## james4beach (Nov 15, 2012)

I don't know your location, but I thought I'd share: my friend is trying to sell his downtown Toronto condo right now, and is unable to. He had to reduce the price and has now taken it off the market.

Taking on a leveraged property as an investment is very risky - you could get stuck with it. It's just not worth it for the 3% yield ($100*12/$40,000) you'd be getting... that's very high risk, for very little reward (3% yield).

The investment game is all about risk vs reward

Hell, you can get 2.85% yield on a 5 year credit union GIC (Outlook Financial). Unless Manitoba collapses within the next 5 years, you're getting a guaranteed 2.85% annual return, no debt, no volatility, no risk of loss.


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## jamesbe (May 8, 2010)

Okay sounds like I should skip this... unless I can pick up the unit for much cheaper $100k? 

I read about cash damming before but was confused, I think I kind of understand it now... can I retroactively pay myself back? hmmmmm....


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## andrewf (Mar 1, 2010)

ICICI also has 5 year 2.85% GICs, and it is CDIC insured.


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## james4beach (Nov 15, 2012)

Maybe calculate the yield that WOULD be worth your while and put in a bid on the property at that price.

Sure, maybe it will be a stink (low) bid, but hey it's a market -- nobody's forcing them to take your bid.


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## jamesbe (May 8, 2010)

Andrew, I'm trying to understand the cash flow damming with a rental... is this how it works?

I worked it out this way:

Tanant pays $1200, I use BMO for my rental expenses. So BMO + $1200
Deductible rental expenses monthly ($600)
HELOC write cheque to my BMO account to pay rental expenses: HELOC - $600
BMO Account deposit check + $600 ($1800)
Write cheque from BMO to personal RBC account (-$600) BMO (total +1200)
Deposit cheque RBC (+600)
Pay down mortgage with this RBC (-600) mortgage debt -600 as well woohoo.

But how do I pay the HELOC? Write another check from BMO for $600????


EDIT: I think I understand... I don't pay the HELOC? It just grows and that interest is now deductible.

But isn't there a law of diminishing returns here? HELOC rates are usually prime +1 or prime +.05 Mortgage is Prime - 0.85 for me currently.


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## andrewf (Mar 1, 2010)

No, rent cheque goes into your personal account as income. BMO account pays related expenses (mortgage payments, insurance, etc.), which can be funded by a HELOC (HELOC transfer to the account to pay the expenses). The interest expense on the HELOC is deductible from income (provided the HELOC is solely used for financing the investment property). 

You use the rent cheque for lump sum/increased payments on your non-deductible mortgage.


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## jamesbe (May 8, 2010)

Yup I think I got it now.

But as I mentioned in my other post which I edited.

If HELOC is 3.5% and mortgage is 2.15% (for example), is there really much savings in the end? The 3.5% would be deductible (before tax dollars), the 2.15% not (after tax dollars) but the in the end the cost of the loan in real dollars may be similar after and before taxes... no?


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## andrewf (Mar 1, 2010)

I hear what you're saying about HELOC rates vs variable mortgage rates. When your investment property mortgage is up for renewal, you can roll the HELOC balance into it by refinancing (provided you have enough equity).

As always, check with your accountant to make sure these transactions are unassailable by CRA. While rates are currently low, they won't be forever.

On the other hand, if you have cash or bonds, you're probably better off reducing your leverage and holding fewer bonds/cash.


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## jamesbe (May 8, 2010)

Oh, now that is very very interesting.

Thanks!

EDIT: Over time though (if / when rates rise) it can cause a cash flow issue with the rental.


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## Just a Guy (Mar 27, 2012)

jamesbe said:


> Yes I have a personal mortgage. I talked to my accountant, as I thought what I wanted to do is not really possible, can't take equity from rental and dump it into personal debt (ie, my mortgage) but I can take equity and put in equities/etfs and keep the


Well, if you put down a cash downpayment say 20% or $32,000 in your example, you can transfer that amount off of your personal debt. So you can "repay" the amount that could have been used to pay down your mortgage instead of investing.


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## andrewf (Mar 1, 2010)

^ I think that would be a prudent move, unless OP wants that much leverage.

Alternately, pay down mortgage, wait for a correction in stocks, then use LOC to buy equities.


