What are rental properties? What are the different types of property rentals and how do they differ? Are rental properties good investments?


What are rental properties?

Rentals properties are properties that a person (owner/landlord) has bought for the purpose to lease to a tenant so that rent money can be collected. The owner/landlord would charge rent money that would cover all the costs associated with owning the rental property, maintaining the property, advertising to find tenants to lease the property, managing the property and the tenants, a reserve fund (this is often overlooked) and hopefully ending with a monthly profit (positive cash flow).

Typically a mortgage loan would be used to purchase the rental property rather than being purchased in full. By utilizing a mortgage, the owner/landlord can purchase the property which otherwise the owner/landlord would not be able financially afford to. By leveraging of borrowed money (mortgage), the owner/landlord can purchase additional rental properties if he/she chooses to. The owner/landlord is responsible for the mortgage, property insurance and costs to maintain the property. Depending on the lease terms, the owner/landlord may be responsible for the property taxes, and utilities (i.e. gas, water, electricity, heat and/or condo fees). Sometimes the tenants pay for these costs directly and at other times it is paid by the tenant indirectly as part of their rent.

What are the different types of property rentals and how do they differ?

There are essentially two types of properties: residential and commercial.

  • Residential properties consists of the following:
    • Houses and townhouses – detached, semi-detached, bungalows, and side/back splits.
    • Apartments
    • Condominiums
    • Store frontage

Residential properties are easier to purchase as they cost generally less than commercial properties. Getting financing for a residential property is also simpler. You can walk into any bank and most will be more than happy to give you a mortgage (assuming you have good credit and that the amount you need is within your means). Property insurance is typically less expensive than commercial properties. The overall maintenance costs are also generally less than commercial properties. Finding tenants for your residential properties usually take much less time than commercial properties. Vacancies periods are generally shorter.

  • Commercial properties consists of the following:
    • Office
    • Retail
    • Industrial
    • Land

Lease terms on commercial properties are generally much longer. The typical office properties lease terms are either 5 or 8 years terms. Industrial properties are generally either 3 or 6 years terms. Late payments or non-payments are less frequent with commercial properties. If commercial tenants are late with their payments, the owner/landlord can change the door locks to the property within a few days. The eviction process with commercial properties is quicker than residential properties. The ROI (return of investments) on commercial properties are generally higher than residential properties.

There are other types of properties (such as churches, schools, etc…) that we are not going to cover as this article focus on properties that used as rental properties.

Are rentals property good investments?

To answer this question, we first need to identify how money is made from rental properties. There are typically 3 income/revenue streams:

  1. Rental Income
    • The main source of income with rentals properties are money collected for the monthly rent. It is important that the rent collected would cover all of the owner/landlord's expenses (mortgage, insurance, maintenance, advertising, repairs and vacancies) so that a monthly profit is made. Every rental property should generate an income. The profit can then be used to fund other investments such as purchasing an additional rental property.
  2. Parking
    • If you have with unused parking space(s), you can rent it out. Some houses do not have parking or sidewalk parking is not an option. A typical driveway on a regular neighborhood a driveway can be rented out for $45 per month. If the property is near a prime location (i.e. university, college, or business areas such as downtown Toronto), the parking spot can be rented for $100 plus per month.
  3. Laundry (coin operated)
    • You can put in coin operated washer and drier machines. Don't expect to become rich off coin operated washer and drier machines. You may earn a little bit of money from these however they are not really worth the investment from a purely revenue generating perspective. Instead, coin operated washer and drier machines can save the owners/landlords on electricity bills (assuming the owners/landlords pays for electricity).

In addition to receiving immediate monthly rent, rental properties can also appreciate in value. Determining the value of a rental property consists of the revenue it can generate. The more money it can make, the higher the property is valued.

Like with any investment, there are drawbacks.

  • The rental property requiring regular maintenance and repairs.
  • Sourcing and negotiating with trades (i.e. painters, plumber, repair man, cleaners, etc…).
  • Not being able to find a tenant for several months.
  • Encountering a bad tenant.
    • Tenants constantly calling the owner/landlord unnecessarily (i.e. light bulb change, etc…).
    • Tenants from one unit arguing/fighting with tenants from another unit.
    • The tenant is constantly late with his/her monthly rent payment.
    • The tenant abuses the use of the paid utilities.
      • Leaves the lights and/or television on even when the room is empty.
      • Opens the window during the winter while the furnace is running.
      • Opens the window while the central air conditioning is running.
      • Leaves the faucet to drip/run.
    • The tenant damages the property.
      • Stains the carpet or cigarette burns the carpet.
      • Constantly slams the door.
      • Leaves the windows open when it is raining.
    • Not paying rent and refuses to vacate.

Most of the above can be solved by hiring a property management company. The property management company would be the company that would deal with the tenants. The property management company would have a list of trades they deal with. If the water pipe burst in the middle of the night, the owner/landlord would not be disturbed. Instead the property management company would get the call from the tenant and the property management company would then contact their plumber contact. Of course this convenience comes with a price. The typical cost for a property management company charge is between 5% to 8% of the monthly rent. The property management company can also find and screen tenants. The charge for this is usually 1 month rent.

Even with all the work, a good rental property can be a great investment. The secret is to delegate the work, have a good team working for you.

  • A real estate agent to find you that wining rental property at a good location.
  • A bank or mortgage broker to provide you with financing.
  • A real estate lawyer to provide you legal advice to protect you and your real estate.
  • A property management company to handle the tenant issues.
  • Trades (i.e. painter, plumber, etc…) to quickly and professionally perform work required. (The property management company will also have their own trades contact).

By utilizing your team of experts, you leverage their knowledge and experiences. Can you do it all? Sure you can. However for every one rental property you purchased, the real estate sales agent bought/sold at least twenty rental properties. You will want to put in a system where every rental property you own is self-sufficient... little involvement on your part by utilizing your team of experts.