Rental Property Income
NOTE: This post does not indicate a recommendation to purchase property. The post is strictly representative of options for generating passive income through rental property. Which, is a popular source for passive income and may be an income stream that interests you.
This discussion excludes growth in the value of the property. Property value is dependent on market conditions and economic factors. Rental income depends on the market conditions where the property is located and availability of stable tenants who pay their rent.
Because I am a West Coast resident, I have taken property value and monthly rent amounts from two markets on the West Coast. Vancouver and the Greater Vancouver area.
These are rent controlled areas. As a result, rent can only be raised by the maximum annual allowable amount each year.
Initially I did not choose San Francisco because of the extreme property valuation to rental ratios (price-to-rent ratio). However, this area is also rent controlled.
Price-to-Rent Ratio
Price-to-rent ratio compares to price of the property to the annual rent for that same property.
Accordingly, for San Francisco this ratio is 50.11, Vancouver 20.41 and Greater Vancouver area 19.58.
The price-to-rent ratio can be used to guide an individual on timing for purchasing or renting property. Additionally, some recommendations show that when this ratio is under 15 then it is a market to own your home in. Conversely, if the ratio is greater than 15 then it is a market to rent your home in.
For our purposes, for generating income from a rental property, the higher the price-to-rent ratio the more stable the market is. A desirable condition for earning passive income from owning a rental property.
In markets with high ratio’s the cost of ownership is significant and there is a broad base of residents looking to rent rather than purchase their own home. UPDATE: In January of 2023, in these same markets, there are no properties available in the price ranges listed below.
Benchmark Prices
The purchase prices used here are based on the Real Estate Board latest benchmark prices.
Averages
Monthly rental rates and property expenses are based on an average from three of each of listed rentals and listed sales. For example, in Vancouver three apartments listed for rent at $2100, $2950, and $2499 average to a monthly rent of $2516 for Property A.
Assumptions
We will assume that there is no mortgage or borrowing involved in purchasing the property that will be rented; and, that the tenant pays utilities.
Rental Property A
Property A Annual Return on Investment: 3.66%
Rental Property B
Property B Annual Return on Investment: 3.53%
We have come this far, let’s include San Francisco.
For San Fran we have taken three condos listed for rent and median purchase price from current MLS trend data. Additionally, we also confirmed availability and pricing of comparable condos in the same area for rent and sale.
Rental Property C
Property C Annual Return on Investment: 3.88%
Managing Risk In The Capital Investment
In all cases above, we have assumed the home was purchased outright with no borrowing. With this in mind, the exposure to ongoing loss of capital if your unit was left vacant is relatively low.
Ongoing expenses with zero income from a vacant unit range from 0.3% to 1.4% of capital invested in these three examples. Subsequently, for protection of this business venture, your emergency savings to ensure ongoing operation of the rental property is less than $7000 CAD per year in capital for all examples.
If you must mortgage to purchase a property generate passive income through renting, even with today’s low mortgage rates, your return on investment can become too low to justify the venture. After this, if you factor in inflation, and because future property value is unknown, this can become a losing proposition.
For these reasons I suggest that owning rental property in these markets is an advanced investment opportunity. Therefore, to be undertaken when your investment capital is large enough to diversify and eliminate expenses associated with purchasing the property.
Never hold more than 1/10th of your total portfolio in any single passive income investment.
Timing Matters
If you had purchased a home in these markets before the housing markets began their steep climbs in cost the return on investment would look much different. Therefore, timing of entering this portion of your investment portfolio is critical.
Do You Love What You Do?
This type of investment makes more sense to me if there is some future personal interest involved. If we say for example, your job takes you away from the area you want to live in when you retire. Then, purchasing your retirement property and earning passive income from that property while you work and before you retire adds a intangible benefit to this scenario. Win-win.
If this passive income stream was part of a portfolio with multiple streams of passive income it is a sound investment. You would need to be a good landlord and follow the rules. Incidentally, thsi means increasing your rent by the maximum amount each year. And, as you did this your return on investment should progress.
Potential Downside
While, future property values are unknown.
You must deal with the tenants.
And, your greatest risk is having a bad tenant who destroys your property.
This is the first aspiration of countries: we are the landlords in our countries so that they remain free, and we can live in security.
Marine Le Pen
Additionally, all of our posts in the Passive Income Series can be found here.
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