Anyone that has been reading my articles knows I love a regular home with a suite or a duplex property, and for over a decade I've been pretty faithful to these residential investments, but recently I have had my attention fixated on a more alluring beast, and that is multi-family investing (apartment buildings) and I have to say, I have a new obsession. It combines my favourite two aspects of real estate, Cash-flow and Value-adding, except it puts both on steroids.
Now before I start, many people may have already checked out after reading the headline. Apartment buildings? That's out of our league, or that's too risky! I'm here to challenge that limiting belief. For starters, obtaining a mortgage on a building that has been run like a business for years is surprisingly less challenging to finance with banks than a residential property. With residential they focus on the strength of the applicant. In multi-family lending they look at the strength of the building's financials.
In terms of risk, it may seem like because the numbers are higher that the risk is higher, but that couldn't be further from the truth. In an apartment building you have only one roof to worry about, one heating system, one property tax bill etc. There's an economy of scale here. For example, a roof for an apartment building is worth approximately $20,000. If you had 10 duplexes and had to do all 10 roofs you would be looking at closer to $100,000 in costs.
What about the risk of vacancy putting strain on your cash-flow? Consider that 5 of your 20 apartment units could suddenly vacate, and you would still be cash flow positive. If one side of your duplex vacates you are faced with an ugly negative cash-flow situation.
Risk aside, my favourite part about apartment buildings is that their value is based on the Net Income. More technically speaking, it is the Net Operating Income divided by the local, current CAP rate. A CAP rate is the expected return on investment for banks and investors. In the Okanagan Valley in 2014, banks are lending against a value that is based on a CAP rate of 6%. This is a fairly high overall yield as compared with larger centers like Vancouver, that only offer 2-3% CAP rates.
For example a building with a net operating income of $120,000/yr divided by a CAP of 6% is worth $2,000,000. Another way of putting this would be that an investor would have to invest 2 million of their own and the bank's capital for an income stream of $120,000 or 10k per month. Typically you would require 25% of your own funds and 75% bank financing. Read all the way to the last paragraph for a free e-book on raising money for a down payment.
So with that knowledge, how does an investor take something from being a solid investment and really turn it into a gold mine? I'm talking raising the value by as much as a million dollars in 2-3 years through a process called normalization. In simple terms, get the rents up to maximum market price and the expenses down as low as one can negotiate them. What happens once you start down this rabbit hole is about as exciting as anything you will find in the world of investment, period. Are you ready for it?
Here's the basic principal. $50 dollars added to the bottom line monthly, equals $10,000 in increased value. Pretty cool right? But don't forget that when you have 20 units that multiplies into $200,000!
So if $50 dollars/month equates to a $200,000 gain, then let's explore how an ordinary investor could profit $1,000,000 (tax free) by systematically going after the lowest hanging fruit over a 2-3 year period.
This is a case study of an average 20-unit apartment building in the Okanagan Valley. I prefer something built in the 1970's as many were built in that era. The reason this era provides for the best opportunity is that due to its age, you can count on the majority of the big ticket items like roof, windows and boiler systems having been upgraded in the past decade. Also, it is very likely that its current owner has not kept up with rental increases over the years and because they don't have debt on the building typically, they are not overly concerned with maxing out the rents. Often they are happy making their 100-120k per year off the building. Now in their 70s, they are ready to sell this investment and exit the landlord business. Here in lies the opportunity!
Our buying Criteria is a building where the current rents are approximately 100-150/mo low for an average unit compared to the market. You would be surprised at how often this is the case. When looking at the financials of a building look for things like utilities being included, which once eliminated can provide an instant increase in cash-flow of about $75/month per unit. That move alone adds $300,000 to the valuation. The other item we are looking for is a high expense ratio. This means that the expenses are high in relation to the Gross income. Anything 40% or higher is the sweet spot. Our job will be to lower expenses by at least 5%.
