Welcome to this month’s installment of Dear Urbaneer where we field real estate questions that are perplexing our clients. This month, our client asks a very timely question, given the swiftly escalating property prices and dwindling affordability in the City of Toronto. He ponders the possibilities of using part of his residence to generate rental income.
After an exhausting house hunt, we have yet to buy a home, so are re-thinking our strategy. Faced with the fact that prices just keep climbing and that our budget is already near the ceiling, we are contemplating shifting our search to include properties that might have a potential to help generate rental income, by letting us rent out part of the home. This could assist in helping us manage the mortgage and/or keeping other cash flow going. What do you think? What sort of things should we be looking for with this new approach? What do we need to know to become landlords in Toronto?
Ruminating On Rental Suites
Here's our response:
No question, with eroding affordability in Toronto, the choice to rent out part your residence in order to generate some income as part of your housing strategy is an approach that remains extremely popular among house hunters. In a market where skyrocketing values presents affordability challenges, becoming a landlord could help you build more equity more quickly, relieve some of your mortgage debt that you’d be taking on (like most house hunters currently), or offset your operating expenses.
A recent survey by the Mortgage Professionals Canada showed that planning to rent out part of a residence is the 'new normal' for home buyers.
In a release about the survey, Paul Taylor, President of Mortgage Professionals Canada, said, "Creating income remains a useful tool for first-time homebuyers…People are looking for ways to make owning a home more affordable. Generating income allows them to reduce their mortgage more quickly."
Some highlights of the survey include:
· First-time buyers are more likely to rent out part of their homes, compared to repeat buyers
· 40 percent of homeowners plan to rent out part of their homes to help with housing costs, with 20 percent of young home buyers (18-34 years old) plan to rent out their homes
· 13 percent of homeowners that took on renovations did so to create a rental unit in their home
· 9 percent of homeowners took out equity from their homes in the past year, mostly to pay for home renovation or repair.
If affordability has you on the sidelines of homeownership, or if the rapidly rising prices are keeping you from the freehold housing market, boosting the income side of your balance sheet with a rental can be a viable option to help bridge that gap (i.e. if a condominium is what you can currently afford, but a freehold house is within reach with an income supplement).
Although renting out part of your residence is gaining a lot more attention in the media as weary house hunters look for alternatives, buying a home with the intention of renting part of it out isn't anything new. In fact, this phenomenon has been ever-present in Toronto for decades. For many immigrants who settled in Toronto since the turn of last century, renting floors or even rooms was common practice. In fact, I also did it myself as part of my home ownership strategy. In my 20s, I bought a detached house in The Beach, where I took on roommates to offset my costs. To increase my income stream, I even built a basement apartment and finished the attic into a fourth bedroom.
The principle (and the benefit) of the strategy of renting out of portion of your residence remains the same: combine your need for shelter with a smart investment strategy that sees your debt reduce and your asset grow more quickly. The difference today is that many people have no choice, in order to make homeownership affordable.
Revising Your Search Criteria
Given that you are looking for slightly different criteria if your main motivation is to buy property that has income potential in addition to satisfying your own shelter needs, there are new things to consider. Here is a post about prudent purchasing: "Buy Smart: Purchasing The Smart Buy". Make sure that the homes you are considering are large enough to accommodate you and potential tenants and, most importantly, ensure the property has easy rental potential, like ensuring the basement has a finished washroom and a separate entrance (which can be costly to add) or a rough in for a kitchen on a second floor. Houses which have, in the past, been income properties do offer this upside as they may have electrical and plumbing lines hidden behind the walls.
Rough-ins are great, but don't pay more than you have to for a "finished product". A dwelling that currently has a ready-to-go rental unit is super convenient, but this feature will come with a hefty premium. The allure here is that in a home where a secondary suite has already been built (converted, etc.), provides immediate income stream. Why do these properties garner significantly higher premiums? Not only is it because the instant rent being generated helps you as the Buyer, it may be a requirement by your lender in order to service the debt.
For those who have available capital, it is far more cost effective to purchase a home and then to convert an area(s) to rental unit(s). The premium attached to the other option doesn’t always warrant the extra cost, when you are looking from an investment point of view.
You're likely familiar with the real estate mantra, "location, location, location"? There are neighbourhoods that you’ll naturally to prefer to live in over others, but when you’ve got an additional business motivation, your location is key to your business plan. You’ll be able to charge premium rents, not just based on what amenities and features that your rental space offers, but also on what kind of amenities are at the doorstep of your home (Tip: A house on a busy arterial road is often less expensive than one on a side street, but if it's on a bus route it can be a benefit for a tenant who can see the bus coming down the street from their front window during a snowstorm!). Similarly, you’ll want to have a solid understanding of supply and demand for rental units in your intended neighbourhood. It’s all about positioning yourself in the market to be successful with your investment.
Here is more information on this and other points that property investors value in our recent post: “What Do Property Investors Dream About?”
Get Familiar With The Rules
Becoming a landlord involves a lot more than hanging a “For Rent” sign. There are numerous regulations and legislation around being a landlord.
Here is a handy resource with a tidy summary of rules etc. for Toronto landlords in this recent post: “Can I Have An Income Suite In My Residence?”. For instance, did you know that to build a second suite within your residence, the home must be at least five years old. It must be detached or semi-detached. The rental suite must be smaller than the principal residence and be fully contained. This is just a start, but certainly things to consider before you select a property.
You also need to comply with municipal bylaws and pass inspections. Similarly, you’ve got to remember that being a landlord can open you up to new levels of liability, so you need to make sure that you are covered in that regard. Incidentally, in the City of Toronto, our estimate is that only about five percent of secondary suites are legal conversions. Basically, the lack of affordable housing has the City turning a 'blind eye' to these illegal suites in terms of zoning and compliance, but it doesn't mean you're assuming any less risk if something goes awry.
And don’t forget that your rental income - after deducting the proportionate share of operating expenses - will be taxed as well, so make sure to remember that in your forecasted income stream.
The Tenant Question
Of course, your rental unit is really only a rental unit if you can secure a tenant to pay for it. And as any landlord will tell you, there is untold value in being able to secure good, long-term tenants. In addition to the peace of mind.
We summarized the recommended steps to take to land those lucrative tenants for the long term in past Dear urbaneer post: “How Do I Find And Keep Good Tenants?”. The post goes into greater detail, but to give you a few basic hints: You need to treat your rental as a business, that means knowing your intended market and catering to them. Target advertising effectively and style the unit to suit the needs and tastes of your desired tenant.
It’s also worthwhile to remember the human component of being a landlord and commit to communication proactively. It’s the cornerstone of every long term relationship, and the tenant/landlord relationship is no different.
So, in a nutshell there is a lot to consider if you are thinking about converting and renting out part of your residence. But if approached as part of a well-researched strategy, it can be an excellent way to help with the costs of homeownership while building up personal wealth at the same time.
With decades of experience in navigating the waters of Toronto Real Estate and real-life experience with purchasing a residence that generated rental income successfully, I’m happy to share my advice with you. We’re here to help!
~ Steven and the urbaneer team
Steven Fudge, Sales Representative
& The Innovative Urbaneer Team
Bosley Real Estate Ltd., Brokerage - (416) 322-8000
- we're here to earn your trust, then your business -
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