One of the main tenets of investing is diversification. Traditionally, investment advisors define diversification as being in many different asset classes, such as stocks, bonds, preferred shares, etc. These are called paper assets. What they usually won’t mention, however, is another class: real estate, or hard assets. The reason many investment advisors won’t mention real estate as an investment option is because they do not get paid on your real estate holdings. This is unfortunate, as owning real estate is an important component of any investor’s portfolio.
When you rent out your basement suite or buy a property to rent out, you get the following three main benefits:
1. A hard asset which will more than likely appreciate in value over time.
2. The ability to take advantage of leveraging – banks generally have no problem lending money when it’s secured by hard assets like real estate. You can multiply your returns on your investment by leveraging (but it must be sensible leveraging).
3. Real estate investing when done properly gives you positive cash flows with little or no income taxes. This is because you can write off mortgage interest, property taxes, insurance, utilities, repairs and maintenance, strata fees and any management fees.
People will always need a place to live, so you should have no issues finding tenants as long as the property is in a good area. If you don’t like to deal with tenants, and then you can always utilize the services of a management firm to manage the property. They usually take 10-20% of the gross rents as compensation.
The most cash flow and tax efficient way to generate rental income is through the renting of a basement suite in your principal residence. If you own a house in which you live, any capital appreciation on it over time is completely tax free. If you rent out your basement suite which makes up 40% of your square footage, you can write off 40% of mortgage interest, property taxes, utilities, insurance, repairs and maintenance. Most of the time, once you write off these expenses, you will have little or no net rental income to report on your personal income tax return.
For example, if you were renting out your basement suite for $1,000 per month, then you could potentially generate an extra $12,000 of cash flow for your household each year with minimal tax because of all the write-offs. Here’s the kicker: most, if not all, of what you are writing off are expenses which you would have incurred anyway.
Of course, you have to weigh the non-financial factors as well – how comfortable are you with a tenant in your basement? Also, you need to keep the rental portion of the house comfortably under 50% of the total square footage to keep the principal residence exemption intact. Finally, you cannot write off tax depreciation on the building portion when you rent out a basement suite (again, you can lose a portion of the principal residence exemption if you do).