So here is a basic Income and Expense scenario for our hypothetical 2 million dollar, 20-unit apartment building:
- 20 Units with an average rent of 800/mo
- $192,000 Gross revenue
- $76,800 In expenses including utilities (40% expense ratio)
- Net operating Income $115,200
- Market Value based on 6 CAP equals $1,920,000
- Raise average rents to 950/mo
- Stop including utilities in rent
- Reduce remaining expenses by 5%
These objectives will take some time to complete (allow for 2 to 3 years to fully normalize a building) but trust me, it's well worth the investment of your time and energy. Now let's look at our investment after we've accomplished our three missions.
- 20 units at an average rent of $950/mo
- $228,000 Gross Revenue
- $55,860 Expenses (After utilities removed and 5% reductions on all contracts)
- $172,140 Net Operating Income
- Market Value based on 6 CAP is now $2,870,000
- Net Gain $950,000
Obviously this is a staggering profit, and anyone would kill to be part of something like this. The simple fact is, very few people will ever make the leap. I consult a very small group of investors on how to acquire, normalize and sometimes even further develop multi-family property. It's something I am deeply passionate about and have begun investing in myself. A few months ago I closed on my first apartment building and have another one pending as I write this.
The deal in the case study is only an example. You can find small 5-plexes for as low as $500,000. An 8-plex will run you about $900,000. A 12 unit building will be about $1,200,000.
A general rule of thumb for buildings with 10 units or more suggests you can expect to pay about $100,000 per unit. Slightly less as you go up in price (more economy of scale).
In closing I just want to point out that you should not let a lack of capital stop you from pursuing this dream. Raising investment money from people in your inner circle is very doable. Partnering with people to do multiple deals is as profitable and fun as any business venture.
If you reach out to me via email I will send you a free e-book titled "The Secret To Raising Money To Buy Your First Apartment Building". A great 27 page PDF that will get the ball rolling for you!
Just drop me a line at [email protected]
We all know someone who became a first generation millionaire during the last market cycle from 2001 through 2008. It doesn’t take impeccable timing, mountains of cash, or any uncanny business acumen. All it takes is a simple plan to follow and the discipline and guts to see the plan through. That’s it, there’s no magic here. Thousands of millionaires will be made right here in the valley in the next seven years, so let's make sure we’re on that list! So how do we ensure we aren’t on the sidelines this time around the merry-go-round?
The real estate market isn’t nearly as complex as we make it out to be. It does the same thing over and over, it goes Slump-Recovery-Boom! And then Slump-Recovery-Boom! And around and around we go. It’s also not hard to determine where we are in the cycle because we know what has already transpired. For example, we know that Kelowna Real Estate was in a slump from 2008 until 2013. We have all read the headlines by now that sales are up, inventory is down, and prices have started to head upwards. So what do you think might happen next?
So here is the plan, it involves purchasing five very ordinary houses in good areas that have legal suites. The suites are important, as without one, a house will rarely cover itself, let alone cash flow. The ideal property is three beds up and two down as these rent typically for $1500 up and $1,000 down in good areas bringing in a total of $2,500. The common two up, two down will work, it will just bring in about $2,100. Mortgage payments on a house like this will be $1,514 with 20% down, $1,703 with 10% down, and $1,798 with 5%. Each of these assumes a 25-year amortization and an interest rate of prime. As you can see, no matter how you finance these typical Okanagan homes, they will cover themselves and then some.
The additional cash-flow can be spent at your whim, used to pay down additional mortgage principal, or my favorite, wisely invested into the property to raise its value even more. I'm talking about new floors, paint, bathrooms, kitchens, this kind of thing. These little additional bonuses are not even considered in the chart below, neither are rental increases, but I don’t want to be too technical. So let's now take a look at a simple grid that shows what happens to our investments as we move through this next seven year recovery-boom phase.
So now it’s the year 2022, we’ve had a good run, factor in the down payments invested, we have a net worth in real estate in excess of 1.5 million. We could sell everything, pay some capital gains tax and be left with a little over a million dollars. Then we could sit on the sidelines and wait for a market correction, pick up great deals when no one else is buying, and put this whole plan on steroids when the market goes Slump-Recovery- Boom all over again. It would have been like having a million dollars cash back in 2009 and wisely buying up all the fire sales that were popping up all around you. Could you imagine what you would have done with a million in cash during the last big correction? Literally a fortune at your feet!
