Would-be real estate investors in Vancouver can find it tough to find a property where the rental income pays for the mortgage and all associated expenses – but that’s not necessarily a problem, according to Peter Kinch, mortgage broker, author and financial advisor.
Speaking January 23 to REW.ca editor Joannah Connolly on her Real Estate Therapist show on Roundhouse Radio 98.3FM, Kinch asserted that not all cash-flow-negative investments are a bad idea.
“Ideally, of course, the investment would be cash-flow positive,” said Kinch, author of the Canadian Real Estate Action Plan.
“In fact the ideal scenario is that you take out a line of credit on your principal residence, use that to pay for the down payment on a rental property, then your rental income covers all the expenses related to that property plus interest on your line of credit, so in 20 years you have an asset that is free and clear. That is the infinite return as it costs you nothing. That’s the ultimate real estate investment scenario.
“But of course the reality with Vancouver prices is that this is unrealistic with 20 per cent down, you’d have to put considerably more money down to achieve this. So the question then becomes, what’s the end result that you’re looking to get from this?
“It all depends on what your budget can allow. If you can afford an extra $300 a month to put into an RRSP, then you can afford to invest $300 in negative cash flow in a real estate investment. Because if you kept paying that for the next 20 years, eventually it wouldn’t be negative cash flow. In 20 years it would still be a free and clear asset.”
Kinch also wrote about the topic in his weekly newsletter the Mortgage Minute:
“Let’s assume a monthly rental income of $2,000 on a $400,000 property. We would access $100,000 from a line of credit on the principal residence and take $10,000 of that and set it aside in a ‘contingency fund.’ This is equal to roughly five month’s rent. We would have a new first mortgage on the rental property for $310,000.
“Our monthly expenses would be:
- Interest on the line of credit taken out on the home = $334 (based on rate of four per cent)
- Interest on new first mortgage on rental property = $1,390 (based on a five-year rate @ 3.5 per cent with a 30-year amortization)
- Property taxes, insurance, property manager and strata fees = $600
- Total: $2,324."
Kinch observed that with $2,000 in rent, the only expense is $324 per month, and the strategy eventually results in a free and clear $400,000 asset (plus any real estate price increases) and a monthly rental income. He compared this with investing $300 a month for 20 years, which at an eight per cent return would result in $178,000 cash with no income.
However, Alisa Aragon, mortgage expert with Dominion Lending Centres Mountain View Ltd., told REW.ca that this can be a risky approach. “If an investor purchases a property with a negative cash flow, what happens if the expenses increase, such as in the case of rising interest rates? And most importantly, with that strategy, will they be able to purchase more investment properties?
"What I recommend to my clients, even though it might take longer, is that it is important to find a property that has a positive cash flow from the start."
To listen to Peter Kinch’s January 23 guest appearance on the Real Estate Therapist show on Roundhouse Radio 98.3FM, click here – and use the time slider to find the discussion on negative cash flow starting at 43 minutes.