Last week in Home Cents, I wrote about how to turn your home into an income property. My focus was managing a property renovation on a budget. But, as several readers accurately pointed out, rental units come with a lot of regulatory red tape.
If your rental unit isn’t up to code, you may not get a return on your investment when you try to sell your house. Likewise, if you’re in the market for a home with a rental unit, it’s important to make sure it’s a legal addition or it could affect your financing.
Raymond Leclair, a real estate lawyer and vice-president of insurance company TitlePLUS, agrees with readers that adding a rental suite, or buying a home equipped with one, requires a lot of homework. “Basically, people think it’s much easier than it really is. There are some real pitfalls.”
Sixty-nine per cent of Canadian homeowners think owning a residential rental property or renting part of their home is a good investment, according to a 2008 Harris/Decima study. But before homeowners and buyers put their money on the line, here are some tips each side should keep in mind.
For homeowners:
Learn the rules. If you want to build a rental suite in your home, start with a visit to your local municipality office. There are multiple provincial and municipal laws in place to determine whether an apartment is legal or not, but your municipality should be able to tell you the steps involved and help you obtain a building permit.
Among the considerations for adding a legal apartment to your property are setback from the edge of the property, parking allocations and minimum square footage requirements. Before a unit can be considered legal, it must also have fire separation between dwelling units and each of those units must have a means of escape, fire alarms and safe electrical wiring.
Mr. Leclair recommends researching the rules on your own, rather than asking your contractor. “Not all contractors know what the requirements are. They’ll provide the construction work, but may suggest you do it without a building permit or won't check the zoning to make sure it permits that kind of a use.”
Make sure you can handle it. “Handling tenants is not the easiest thing and not everyone has the stomach for it,” Mr. Leclair says. “Go over not just the legalities, but the practicalities as well.”
As a landlord, you’re on the hook to keep your rental unit in good condition. Avoid necessary repairs and you can lose the rental income you’re depending on. Tenants can obtain a rent freeze if their rental unit is not being well maintained – if it has crumbling balconies, for example. Don’t count on raising the rent whenever you want either. Rent increases can only be taken once a year and if property taxes go down significantly, rent must be lowered in proportion.
For buyers:
Check documentation. Many first-time home buyers have an interest in homes with a rental suite because they can acquire a larger mortgage, according to Heather Paterson, a mortgage broker with Invis. “The most important thing to keep in mind if you need the rent income in order to qualify for the mortgage amount is it needs to be a legal apartment.”
Some lenders will apply as much as 80 per cent of the monthly rental income against the monthly mortgage payment when approving a buyer for financing. That means if you expect to rent an apartment for $1,000 per month, you can add an extra $800 of income to your mortgage application. However, the bank will only approve the income if you can prove that the retrofit was done to regulation.
If a property is zoned as a single family dwelling and the owner has renovated it to contain an income property, there should be documentation to prove it, Ms. Paterson says. If the rental unit is not legal you can still use the income, but you won’t qualify for a higher mortgage based on that income.
Involve your real estate lawyer. Mr. Leclair often hears from eager buyers that secured a mortgage based on income from the rental unit and have made an offer on a home only to discover the apartment is illegal. “Sometimes you find out and it’s too late.”
Involve your real estate lawyer as soon as possible in the process, he advises. Tell the lawyer that you’re looking for a property with a rental component. “If you don’t do that step and sign an agreement, you’re already on the hook to buy. You may be in a situation where you lose your mortgage commitment and you’re stuck with the obligation.”
A real estate lawyer may be able to put clauses into your offer that that will give you the option to back out of the contract if you can’t confirm the legality or compliance of the unit.
Mr. Leclair suggests using a local lawyer that is familiar with the regulatory landscape for rental properties in the area.
Despite all the cautionary words, generating an income from your property is likely to remain attractive in our hot real estate market. And it could make a good long-term investment. As Ms. Paterson says, “It really increases your resale value if you do it right the first time.”