This article isn’t about hindsight however, it’s about foresight. Those that have it will be a millionaire seven years from now and a multi-millionaire 15-20 years from now. And all it takes is the first step.
If you’re a first time buyer, good news - you can start building your portfolio with 5 or 10% down. Those of you that are little more established will need 20% down. For this there are many options; borrow against your primary residence, or bring on a money partner, private mortgage, vendor take backs, the list goes on.
Now as an important side note, it’s crucial to choose a bank that will use rental income offsetting, so that each property you add to the portfolio doesn’t make the next more difficult to finance. I have found that TD is currently the most favorable to the investor when taking rental income into account.
I want to conclude this by noting that what you’ve just read is not inherently risky, anyone you know who has ever lost money in real estate, including myself, has done so by speculating on real estate. We are not speculators! We are investors, and we are hunting cash flow. It is this cash flow that recession proofs any portfolio, so that even if you decide not to sell off at the end of the next cycle, your investments will continue to be paid down and yield a return. I am speaking from experience on this. I followed this simple plan to create a seven figure net holdings in real estate the last time around, and I’m excited to do it all over again this time. It’s an exciting ride, I recommend being on it.
People lately have been asking me what the best place to put their investment capital and energy is now that the real estate market is showing signs of becoming a bull market again. This question is a challenging one to answer because there are so many variables. Not the least of which is a person’s risk tolerance.
A good flipper can hit 30-35% return on their cash invested and turn two or three properties a year, for annualized returns of up to 100%. However, this requires a lot of time, skill, and a fairly high tolerance for risk. In a flip there are just so many un-known factors to be considered low risk.
A person with cash-flow property goals can follow a simple 10 times rent multiplier rule and see returns of 20% on their equity. This is playing the long game. Cash flow is only one part of the equation as I’ve shared many times in previous articles. The true returns will never be known until it comes time to sell and you factor in your mortgage pay down (none of which came from you) and your market appreciation. A five year hold often produces overall returns that would rival the best flipper and the risk is much lower. It’s also far less effort to manage a duplex then it is to manage multiple, successful flips per year.
Now it may sound like I am steering you towards cash flow properties over flippers but in actuality I recommend a healthy mix of both. In my own real estate journey I’ve always tried to use the capital from one to fund the other. This can work in either direction because both require adding value to the property whether it be to flip, or to hold.
My previous article about how far 100k could take an investor seemed to resonate with a lot of people, so consider this a continuation of that train of thought. 100k invested into a duplex around 450,000 in need of some renovations, would be a great place to start.
*Bring its value up to $550,000 by finishing basements or upgrades and re-capture your 80k on a line of credit.
80% of 550,000 = $440,000
Current Mortgage $360,000
Available Equity = $ 80,000
Now take this 80k and buy a 250k townhouse and put 20k into it to create a nice, 320k resale property. When the smoke clears you will have your 100k back in the till and should be looking to add another holding property to the portfolio.
This system will work until the banks decide that they won't give you any more mortgages, which will happen at about the five properties in your name level. This makes absolutely no sense, but banks seem to prefer rookie investors to professional ones - go figure. At that stage it's time to go multi family (5 units or more) and then you deal with the commercial department of a bank and it’s a whole new ball game. More on that in my next article!
So for now if you are stuck and want to know where to start, feel free to reach out, I’m always happy to help people gain control of their finances and income through the exciting world of real estate investing. There truly is nothing like it in the world. Show me another investment or stock that you can choose to add value to whenever you want, you can live in it, you create a home for someone else. You can borrow against it, subdivide it, farm it and on an on it goes. It really is in a league of its own and that is why I live, breath eat and sleep this stuff.
Do you want the secret for how I find such amazing positive cash flow rental properties? Well this month’s article is all about one shockingly simple formula that once you're tuned into, things become almost ridiculously simple.
