Case Study: Owning Rental Properties in Montreal, Quebec

By: Laura Sehn

November 2006

Jill and Bill, at age 48 and 47, began researching the possibility of purchasing rental properties in Montreal, the city in which they have lived their entire lives. There were several factors that influenced their decision to invest in real estate. Between the 1970s and the 1990s, the political situation of Quebec led to a mass exodus of Anglophones from the province. For many years, the Smiths were also uncertain if they would remain in Quebec, but when Bill received permanent rather than contractual work, the decision was made that Montreal is where they will continue to live. This peace of mind allowed them to begin thinking of ways to invest their money and plan for their retirements. The Smiths were looking for an alternative to the stock market, with its unpredictable fluctuations and unreliable returns. The real estate market, on the other hand, was much more stable, and they knew the potential benefits from personal experience: Bill’s grandfather had actually invested in real estate in the mid-twentieth century throughout Montreal in booming locations such as on St-Catherine Street and St-Laurence Boulevard.

In the meantime, Jill was very interested in the architectural heritage of Montreal, and in the year 2000, went on an historical and architectural tour of a district called St-Henri (which can be seen from above from highway 720 as you approach the downtown). This currently very residential area was rich in history and was undergoing gentrification. This process, however, led property owners to sell their run-down buildings for unreasonable prices, which would take away from the potential annual rent income. Also, as Jill and Bill spent more time in St-Henri, they learnt of some current negative social conditions: the drugs, the crime, and the arson. After several months of research and two unsuccessful offers, they decided to abandon the idea of St-Henri. Throughout this process, however, they had gained much experience in evaluating opportunities, bidding on revenue properties, and learned that the best value was in six-plexes.

An agent that they had been working with recommended looking in Verdun, another district of Montreal, just west of St-Henri. Verdun is an area that began developing, in its unique style, in the 1920s when Montreal received a huge influx of immigrants and rural Quebecers. In Verdun, street after street, there are rows of six-plexes typically owned by absentee landlords—just what the Smiths wanted. These buildings that were for sale were newer and in better condition than those in St-Henri, which meant less maintenance would be needed upon purchase. Also, the ratio of asking-price to return was quite favorable, due to the low asking prices they were encountering. These lower prices were the result of a negative perception of the neighborhood that developed in the 1990s. Bill, having worked in Verdun for several years was familiar with the area, and believed that it was on the verge of an upswing. He predicted that Verdun would soon follow in the path of St-Henri as a sought-after neighborhood for Montreal’s hot tenant market.

In 2001, Jill and Bill made the decision to start buying rental properties in Verdun. At this time, there was an abundance of properties available due to the localized economic slump, which also had the effect of keeping selling prices down. Many sellers had been on the market for long periods of time and were eager to sell—a perfect opportunity for the Smiths to buy. Because of the large supply of buildings for sale, the buyer had the upper hand in negotiations and was able to buy for much less than the asking price, and in some cases, even less than the low municipal evaluation price. With these desirable conditions, the Smiths began visiting many six-plexes. They developed a spreadsheet that they used to evaluate which properties had the best values. They also looked for the buildings that had the potential for rent increases, and avoided buildings that seemed to have delinquent tenants, since Quebec’s rental board laws make it difficult for landlords to evict them.

Fig. 1: Example of “plex” buildings in Verdun. A six-plex would be slightly wider than this triplex.

They worked with a real estate agent that was very knowledgeable in building construction, managed seven rental properties herself, and who was a great negotiator. However, she was still a real estate agent and would be willing to sacrifice the ultimate benefit of her client in order to make a sale. Bill, who is also very knowledgeable in buildings, and a great negotiator, had to be vigilant and remind the agent on several occasions that she is working for them and that she must push for a better deal.