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## jamesbe (May 8, 2010)

Andrew that is more and more (as I think about this) perhaps the way I will go...

I want to put $36,000 on my personal mortgage sometime soon (just waiting to calculate my tax owing first).

I don't yet have a HELOC but I can get one I'm sure easily enough.


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## Just a Guy (Mar 27, 2012)

You don't actually have to pay it down, you can write off a portion of your mortgage, just calculate the percentage. It's probably cleaner to pay it down, but it is still legal if you can prove the deduction is valid.


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## gibor365 (Apr 1, 2011)

Several years ago I was thinking about such option, but didn't do it because imho to rent condo it's too much headache.
I'd would prefer another option...buying some good quality REIT stocks, you may even split between retail REIT, residential etc...
Some pretty solid REITs , with reasonable price/AFFO ratio like CUF.UN, AX.UN paying juicy about 7% yield, D.UN - 6% ... and imo those dividends are sustainable... as another alternative ZRE is a good weighted ETF


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## My Own Advisor (Sep 24, 2012)

I love that call....pay down mortgage, wait for a correction in stocks, then use LOC to buy equities. 

This is my plan once my mortgage is at a more manageable level (under $100 K).


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## jamesbe (May 8, 2010)

Just a Guy said:


> You don't actually have to pay it down, you can write off a portion of your mortgage, just calculate the percentage. It's probably cleaner to pay it down, but it is still legal if you can prove the deduction is valid.


Oh I understand what you are saying, basically "loaning" myself the money I would have otherwise used on my mortgage.


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## Sampson (Apr 3, 2009)

Just a Guy said:


> You don't actually have to pay it down, you can write off a portion of your mortgage, just calculate the percentage. It's probably cleaner to pay it down, but it is still legal if you can prove the deduction is valid.


How exactly could you prove the use of funds in an audit without the clear separation?


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## jamesbe (May 8, 2010)

I agree, sounds plausible but kind of sketchy and hard to prove.

Best to just put the money on the mortgage. Problem I always come back to is my low mortgage rate, just 2.15% 

I'd have to make good returns on a 3.5-4% HELOC to even cover the difference. I'll have to do the exact math to figure out how 4% pre-tax compares to post tax.


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## Just a Guy (Mar 27, 2012)

You basically have the downpayment portion in paperwork from the purchase, it's all in the legal papers you sign, or the final bill from the lawyer. Let's say $39k. If you have a pre-existing mortgage of let's say 100k starting jan 1, also the date you bought your rental, you could claim 39% of the mortgage interest. 

The math gets more complicated with different dates and things...

It's better to refinance the property or have a heloc, but as long as you don't try to claim the downpayment twice, you can self finance it and deduct the interest in proportion. 

Also a reason I'd suggest an accountant.


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## andrewf (Mar 1, 2010)

It's not really worth the level of documentation and tracking required to co-mingle investment and personal loans.


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## james4beach (Nov 15, 2012)

Keep in mind a HELOC is callable. If the lender suddenly decides they don't want to lend you the money any more, they can demand it back. It's totally unpredictable but I imagine this could happen in an economic slowdown or when the banks start having big problems.


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## Just a Guy (Mar 27, 2012)

Read your mortgage documents...they are no better. Banks won't go after the good loans, they can't afford to.


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## Xoron (Jun 22, 2010)

andrewf said:


> Cap rate is gross rent/value, no?
> 
> I get 1100*12/160,000=8.25%.
> 
> The leveraged yield is $100*12/$40,000 equity=3%. And that is a highly leveraged investment. A modest correction in RE could cut that equity in half. A full blown correction would wipe it out.


This is the site I used as reference for my calculation:
http://realestate.about.com/od/knowthemath/ht/cap_rate_calc.htm


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## jamesbe (May 8, 2010)

Well after going to my unit today and trying to show it and stuff. I've decided not to buy another unit. 

But I may take some equity out of this one to buy an ETF.


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## jamesbe (May 8, 2010)

For now I've decided that I'll put a lump on my mortgage until things settle down.

I found out earlier in the week that my BMO mortgage cash account is re-advancable at the mortgage rate (basically the principal just gets added back to the mortgage). This is a win-win for me. Guaranteed return on my investment into my mortgage. And if I want to invest the money later I can just pull it back out.