The simple rule I am referring to is the 10 times rent-multiplier. The best part of this formula is how easy it is to do in your head, which allows you to instantly analyze the positive cash flow potential of any Kelowna property for sale, anywhere. I will share 10 great examples of properties that fit this formula to eliminate any doubts that you may have.
First let me explain the formula;
Take the annual rental revenue for a Kelowna investment property for sale, and then multiply it by ten. That’s it, the entire formula! The number you now have is what you want the property price to be equal to or awfully close to if you are considering it as an investment property. For many people especially ones that have rental property that falls way outside this rule of 10 don’t leave me just yet, please allow me to show you some real world examples:
1. 5-plex in Enderby listed at $369,000
- rents are 36,000/year
- $36,000 x 10 = $360,000
- Net cash flow = $ 1004 /mo
2. 5 bed House with legal suite purchased at $312,000
- rents $31,000/yr
- $31,000 x 10 = $310,000
- Net cash flow = $ 981 /mo
3. Condo at Discovery Bay listed 339,000
- Rent $35,000/yr
- $35,000 x 10 = $350,000
- Net Cash-flow = $1083 /mo
4. Half Duplex with in-law suite purchased $240,000
- rents are $24,000
- $24,000 x 10 = $240,000
- Net cash flow = $810/mo
5. 2 bed Condo in Alexis Park Purchased $70,000
- rents are $7,200
- $7,200 x 10 = $72,000
- Net cash flow $318/mo
6. Side by Side duplex with in-law suites purchased $484,000
- Rents $48,000/yr
- $48,000 x 10 = $480,000
- Net Cash flow $1398/mo
7. Side by side duplex in Rutland purchased $360,000
- rents are $36,000
- 36,000 x 10 = $360,000
- Net Cash flow $1107/mo
8. House in Phoenix Arizona purchased for $160,000
- rents $16,500
- $16,500 x 10 = $165,000
- Net cash flow $527/mo
9. Condo in Scottsdale purchased for $118,000
- rents $12,000
- $12,000 x 10 = $120,000
- Net Cash flow $ 456/mo
10. House in Fort Mac Murray listed for $750,000
- rents $72,000
- $72,000 x 10 = $720,000
- Net cash flow $2065/mo
The last few I included to illustrate the point that things fall into this factor of ten in all the hottest markets you've been hearing about, up north or down south. Most people are led to believe that these fabulous positive cash flowing investments are only if you are brave enough to invest someplace far far away. I’m here to tell you that the above examples are all real, and there are dozens more I could share with you. The bottom line is, they exist and with bank rates now under 3% for fixed term mortgages, the cash flow picture keeps getting sweeter. Let me illustrate for the fellow number geeks out there:
$360,000 Purchase price
$ 72,000 invested in cash
$ 2,400 taxes
$ 1,400 insurance
$ 1,440 Vacancy (4%)
$ 2,160 Maintenance (0.6%)
$ 14,200 Net cash flow
$ 6,000 mortgage pay down
$ 20,200 per year in profit
Buy and hold this property for 5 years and let's see what we get for results:
- Mortgage reduction $32,084
- Positive Cash-flow $72,000
- Total gain $104,084
- Gain is 70% without factoring in any property appreciation.
Now this is obviously an overly simplified way of valuating a rental property, the long handed way of doing it, is to take the net operating income and divide it by prevailing market CAP rates at the time. This requires a thorough analysis from your professional Kelowna Realtor once you’ve decided to pursue the property.
For an updated list of Kelowna real estate for sale that cash flow well from day one please don’t hesitate to reach out us at any time.
Read more Investment Real Estate articles
- 5 Deadly mistakes house flippers make Mar 21
- 2013 review: What worked...what didn't Feb 2
- How far can $100,000 get you? Jul 19
- Top ten landlord tips May 11
- The 'L' word Mar 26
- Rent to own, good or bad? Feb 22
- Waking the Dead...Equity Jan 15
- Real estate - listen to the pros! Oct 19
- How does today's 30 year old retire at 55? Aug 13
- Flipping 101 - Is it time to quit your day job? Jul 20
(Click for RSS instructions.)