At the same time, Jill and Bill were conducting another search, but this one was for banks. They met with lending agents at six different banks trying to find one that would give them the best mortgage rates. They were successful and found a bank that offered them a 25-year amortization period at a rate of 6.3%. With everything in order at the bank, the Smiths purchased two six-plexes at once, one for $163,000, and the other for $185,000, at an average price-to-revenue ratio of 5.5. Although there were other initial costs, such as inspections, notary fees and welcome taxes, the down payment of only 25% allowed them to purchase these two buildings at the same time. Since their own home was debt free, they took out a mortgage on their home for the purpose of investment and were able to use the interest payments on this loan as an income tax deduction.

At the end of the first year, after considering additional expenses for insurance, taxes, maintenance, and a 1% vacancy rate, they still saw a profit of $18,126. The following year, they purchased a third six-plex for $145,000, at a very favorable ratio of 5.1. This purchase put them in greater debt, but generated a greater annual income of $24,652. In the third year, they decided to purchase a fourth six-plex, but by doing this the bank considered them to be “Real Estate Operators” and increased the required amount of down payment to 35%. However, the incomes generated from the buildings from the previous years, along with refinancing their mortgage to a rate of 4.9%, allowed Jill and Bill to purchase the fourth six-plex while the prices were still reasonable. This property was purchased at 7 times the annual revenue. By this time, the prices were already increasing as more investors were purchasing in the area and as interest rates fell. However, the ratio of purchase-price to return still provided a good investment. Their fourth building was bought for $252,000, and gave them a total annual return of $54,173.

In 2001, the Smiths had taken a risk and begun purchasing rental properties, not knowing for sure how great the returns would truly be. If their money was currently sitting in a bank, the return from the interest of just a few percent could not even compare to the approximate 20% annual return they currently receive.

For the complete financial analysis of the five years that they have been involved in the real estate investment business, see Annex 1.

Although a great addition, a 20% return on their investment is not enough annual income to live comfortably. Managing these four rental properties is a part-time activity for the Smiths, in addition to their full-time careers. They work with a local, affordable, and trustworthy maintenance man that takes care of most of the buildings’ maintenance and renovations, and who is available in case there are emergencies at the apartments. The four buildings are within a few blocks from each other, and from Bill’s work, which minimizes the time it takes to collect rent and to reply to tenant needs and solve problems when they occur. The care they took in strategically choosing the buildings clearly has added to the total benefit of their investment. The Smiths have stated that it would be unwise to purchase more rental properties at this time because prices are too high, but also, managing more properties would become too time consuming and would take away from other aspects of their lives. This decision, however, will be reevaluated over the next few years, as rental property prices are expected to decline.

Although most of Jill and Bill’s experience so far has been very positive, they have been faced with some obstacles. The most reoccurring one is definitely having to deal with delinquent tenants. It seems to be a problem in Verdun that some tenants simply don’t respect their obligations, and the apartments in which they live. It is a very low-income neighborhood and most of the residents do not have much education. There have been several cases where the Smiths have had to take tenants to court in order to evict them and collect money. However, as the years go on, they are becoming more familiar with the process of selecting tenants, and are having fewer problems.

One potential risk of this business, that they have not yet experienced, but could arise, is an increased vacancy rate. The Smiths have been very fortunate with the current economic situation of Montreal, and Verdun in particular, and have only experienced an approximate vacancy and non-payment rate of 1%. However, these desirable conditions could easily change, resulting in less annual revenue. Another potential risk is increased mortgage interest rates which would add to the annual expenses. They would counter this eventuality by reducing the amount of mortgage debt in order to maintain a suitable profit level.

Nevertheless, these minimal drawbacks are definitely outweighed by the financial benefits. The extra income has given them the freedom to live a more comfortable lifestyle, and will provide them with a steady income when they retire. Jill and Bill were extremely wise to purchase the six-plexes when they did, just before property values of Verdun increased, as today, their buildings are worth double their purchase-prices. Their strategic approach to the real estate investment business has proven successful by the high annual returns, and their increasing experiences, both positive and negative, will absolutely guide them to greater successes in the future.

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