COVID-19 might kill the rental property industry
The net profit from a rental property is minimal
Chris Seepe
REM
The financial situation of every rental property is as different as a fingerprint. Every operator applies their level of experience, understanding, operating sophistication and personal values of what’s most important to them in owning and operating a rental property.
Therefore, the numbers below can only very roughly approximate the breakdown of costs of owning and operating a rental property. Nevertheless, the overarching conclusion, regardless of what numbers you use, is that the net profit from a rental property is much less than tenants, media and the government believe, and it’s these same entities who collectively think residential landlords are rich and can afford to carry all the consequent losses caused by COVID-19.
Here’s a rough breakdown of where each investment dollar goes in a six- to 20-unit multi-residential investment property using an average of two six-plexes, one nine-plex, one 11-plex, and two 12-plexes in Oshawa, Ont., arguably levying the third-highest property tax of 444 municipalities in Ontario:
- $1.00 rental income (no HST)
- 18.8 cents – property tax
- 2.2 cents – building insurance
- 3.5 cents – electricity (common area only)
- 3.4 cents – gas heating (included in rent)
- 3.4 cents – water/sewer (included in rent)
- 8.8 cents – repairs & maintenance
- 3.1 cents – property management, janitorial, placement fees
- 1.4 cents – professional fees
- 44.6 cents – operating expenses
- 39.8 cents – principal & interest (5-yr closed fixed, 25-year am, 75 per cent LTV, three per cent interest)
84.4 cents total costs
- 15.6 cents – net profit before corporate taxes (cash flow)
- 7.8 cents – corporate tax (50 per cent “passive” income)
7.8 cents – net profit after tax BEFORE capital costs (new roof, furnace, boiler, windows, etc.)
So, on $100,000 of gross income from an average nine-plex rental property, the owner takes home about $7,800 before paying for hopefully infrequent capital costs. Factor in capital costs such as replacing the windows every 30 years, say, $50,000. Keeping the numbers super-simple, that’s $1,667/year; boiler at 20 years and $20,000 = $1,000/year, roof 15 years and $10,000 = $667/year totaling $3,334/year capital costs – paid from the $7,800 annual take-home pay.
The above is overly simplistic and subject to many sophisticated cost-reduction management techniques and best practices to streamline those expenses and maximize return. It’s just a baseline value.
A new boiler may reduce gas consumption by 30 per cent, resulting in a notable equity increase: for example, a $2,000 gas savings might add $40,000 (at a five per cent cap rate).
Depreciation (capital cost allowance) will reduce the taxable income too but the money must all be paid back when the property is sold so it’s a tax deferral scheme, not a tax write-off.
A higher amortization period for financing will improve cash flow but you pay more interest over the term. You could pay off your mortgage quickly, which would substantially improve your cash flow (profit) but then all that equity is “dead” money, which is not working to help you create asset wealth.
I have been receiving insurance quotes for multiple buildings these past three months and every company has been quoting 11 to 15 per cent higher premiums than the previous year, despite not making any claims for more than five years, notable investments in improvements and no explanations from the companies explaining this industry-wide cash grab in a time of enormous financial upheaval.
Ontario’s electricity rates went up 55 per cent last November but the increase was hidden by a 31.7 per cent short-term rebate.
My local water/sewer costs went up about 40 per cent in the past five years. But rental income was “allowed” to increase about 17 per cent over the same five years.
I couldn’t find a quotable statistic on the number of investment properties that are financed but I remember hearing that perhaps 85 per cent of rental properties have some amount of a mortgage.
How much money is left over for a landlord to meet all their obligations in the midst of pandemic emergency measures?
Say a “modest” 10 per cent of tenants don’t pay their rent. Which companies and government agencies have offered relief or forgiveness on the above costs? What will deferral of interest payments accomplish if there’s no increase in rent? How long will most or all of the landlord’s income we live on go towards the forced extended loans and accumulated interest payments?
COVID-19 may be the catalyst but it wouldn’t be the culprit of a collapsing rental property industry. The attraction of leveraging real estate to create asset wealth is a powerful lure but the best advice may be to shed the “bonds” of interest-tyranny and reduce your dependency on lenders.
Many of our risks were artificially and unnecessarily created by ill-conceived, short-term, simple-minded legislation enforced by a fundamentally dis-“membered” Landlord and Tenant Board. In the rental housing industry, ignorance of the law may turn out to be the single greatest “excuse” for financial ruin.
© 1989-2020 REM Real Estate Magazine