Residential real estate investments are properties such as houses, apartment buildings, townhouses, and vacation houses where a person or family pays you to live in the property. The length of their stay is based upon the rental agreement, or the agreement they sign with you, known as the lease agreement. Most residential leases are on a twelve-month basis(usually).
Commercial real estate investments consist mostly of things like office buildings and skyscrapers. If you were to take some of your savings and construct a small building with individual offices, you could lease them out to companies and small business owners, who would pay you rent to use the property. It isn’t unusual for commercial real estate to involve multi-year leases. This can lead to greater stability in cash flow, and even protect the owner when rental rates decline, but if the market heats up and rental rates increase substantially over a short period of time, it may not be possible to participate as the office building is locked into the old agreements.
Industrial real estate investments can consist of everything from industrial warehouses leased to firms as distribution centers over long-term agreements to storage units, car washes and other special purposes real estate that generates sales from customers who temporarily use the facility. Industrial real estate investments often have significant fee and service revenue streams, such as adding coin-operated vacuum cleaners at a car wash, to increase the return on investment for the owner.
Retail real estate investments consist of shopping malls, strip malls, and other retail storefronts. In some cases, the landlord also receives a percentage of sales generated by the tenant store in addition to a base rent to incentivize them to keep the property in top-notch condition.
Mixed-use real estate investments are those that combine any of the above categories into a single project. Mixed-use real estate investments are popular for those with significant assets because they have a degree of built-in diversification, which is important for controlling risk.
When you invest in real estate, your goal is to put money to work today and make it grow so you have more money in the future. You have to make enough profit, or “return”, to cover the risk you take, taxes you pay, and the costs of owning the real estate investment such as utilities and insurance. This overview explains the basics of real estate investing for beginners to help you learn what to expect and how investors make money from their real estate properties.
The 4 Ways Real Estate Investors Make Money
When you invest in real estate, there are several ways you can make money:
Real Estate Appreciation: This is when the property increases in value due to a change in the real estate market, the land around your property becoming scarcer or busier like when a major shopping center is built next door, or upgrades you put into your real estate investment to make it more attractive to potential buyers or renters.
Cash Flow Income: This type of real estate investment focuses on buying a real estate property, such as an apartment building, and operating it so you collect a stream of cash from rent, which is the money a tenant pays you to use your property for a specific amount of time. Cash flow income can be generated from well-run storage units, car washes, apartment buildings, office buildings, rental houses, and more.
Real Estate Related Income: This is income generated by “specialists” in the real estate industry such as real estate brokers, who make money through commissions from buying and selling property, or real estate management companies who get to keep a percentage of rents in exchange for running the day-to-day operations of a property. This type of real estate related income is easy to understand. For example, a hotel management company gets to keep 5 percent of a hotel’s sales for taking care of the day-to-day operations such as hiring maids, running the front desk, mowing the lawn, and washing the towels.
Ancillary Real Estate Investment Income: For some real estate investments, this can be a huge source of profit. Ancillary real estate investment income includes things like vending machines in office buildings or laundry facilities in low-rent apartments. In effect, they serve as mini-businesses within a bigger real estate investment, letting you make money from a semi-captive collection of customers.
1. Game Plan
What are your mid to long term investment goals? Are you planning on buying only one property? Interested in investing in several different areas? Do you want to finance one property or ten, and over what span of time?
You need to demonstrate a great track record of payments to other creditors, to make you a good bet with the lender. Not sure how your credit measures up? Check your own credit (see Equifax.ca for free or paid ways to do this) and see how your credit looks. A credit score of at least 680 is the minimum you should aim for. If you aren’t quite there, don’t let it stop you – take action to improve it (talk to your mortgage broker). The better your credit, the more options you will have for financing.
3. Proof of Income
The lender will be looking for evidence related to how you will be paying for the mortgage. For example, if you are a salaried employee, you will need a recent (less than 30 days old) letter of employment and pay stubs. The lender may also ask for copies of your most recent Notice of Assessment NOA from CRA, and possibly your completed T1s or tax returns. If you are self-employed, or if commission income comprises a large portion of your income, you will need to provide proof of income for the last 2-3 years in the form of NOAs and possibly T1s and/or Financial Statements for your business, as well as proof of business such as business registration or a website URL. If you receive income in some other way, every piece of documentation that you can provide will help put you in the best possible position for qualifying to borrow money.
4. Proof of Down Payment
In most cases, you will personally need to provide a down payment of at least 20% of the purchase price of the investment property (although some alternative lenders will allow a 15% down payment, but might charge you a bit more in interest and lender fees). Your lender will be looking for proof that your down payment isn’t borrowed. For example, are you getting your down payment from a bank or brokerage account? Then you will need banking statements to confirm that the full down payment has been in your account for at least three months. Alternatively, if you are planning on advancing funds from your home equity on your principal residence using a Home Equity Line of Credit or increasing your mortgage amount, you will need to get this set up first. You’ll then need to provide statements showing the amount advanced and deposited to your bank account and the most recent statements showing the amount now owing. Or, if the money for your down payment is coming from the sale of another property, the lender will be looking for documentation such as an agreement of purchase and sale, together with a recent mortgage statement showing how much money will be coming to you from the sale.
5. Emergency Funds / Closing Costs
In addition to the down payment, you will also need to show at least 1.5% of the purchase price in closing costs to the lender. You will also want to have a contingency fund set aside that will help you deal with unexpected expenses. Many investors choose to use a HELOC (Home Equity Line of Credit) secured by their home, or money in a savings / brokerage account. This is a provision to ensure that you have funds set aside in the case of an emergency.
6. Existing Property Details
If you have other properties, you will need to provide the lender with mortgage statements and property tax statements for all of them, as well as lease agreements if they’re rented. Ideally, you need to show that existing properties either carry themselves (i.e. that they are “cash flow positive”), or if they aren’t cash flow positive, that you can afford to cover the shortfall on an ongoing basis.
7. New Property Details
In addition to the MLS listing, Agreement of Purchase and Sale, and applicable waivers, you will need to provide either a lease(s) for the new property, or a letter from an appraiser confirming the market rental price that can be expected from your property.
8. List of Experts
To ensure that you get the very best results from your investment efforts, you will want to work with a good mortgage professional, real estate agent, property insurance broker, home inspector, real estate lawyer, property manager, and accountant. Don’t panic! If you don’t know people in these categories, your real estate representative should be able to recommend someone. Remember; don’t hold back any information from your advisors, no matter how negative you feel it might be. Finding out something unexpected partway through the process can add significant challenges and interfere with your attempts to get financing.