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## fatcat (Nov 11, 2009)

jamesbe said:


> For now I've decided that I'll put a lump on my mortgage until things settle down.


the "yield" on living mortgage free and debt free is priceless ...


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## jamesbe (May 8, 2010)

yes it is. Unfortunately I've got a LONG way to go .

It actually makes me think sometimes.

If I were to cash out my TFSAs and sell my rental property today. I would probably be able to pay off the rest of my mortgage in just 3 years.


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## fatcat (Nov 11, 2009)

jamesbe said:


> yes it is. Unfortunately I've got a LONG way to go .
> 
> It actually makes me think sometimes.
> 
> If I were to cash out my TFSAs and sell my rental property today. I would probably be able to pay off the rest of my mortgage in just 3 years.


i don't know how old you are but if you are under 40, it probably makes sense to incur a fair bit of debt (assuming you manage your money impeccably) you will make more in the long run by owning lots of stuff since you will have inflation hedges and and a portfolio of assets (even though they are encumbered) ... once you hit maybe 55-60 i think it's time to try and get debt free


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## jamesbe (May 8, 2010)

I'm under 35.

I'm certainly not going to sell my stocks in my TFSA and if I can rent my rental I'll keep it. But I've come to the realization how in-liquid it is. Tough to rid of, fees costs etc to sell it and penaltys for breaking the mortgage.

I'd rather hold more liquid assets. It will appreciate a little but it's near its ceiling from what I can tell. A small condo in the burbs is only worth so much.


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## mrcheap (Apr 4, 2009)

cap rate is (net operating income) / (purchase price) not (revenue) / (downpayment) - http://en.wikipedia.org/wiki/Capitalization_rate. 

Given that a rule of thumb for the average operating-expense ratio of a residential rental property is 45% (http://www.johntreed.com/positive.html), and that a condo will likely be (potentially much) higher than this. We can estimate the best case cap rate as being (0.55 * 1100 * 12 / 162000) or 4.5%. I think you can do much better than this on other investments.


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## Sampson (Apr 3, 2009)

You mention two issues, liquidity and potential for return.

Why are you concerned about liquidity? If it is because you have a disproportionate amount of money allocated to real estate, then asset allocation may be the problem. If you are expecting to need lots of money soon, then maybe you need to save more for that purpose.

Regarding potential return, if you are confident in this assessment, you might want to consider selling, and also selling your personal residence also. You could dip your feet into the real estate market using REITs - but this type of call could be difficult to time correctly.


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## jamesbe (May 8, 2010)

My personal residence is a home, not an investment I wouldn't sell it unless I had to. Heck we just moved 2 years ago. 

I have more than enough cash, I just like keeping my options open. With a rental unit it is basically never sellable with a tenant in it. So there is a risk there.

I'm always weighting my options, never really need to do anything, I could just keep on trucking.

I am kind of tired of having to fix things or deal with bad tenants though -- I'm very busy with 2 other jobs so it can be a pain. Just went today to show it and see they somehow damaged the laminate floor I just put in. ARGH!!


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## Just a Guy (Mar 27, 2012)

There are people who only buy places with tenants. They like long term ones, on cash flow properties. There are always people who will buy. Remember, you only ever need one buyer who will pay your price.


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## Sampson (Apr 3, 2009)

jamesbe said:


> I am kind of tired of having to fix things or deal with bad tenants though -- I'm very busy with 2 other jobs so it can be a pain. Just went today to show it and see they somehow damaged the laminate floor I just put in. ARGH!!


Then this alone should drive your decision.



jamesbe said:


> With a rental unit it is basically never sellable with a tenant in it. So there is a risk there.


You landlords in Ontario really have it tough. Here in Alberta, one could just increase rent by one-third, give the minimum notice and gone.


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## jamesbe (May 8, 2010)

Interestingly I have a person that wants to look at it this week. They want to rent-to-own. Or rent for a year or two and then buy it.

Not holding my breath but it is an ideal situation for me.


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## Jungle (Feb 17, 2010)

I believe stocks will outperform real estate. Dividend growth stocks with drips will grow income faster than you can raise rent. 
I rent property too. They can pay off the mortage while my cash flow is going in the stock market.


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