Purchasing an investment property can provide passive income and long-term equity growth or capital gains. Real estate investing remains one of the best ways to build wealth. However, with tighter lending rules, rising mortgage rates, and a cooling yet unpredictable real estate market, you need to know how changes in the market can impact your growth potential if you plan to buy an investment property.

Whether you’re a first-time landlord, house flipper or looking to expand your real estate portfolio, here’s what you need to know before buying an investment property in today’s housing market.

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Key Takeaways

• Investment properties that are not owner-occupied require a minimum 20% down payment.
• Financing options for investment properties vary based on whether the property is owner-occupied and its number of units.
• Income from rental properties is taxable as income, while profits from flipped properties are fully taxable as business income.

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What Is an Investment Property?

An investment property is any real estate purchased to generate income or profit rather than serving as the buyer’s primary residence. Investment properties can be rentals or properties purchased to fix and flip for a profit. Investing in real estate can provide several benefits, including short and long-term appreciation, cash flow through rental income, tax advantages, and portfolio diversification. 

Rental Properties

Rental properties generate income through the collection of monthly rent from tenants. These types of investment properties are typically held as long-term investments. Investors aim for steady cash flow, pay down the mortgage, and benefit from the long-term appreciation of this asset. 

Rental properties can provide a stable return and become self-sustaining over time. However, they also involve ongoing responsibilities like property maintenance, tenant relations, and navigating rental rules and regulations, which vary by province. 

Flipped Properties

Flipped properties generate income through the purchase of real estate, renovating or rebuilding to increase property value, and reselling at a profit. These types of investment properties are typically held as short-term investments. 

This strategy can yield high returns quickly but carries significantly more risk, especially in volatile markets or when renovation budgets and timelines fall off track. Flippers must also factor in capital gains taxes, anti-flipping tax rules (if applicable), holding costs, and the potential that interest rate increases could affect the resale value or buyer demand. 

Down Payment and Qualification Criteria

Unlike a primary residence, where you can purchase a home for as little as 5% down, investment properties require a minimum 20% down payment if not owner-occupied. If you purchase a $600,000 property as an investment, you will need at minimum $120,000 as a down payment compared to $30,000 if you purchase that same property as your primary residence. 

Qualifications

• The mortgage stress test will apply to financing rental income properties.
• To qualify, lenders may include projected rental income, depending on the lending guidelines for the inclusion amount (50% to 80% of market rent).
• You’ll face higher interest rates than owner-occupied residences.

Financing an Investment Property

When purchasing an investment property, your financing options will largely depend on the number of units and whether you will occupy any part of the property as your primary residence. The only exception to the below is in Quebec, which allows up to 5 units on the residential side before you require a commercial mortgage. 

Rental or Flipped Property 1-4 Units

For properties with 1-4 units that you will use solely as a rental or flipped property, you can fund up to 80% of the purchase price, put down 20% or more and get a residential mortgage specifically for investment properties through many lenders. 

These types of mortgages typically have higher interest rates to compensate for the added risk that investment properties pose to the lender. Lenders assume you have a higher probability of not paying your mortgage on an investment property if you’re going through financial difficulties instead of choosing to prioritize maintaining your primary residence and keeping a roof over your head. 

Owner-Occupied Rental Property

If you purchase a multi-unit property with up to 4 units and intend to live in one of the units as your primary residence, you can get an insured or conventional mortgage. You can put down as little as 5% and benefit from lower interest rates when you purchase a property with up to 2 units. 

For 3-4 units, you can put down as little as a 10% down payment and still benefit from lower interest rates. You can rent out the other units to generate rental income and benefit from long-term gains while living in the property.   

Commercial Property 5+ Units

If you purchase a property with 5 units or more, it is considered commercial and requires a commercial mortgage. When qualifying for a commercial mortgage, lenders will assess the property’s ability to generate cash flow that can service the debt. 

These types of mortgages come with much higher rates to reflect the increased risk associated with commercial properties. In Québec, you can purchase up to a 5-unit multiplex through many mortgage lenders’ residential financing policies, and on exception, up to 6 units.

Budgeting Beyond the Mortgage

One of the biggest mistakes new investors make is underestimating their operating costs. Expenses can quickly add up between mortgage payments, property taxes, condo fees (if applicable), utilities, insurance, and property maintenance and management.

Don’t forget to account for:

• Vacancy periods 
• Annual property maintenance
• Repairs (roof, plumbing, HVAC, etc.)
• Legal and accounting fees
• Tenant screening or property management services

If you’re a new investor flipping a property, the purchase price and mortgage are just the beginning. Renovation projects come with unpredictable costs, timelines, and potential permits and construction delays. 

