Several months ago, I entertained investing in a rental property. After much thought, meetings, spreadsheets and more meetings, we decided to take a break from looking for a rental property (I don’t use “we” in the royal sense; I had several potential partners; if you are one of my American readers, lest you think I have lost my senses, Canadian real estate has managed to hold its value- for now although things are really softening- and we started looking when values were still relatively high late last year). It was more a matter of timing than the concept itself. We may come back to looking at investing in real estate.

But as we were looking, we started getting into a real conceptual debate about what was a greater priority- cash flow or appreciation.  I believe we found the right urban area to target (Waterloo/Cambridge/Kitchener- home of Research in Motion and the real Silicon Valley North- sorry Ottawa) which, assuming the assumptions are correct, appreciation would take care of itself since a sufficient amount of people would be moving into the area to raise demand. The concern was increasingly becoming that the acquisition price kept going up but the rental rates were not increasing at the same rate. If you are an owner, this is great since your house is appreciating but, assuming interest rates do not rise significantly on a variable rate mortgage, your debt to income ratio (% income to cover debt) remains relatively constant. Without increasing costs, you have a paper gain.

But the game is different in real estate investing. Low interest rate environments are bad for real estate investors- it means that there is a low barrier of entry into the housing market which decreases the rental pool as renters become owners and an increasing number of people, with cheap mortgages, are bidding up real estate prices. Decreasing renter base + increasing property prices = unhappy real estate investor. An investor ends up getting less bang for the buck as it costs more to acquire a property renting for approximately the same amount as the year previous (remember that as the number of renters decrease, rents decrease as well; in Toronto, landlords are giving out free LCD TV’s to entice renters since everyone started buying condos instead of renting and, you guessed it, property prices in the “good” parts of the city began to reach unaffordable levels for most middle class families).

Ideally, a real estate investor wants to avoid the south Florida housing trap- lots of real estate being bidded up, no real renter base relative to the number of new homes going up and an over-supply of most types of housing (I may call this the Vancouver trap in a few years). No one is happy- home owner or real estate investor.

The other approach we looked at was to look purely at a cash flow property. This meant looking at old dumps (I believe that’s the technique term) with multiple units which could be rented out or duplexes and triplexes which were not dumpy (again, a technical real estate term). For duplexes and triplexes, we ran into the same issue- appreciation was too high even with multiple units. We had to put a lot down and still not yield that much rental income relative to acquisition costs. The issue with trying to purchase duplexes and triplexes in appreciating areas is that purchasers are buying for both appreciation potential and the cash flow multiple renters provides which adds a premium to pricing. Whatever gain you get from multiple sources of rental income is being off-set by the amount of money you have to put up to acquire the property. With respect to investing in a dump and becoming a slumlord, no one wanted the headaches. Enough said. Perhaps, we were looking too soon and with the market softening, a wait and see attitude may be the most prudent one.

…and so we wait for the market to hopefully soften….and I may fall into the arms of my old reliable of dividend yield stocks (yes, even the banks). If you are interested in become a real estate investor, try this blog on real estate investing. To be continued?