Investment Property in Canada: Types, How to Buy & Taxes

An investment property is a real estate purchased to earn a return on investment. Real estate investing can provide two types of income: rental income and income from capital gains. Investment property can be held by an individual, a group of individuals, or a corporation.

There are three distinct strategies how to invest in real estate:

• Property Rental (Long-Term)
• House Flipping (Short-Term)
• REITs & Related Financial Products

Property rental offers a long-term consistent income from the rental income and a one-time capital gain or loss at the time of sale. House flipping offers a one-time payoff after short-term work to fix and renovate the property. Real Estate Investment Trusts (REITs) and other financial products, such as REIT ETFs, allow investors to own professionally managed investment properties via the stock market.

Real estate investment offers the potential for two types of gains: rental income and price appreciation. To generate rental income, you must purchase and lease a property. To generate capital gain, you must purchase a property at a low cost and sell it at a higher price. You can also get both incomes using various real estate investing strategies, such as BRRRR, or simply renting your investment property out before selling it.

Before you purchase an investment property, you should ensure that the property you are buying matches the chosen investment strategy. It may be worth flipping a large house in a suburban region in Canada, but it may be better to own a rental property in a large city with a strong rental market. You can look for a property by yourself using various services such as Realtor.ca, or you can work with a real estate agent to find the property.

Once you find the property you want to purchase, you must decide how to finance it. Most properties in Canada are purchased with a mortgage, and getting a mortgage may be one of the hardest steps in buying an investment property. Ideally, you should get a mortgage pre-approval before looking for a property, but you can also finance your property once you find the right one.

A rental property is best for locations with low vacancy rates. A recent Canada Mortgage and Housing Corporation (CMHC) report shows that current vacancy rates are historically low across Canada. In 2023, purpose-built rental houses had a vacancy rate of 1.5%, with an average monthly rent of $1,359 for two-bedroom units, while the vacancy rate for condominium apartments was 0.9%, and the average rent for two-bedroom units was $2,049. This data shows that national vacancy rates are at historic lows in Canada, meaning residential units can easily be rented out.

National data suggests that renting out a residential unit in Canada would be easy on average. On the other hand, rental markets are very local, so local vacancy rates can drastically differ between different regions. Before making any investment decision, you should check the vacancy rate in the specific area of your interest.

Statistics of Rental Condominium Apartments in Major Canadian Cities in October 2023

Source: Rental Market Survey (CMHC)

Rental property purchases are typically considered long-term investments, so future rental demand is an important factor to consider. Generally, an increasing population increases rental demand. In many developed countries, low birth rates and an aging population result in a declining population.

Canada's relatively high immigration levels outweigh the low birth rate, resulting in a growing population. At the end of 2023, Canada's population stood at 40,769,890, representing a healthy annual growth rate of 3.2%. There are indications that immigration to Canada will continue, further driving population growth and housing demand.

It's important to note that immigrants are not distributed evenly across the country. Approximately 80% of immigrants go to three provinces: Ontario, British Columbia, and Quebec. There is also interprovincial migration that shifts the population from Ontario to Alberta.

Migration also occurs inside provinces, so it is essential to consider population changes that might happen where you are investing. To see how far the regional population can deviate from national levels, consider Wabana, a town in the province of Newfoundland and Labrador. At its peak around 1959, Wabana had a population of nearly 12,000. Currently, its population is close to 2,000.

Job creation is the most important driver of population growth, while job destruction is the most important driver of population decline. So, to predict changes in the local population, you can study the local job market. Retirees and those who work remotely can choose their residence independently of the job market. Thus, the quality of life in an area, which includes security, weather, and affordable housing, can also affect changes in the population.

If you flip a house, you should consider how easy it is to sell the property in your area. Days on the Market (DOM) may be a good metric to estimate how easy it would be to sell a property there. DOM is the average number of days a property takes to sell after it is listed.

Another indicator that one can use to judge how easy it is to sell a property in a market is the months of inventory. The months of inventory metric measures how long it takes for the current number of houses to sell at the current rate of sales activity.

A popular and often profitable strategy that simultaneously aims to maximize capital gains and rent is called BRRRR (Buy, Rehab, Rent, Refinance, Repeat). This strategy aims to maximize rental income and capital gains income in the same strategy.

The BRRRR is an abbreviation for the steps needed to execute the strategy:

Buy: Buy the investment property. It should be located in an area with a low vacancy rate and require repairs and renovations to increase the house's value.

Rehab: Repair and renovate the house. This step should increase the house's value by more than the cost of repairs.

Rent: Once your investment property is renovated, you can find tenants to rent it out.

Refinance: Your house value increased after repairs, so you can do a cash-out refinance to pull cash against your home equity. You can use the projected rent to supplement your income for the refinance requirements.

Repeat: Once you have cash for the down payment, you can repeat this strategy with another property.

A good planner always has a plan B, and this is especially true in investing. The natural plan B for a rental investment is to flip, and the natural plan B for a flip is to rent out. So whether your strategy is to flip or gather rent, it is best to find a property that is simultaneously suitable as a flip and a rental.

Rental income is considered income tax. A rental property owner has to pay income tax on their net rental income, just like their employment income. Tax on the rental income considers the Net Rental Income as the base for the calculation.

Rental income is all the rent you have received from your tenants. Rental expenses are all costs that you incur when renting your property. Common rental expenses include property taxes, landlord insurance, interest on the mortgage for rented properties, and depreciation. The amount of depreciation you can claim each year is known as capital cost allowance.

A real estate investment often ends with the sale of investment property. You can determine the capital gain you have made by subtracting the adjusted cost base from the sale proceeds to calculate your capital gain.

Income tax law treats capital gains more favorably than other forms of income. Only 50% of Capital Gains have been taxed over the last two decades. The Capital Gains tax may change in the future. Recently, a caveat has been added to this favorable treatment of capital gains for real estate investors.

In 2021 and 2022, Canadian houses became extraordinarily unaffordable, and flippers share the blame. Thus, the government changed the rules to consider any capital gains on houses sold less than a year after their purchase as business income. This new rule has been in effect since January 1st, 2023.

Principal Residences are exempt from capital gains tax. The principal residence is the main home a homeowner lives in. For many people in Canada, principal residence is their largest investment. If your principal property appreciates enough, you can sell it and purchase multiple properties on the proceeds in a cheaper area.

If you want to purchase your first property, you might get some financial help from the government to become a principal residence owner, which may provide you with valuable information and financial support.

For a flip, you can divide the capital gain by the initial investment and multiply by 100 to derive the operating profit margin. To compare this profit with other investments, you can annualize the result. For rental investments, you can use the cap rate as a measure of profitability. Before any investment, projecting all your cashflows and calculating the internal rate of return is very valuable. Repeating this practice after the investment helps you keep the score.