Don’t forget to account for:

• Plan for overages by adding a buffer to your reno budget for unexpected costs.
• Include permit fees, inspections, and utility hookups in your planning.
• Budget for holding costs, such as mortgage interest, property tax, insurance, and utilities, while the property is under construction and waiting to be sold.
• Don’t forget real estate commissions, legal fees, and closing costs on the resale.
• Set aside funds for staging and marketing to help the property sell faster at a higher price.

Income Potential and Return on Investment (ROI)

Understanding how your investment will perform over time is essential before you commit to a property. Whether you plan to collect rent or aim for a quick profit through resale, evaluating the income potential and return on investment (ROI) will help you determine if the property has potential. 

Rental Income

When you collect rent, this is considered income and is taxable at your marginal tax rate, just like employment income. However, you can offset your net rental income by deducting rental expenses. You can deduct expenses from rental income, including property taxes, insurance, mortgage interest, and depreciation, known as the capital cost allowance.

With rental properties, ROI is an assessment of your cash flow or how much you earn from the property compared to how much you put toward it. Steady rental income can cover your carrying costs and generate profit, especially in high-demand rental markets. 

Over time, as tenants help pay down your mortgage and property values increase, your equity builds. Factoring in tax deductions such as mortgage interest, property taxes, maintenance, and depreciation can also boost your net return. 

Flipped Income

For flipped properties, ROI is realized through the profit made from reselling the home at a higher value than what you paid. All costs, including the purchase price, renovations, financing, holding expenses, and other costs, must be carefully tracked to ensure the property remains profitable. 

For example, if you purchased a property for $500,000 and all expenses to renovate and resell add up to $300,000, you have invested $800,000. If you resell it for $1,000,000, you make a profit of $200,000, which leaves you with a 25% ROI. 

However, with flipped properties, you must factor in property tax rules, which will affect your profit and lower your ROI once you file your taxes. Since any profit from flipping a property is 100% taxable as business income, it will be taxable at your marginal tax rate. This could significantly reduce your ROI depending on your other income sources, profit from the sale, and which tax bracket you fall into.  

Federal Flipped Property Tax Rules

If you are purchasing an investment property intending to flip it, the federal government has changed how it will be taxed. Since January 1st, 2023, any gains from a residential property held or owned for less than 365 days will be fully taxable as business income. 

This means that any gains from the sale of a flipped property are no longer eligible to be treated as capital gains. Any reasonable expenses incurred to earn business income are still tax deductible. However, selling the property at a loss cannot be claimed as a business loss. 

Provincial Anti-Flipping Rules

In addition to the federal rules for flipping property, BC is the only province with an additional tax. The BC home flipping tax applies to property sold on or after January 1st, 2025, and is a separate provincial tax for property owned for less than 730 days in BC. This tax applies to the net taxable income from the sale of the property and is subject to a tax rate of 20% if sold within 365 days, with the rate decreasing over the next 365 days. 

Managing the Realities of Investment Properties

Being a landlord requires effort, especially when managing tenants, maintenance and repairs. Hiring a property manager can alleviate stress but will reduce your profit margins.

If you want a more hands-off investment, consider:

• REITs (Real Estate Investment Trusts) allow you to invest in real estate portfolios through publicly traded shares, similar to buying stocks without physically owning property.
• Fractional property investments allow multiple investors to co-own property, each holding a share proportional to their investment. This allows you to enter the market with lower capital and share income and potential appreciation. 

Is Now a Good Time to Buy an Investment Property?

Before you buy an investment property, it’s a good idea to assess your financial situation to determine if you can comfortably handle the added expenses and uncertainty, the housing market, the state of the economy, and interest rate predictions. 

Ask yourself if you can still handle your existing financial obligations while covering an additional property and if you have the cash flow to cover repairs or expenses related to the investment property if you cannot rent or flip it within a specific timeframe.  

Frequently Asked Questions (FAQ) About Buying an Investment Property

Final Thoughts

Owning an investment property in Canada can offer tax advantages and long-term financial stability while helping create generational wealth. But it’s not without challenges, as fluctuations in the housing market, interest rates, and the economy can all impact your potential gains. Whether purchasing your first investment property or expanding your real estate footprint, a tailored mortgage strategy is key to long-term success.

Contact nesto mortgage experts for a personalized mortgage strategy that helps you confidently build your investment portfolio.