5 Real Estate Investing Myths Debunked!
In this video, I’m going to debunk 5 real estate investing myths that we frequently hear from new clients. Chances are you might have some of these misconceptions, so hang on tight and watch till the end. Now without further ado, let’s go into myth number 1.
Myth 1: A House Is a liability
According to the book, Rich Dad Poor Dad, author Robert Kiyosaki tells his readers that a house is a liability! The theory is this: you’re paying for the mortgage, utilities, taxes, maintenance, and repairs each month so it’s not actually your asset, it’s not generating wealth but you’re creating more debt for yourself.
Here’s the thing – Toronto’s seen steady annual appreciation of 8% over the past 10 years. When you combine higher returns with lower costs of funds, it’s actually a great investment!
Let’s look an example where you purchased a property in 2015 for $600,000. With a 20% downpayment and closing costs, the total capital required is around $138,000. Then you get a 5 year fixed mortgage at 2.5%, which means your monthly mortgage is around $1,900.
Each month, on top of the mortgage you also have to pay for utilities, property tax, insurance, maintenance and repairs so your total outgoing monthly cash flow is around $2,700. Fast forward 5 years, and you sell the property at market in 2020 for around $880,000 based on actual 8% appreciation per year. So did you make money?
Let’s start by deducting everything you paid for. There’s selling costs of around $35,000, all of the outgoing cash flow over the past back the balance of the mortgage of around $423,000. We’ll take out the initial capital of $138,000 as well so that leaves a tax free net gain of almost $105,000. You can also interpret this as a return on investment of 76% plus you got to live there rent free for 5 years!
So, if you can qualify for a good mortgage, and can afford to pay for the downpayment and monthly expenses, then buy a house is an appreciating asset, not a liability.
Myth 2: I have to pay capital gains tax when I rent out the basement of my house.
First of all, I have to say that I’m not a tax professional so please you consult your accountant to verify this information. Now, when you rent out a property, it’s considered a business so technically you should be paying taxes on it. At the same time, there’s a capital gains exemption if you sell your principal residence in Canada. So which one is it?
Based on our discussions with our accountants, the general consensus is that capital gains exemption can apply as long the primary use of the property is your home, and the basement suite is secondary. The CRA website gives more colour here and tells us that a rental suite needs to meet these three conditions to be considered part of your principal residence:
- Your rental use is relatively small in relation to your principal residence. This is kind of vague here but we generally think it should be less than 50% of the total living space.
- You did not make any structure changes to the property to make it more suitable for rental use. So basically if you bought your property with a basement suite, then it’s definitely ok.
- You do not deduct any capital cost allowance. So when you deduct capital cost allowance, you’re depreciating part of the rental unit to reduce your income taxes. And if you’re doing this, you’re telling the government you intend to treat it like a business so that’s why the government says you should be paying taxes in this case.
Myth 3: When you buy an investment property with a spouse, the capital gains can be split equally.
Ok so one of the reasons some couples might do this is if one spouse makes a lot more than the other. By splitting the income and gains, they hope that can lower their combined taxes.
Again, not a tax professional here but based on our accountant’s advice, how things should be taxed really comes down to who contributed the money. If the higher income earner is the one that’s actually put money into the investment property, then the income and capital gains should actually be allocated to that person.
If you really want to income split with your spouse, a better option is to create spousal loan beforehand based on CRA’s prescribed interest rates. How it works is that the higher income earner would lend the other spouse half of the capital required, and then both of you would invest together in the property. At the end of each year, the borrowing spouse would pay interest to the lending spouse, and this extra process effectively makes income splitting possible.
Myth 4: Cash flow is king.
Cash flow is definitely important because you don’t want to be stressing out about making mortgage payments on your investment property every month. But it shouldn’t be the only thing you consider.
There’s actually 4 parts that contribute to real estate returns and we think it’s important to put some weight on each of these four parts. The concept is similar to multiple streams of income. If one income stream is affected, you still have 3 more income sources to fall back on. I dive into each of these four parts in this video here so if you want to learn more you can head over to the video by hitting the link in the description below.
Myth 5: I can’t qualify for another mortgage so I can’t buy a rental property.
When you say this we will follow up with did check yet and did you consult multiple banks? The reason we ask this is because banks look at rental properties slightly differently compared to how they look at your primary residence.
So just because you maxed out on you primary residence it doesn’t automatically mean you don’t qualify for another property. On top of this, each bank’s approval process is also a bit different:
- Some banks use 50% of your rental income and others will use all of it and add it to your total income
- Some banks disregard operating expenses of rental properties which reduces your total debt
- Other banks let you pull equity out of existing properties to pay for the new property’s downpayment so this allows you to scale quicker
- Banks might also look at self employed income, dividends from registered accounts, and foreign income differently
This means there could be a better bank for you if you have a special situation.
If you don’t know which bank to go to, our team can help out. We’re happy to schedule a free discovery call with you if you’re looking to buy an investment property in Toronto. We’ll look at your situation and figure out which banks or brokers are best for you!