20 Year Investment Story - Basement Apartment
Renting out a basement apartment in Toronto can be a lucrative investment, especially if you’re prepared for the initial costs and committed to long-term growth. In this blog, we'll explore the potential earnings from renting a basement apartment over 20 years, factoring in a startup cost of $75,000, annual rent increases, and the impact of investing rental income in the stock market with an 8% average annual return. We’ll also calculate how long it would take to recover your initial investment and determine the overall Internal Rate of Return (IRR).
Calculating 20 Year Increase in Wealth
1. Initial Setup Costs: $75,000
Before you start earning rental income, you’ll need to invest in setting up the basement apartment. These startup costs could include renovations, permits, and any necessary upgrades to make the space livable and legally compliant. For this analysis, we’ll assume a total startup cost of $75,000.
2. Starting Monthly Rent: $2,000
Let’s assume you start by renting the basement apartment at $2,000 per month. This translates to an annual income of $24,000.
3. Annual Rent Increase: 2%
We’ll assume that rent increases annually by 2%, which is a typical rate aligned with inflation in Canada. Here’s how the rent and cumulative income would develop over 20 years:
| Year | Monthly Rent | Annual Rent | Cumulative Rental Income |
|---|---|---|---|
| 1 | $2,000 | $24,000 | $24,000 |
| 2 | $2,040 | $24,480 | $48,480 |
| 3 | $2,081 | $24,970 | $73,450 |
| 4 | $2,122 | $25,469 | $98,919 |
| 5 | $2,165 | $25,978 | $124,897 |
| 10 | $2,430 | $29,158 | $258,864 |
| 15 | $2,740 | $32,882 | $432,314 |
| 20 | $3,091 | $37,092 | $642,703 |
---
By the end of 20 years, the cumulative rental income would be $642,703.
Recouping Your Initial Investment
To determine how long it would take to recover the initial $75,000 investment, we’ll look at the cumulative rental income over the first few years:
- Year 1: $24,000
- Year 2: $48,480
- Year 3: $73,450
- Year 4: $98,919
By the end of Year 3, your cumulative rental income would be $73,450, which is slightly below the initial investment. However, by the middle of Year 4, you would surpass the $75,000 mark, meaning it would take approximately 3.5 years to recoup your initial investment.
Investing Rental Income in the Stock Market
Now, let’s consider the potential earnings if you invest the rental income in the stock market, with an average annual return of 8%. We’ll assume that you reinvest the rental income monthly.
1. Monthly Investment
We’ll start by investing the $2,000 monthly rent, and as the rent increases, the investment amount will also increase.
2. Compounding Growth Over 20 Years
Given the monthly rental income and an 8% annual return, here’s how your investment portfolio might grow over 20 years:
| Year | Monthly Rent | Annual Investment | Investment Growth (End of Year) |
|---|---|---|---|
| 1 | $2,000 | $24,000 | $24,962 |
| 2 | $2,040 | $24,480 | $52,497 |
| 3 | $2,081 | $24,970 | $83,731 |
| 4 | $2,122 | $25,469 | $118,922 |
| 5 | $2,165 | $25,978 | $158,354 |
| 10 | $2,430 | $29,158 | $388,243 |
| 15 | $2,740 | $32,882 | $718,817 |
| 20 | $3,091 | $37,092 | $1,231,131 |
---
By investing your rental income monthly, your portfolio could grow to approximately $1,231,131 over 20 years.
Calculating the Internal Rate of Return (IRR)
The Internal Rate of Return (IRR) is a measure used to evaluate the profitability of an investment. It’s the discount rate that makes the net present value (NPV) of all cash flows (both inflows and outflows) equal to zero.
1. Cash Flows
- Initial Investment (Year 0): -$75,000
- Annual Rental Income (Years 1–20): Starting at $24,000 and increasing annually by 2%.
The IRR calculation considers the initial outflow of $75,000 and the annual inflows from rental income.
Given the cumulative rental income and the compounding investment growth, the IRR for this investment would be approximately 14% over 20 years. This IRR reflects the combination of direct rental income and the compounded returns from investing that income in the stock market.
Total Potential Earnings Over 20 Years
Finally, let’s summarize your potential earnings:
- Total Rental Income: $642,703 + Investment Growth: $588,429
- Total Potential Earnings: $1,231,131
After accounting for your initial $75,000 investment, the total net earnings would be $1,156,131 over 20 years.
Additionally, the $75,000 investment will increase the value of the property at an exponential rate, ranging from $150,000 to $200,000.
Conclusion
Investing in a basement apartment in Toronto could yield nearly $1.3 million over 20 years when considering rental income, compounded investment growth as well as increased property value. With a startup cost of $75,000, you could recoup your initial investment in about 3.5 years, with an overall IRR of approximately 14%. This highlights the strong potential for real estate investments when combined with disciplined, long-term investing.
If you’re considering renting out a basement apartment, understanding the long-term financial benefits and planning your investment strategy accordingly can help you maximize your returns and achieve substantial financial growth over time.
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