Buying a rental property is one of the most common wealth-building strategies. However, the reality is that just because a property looks appealing on this page does not mean that it is a smart investment. Some properties lose money faster than they make money, while some properties appear expensive at the outset but will be a long-term win. So how to assess if a property is worth the investment?
This post breaks down the fundamentals of how to assess if a property is worth the investment. Along the way, you’ll see real-world examples, hear cautionary stories, and get practical steps you can use whether you’re buying your first rental or expanding your portfolio.
Start With Rental Income Potential
The first step is figuring out how much rental income the property can generate. Relying on the seller’s claims isn’t enough. Look at current rental listings in the same neighbourhood. Compare by size, number of bedrooms, condition, and amenities.
For example, if a two-bedroom condo down the street is renting for $2,200 a month, if you are targeting a similar condo, expect the same. If the average rent is $1,800, and you are planning on $2,500 to make the deal work, that is a bad sign.
Practical takeaway: Always validate rental income potential with real market data, not pie-in-the-sky, happy thoughts.
Don’t Forget the Expenses
Income tells part of the equation as an investment. Depending on how much of the rental income goes to expenses, it reflects the worth of the property as an investment.
- Mortgage payments: principal and interest
- Property taxes: varies by city and property type
- Insurance: higher for rentals than owner-occupied homes
- Repairs and maintenance: from leaky taps to roof replacements
- Property management: if you hire outside help
- Vacancy allowance: money set aside for months without tenants
Consider this analogy: owning a rental is like running a small business. Revenue is your rent; expenses are all the bills that keep it running. What matters most is the profit left at the end of each month.
Practical takeaway: Calculate every recurring and potential cost. Overlooking even one major expense can turn projected profits into losses.
Key Metrics to Judge Investment Quality
Once you have income and expenses you can apply two simple metrics that you could use, and they are some of the basics for others to rely on in investing.
- Cash Flow: the monthly profit, after expenses. Positive cash flow means that the house is paying you. Negative cash flow means that you are subsidizing the property.
- Cap Rate: net operating income (NOI) divided by the purchase price. which is a house in your ownership.
- Cash-on-Cash Return: You take your annual pre-tax cash flow and divide it by the cash you invested (down payment, closing costs). This gives you an idea of how effectively your money is working.
For example, let’s say you purchase a property for $100,000 and it makes $7,000 per year in net cash flow, your cash-on-cash return is 7%. Your rental income and appreciation potential will be closely tied to where the property is located.
Practical takeaway: Learn these metrics and practice calculating them. They’ll help you compare properties objectively, not emotionally.
The Power of Location
There’s a reason the old saying “location, location, location” is repeated endlessly. Rental income and appreciation potential are tied closely to where the property sits.
Now think of two identical duplexes, one of which is located next to a transit hub that has a steady job and economic growth year over year, while the other is located in a town that is becoming obsolete and has a declining population. Even if the second is obviously the cheaper option, the first will perfectly hold its value, attract tenants, and ultimately return money because of its location.
Practical takeaway: Look beyond the property itself. Study the neighbourhood, vacancy trends, job market, and future development plans.
Case Study: The Hidden Costs Trap
Let’s look at Ravi, who purchased a triplex that was over a century old because it “looked cute” and was priced lower than anything else on the market in the area. He became caught up in the excitement and did not factor in the costs associated with maintaining a property that was older. In the end, over his 2-year ownership, he ended up spending $25,000 on replacing the roof and upgrading plumbing while regularly addressing issues as they arose. These things have to be appropriately factored into the budget remodel.
Practical takeaway: When considering properties, keep the age and condition of the property in mind. It is not unsurprising for properties to be priced lower for a number of reasons.
Stress Testing Your Numbers
It is also important to understand no matter what you believe will happen, larger shifts in the market could easily throw off your projections, such as rates going up, tenants moving out, or major unexpected repairs.
Ask: What if a property decreases its rental prices by 10 percent or vacancy doubles? If the property is still making break-even results, the property seems that much safer.
Practical takeaway: Make sure you are always running numbers in these scenarios before you purchase any property.
Thinking Beyond Monthly Cash Flow
Although having a monthly income is very important, do not lose sight of wealth accumulation over time. Sure, some properties will provide reasonably small monthly cash flow but appreciate significantly over time, providing equity growth. Others will provide strong short-term income cash flow but may not appreciate much in the long term given the lower price point.
Take Toronto and Hamilton as a note. In Toronto, for example, an investor may be more comfortable with a rental property cash flow return at lower rental yield levels due to high property prices making it more difficult to achieve more than just acceptable cash flow at the end of the month. Many invest with the thought that long-term appreciation will outweigh small margins today when investing in cash flow property.
In Hamilton, the opposite is very often true, where property prices are considerably lower relative to one another compared to Toronto, but the rental demand is still very strong, driven by a growing population and increasing transit connections, which lends itself to healthy rental cash flow potential. There have been many investors who believe that investing in a city like Hamilton for both stability and income properties has become a more attractive option familiar to many investors on the Toronto side of things as refugees settle and live in Hamilton for employment.
Practical takeaways: Decide if you are investing for income, growth, or potentially focused on something in between. Cities like Hamilton can sometimes capture the sweet spot of affordability, tenant demand, and
future appreciation.
Pulling It All Together
A rental property is an investment; therefore, running property numbers isn’t about guessing or hoping but about understanding how they look and weighing the risks of short- and long-term returns.
Think about location, condition of the property, and long-term potential for appreciation.
To recap:
- Start by verifying rental income with real market data.
- Account for every possible expense, not just the obvious ones.
- Use key metrics like cash flow, cap rate, and cash-on-cash return to compare properties.
- Factor in location, condition, and long-term appreciation potential.
- Stress test your assumptions to see how strong the investment really is.
Final takeaway: A rental isn’t just a newer used house or condo. It’s a business so treat it like a business and see the differences. You’ll make clearer and more profitable decisions.
Final Thoughts
Knowing whether to invest in a rental property or not is the key to successful real estate investing. It’s what separates investors who are successful from those who will lose. Perfection isn’t the goal; preparation is,
doing the work up front so you are not surprised.
