The phone as of late has been ringing off the hook with investors looking to claim their piece of the inclining real estate market that we are experiencing. On the surface this is a great thing. The problem is that everyone has the same idea, thanks in part to the plethora of HGTV flip shows we see. Everyone wants to quit their job and flip homes for a living. Now I believe that this is entirely possible in certain markets, particularly the buyers market we just came through. Two years ago you could negotiate a great deal with an anxious seller. Now the market has shifted to the advantage of the sellers, homes sell quickly and for top dollar, often for bidding wars as inventory has dipped to near 2007 levels.
A successful flipping venture requires you to find a distressed property and purchase it at a deep discount. You then must renovate and control your costs to eventually sell at a new premium. The challenge now, is that anything cheap goes into multiple offers and contractors if you can find them at all, don’t do anything “for cheap”. This makes executing on budget and on time a real challenge. Again not impossible, you are just swimming against the current.
That aside, I want everyone reading this column to understand that you don’t flip your way to prosperity. Anyone who has created serious wealth through real estate has done so by holding properties that cash –flow. Now here comes the good news, this market that may not be so great for flippers, is a hell of a market to be a landlord in. In Kelowna, you have near a zero vacancy rate, which means you can have your pick of quality tenants willing to pay premium rent for decent units and you have mortgage rates that just got even lower making your mortgage payments well below what you can rent for.
"But AJ, I want to showcase my amazing design skills" you say, "I want the big before and after reveal." No problem, buy a home that needs your TLC, showcase your design skills and impress the heck out of your friends, realtor, appraiser and most importantly the lucky tenant that will occupy the property for the next few years.
With a buy fix hold strategy, you still profit from your hard work, in fact you get even more sweat equity, because you don’t pay real estate commissions or capital gains tax. All of the value increase would be immediately available to you on a line of credit.
Let me illustrate:
You purchase a 5 bedroom home on a decent street for $400,000 with 20% down you invest $80,000 of your hard earned savings into the property when you purchase. You wisely spend $20,000 on the home updating floors, paint, trim, fixtures etc and raise the value of the home to conservatively $450,000. This is doable even if you paid market value for the home on the way in. This may sound like a profitable flip, but If you sold now you would at best break even after fees and carrying costs. A better plan is to hold and utilize a STEP mortgage. To remain a conventional mortgage you can access up to 80% of the appraised value.
(80% x $450,000 = $360,000)
Since your original loan was for $320,000, this means that you can draw $40,000 out. You spent $20,000 to profit $20,000. The cost to access the profit is an interest only payment on the 40k at 2.75% which equates to $91 dollars per month.
By investing in the cosmetics you attract a high quality tenant willing to pay a minimum of $500 more per month than the time warp you started with.
Example: A 5 bedroom home with wood paneling and stinky old carpet would rent for approximately 1800/mo. The same home with new floors, paint and fixtures will fetch 2300/mo. all day long.
Your annual net on the $40,000 you pulled out tax free is nearly five thousand dollars in increased revenue. ($6,000 increased annual income subtract $1,092 annual interest cost.)
So not only do you make a 100% return on the investment and receive it tax free, your $20,000 invested continues to return $5,000 per year infinitely. If all of that wasn’t sexy enough on its own, you get the massive benefit of the tenant paying down your mortgage to the tune of $10,000 per year. You get to participate in the market appreciation we are seeing this year of at least 5% approximately another $20,000.
Now add it all up:
You created $20,000 profit on the renovation
You received $20,000 in market appreciation after a year
Your mortgage got paid down by $10,000
And you saw positive cash flow of $5,000 per year even after hiring a property manager
That’s $55,000 on an $80,000 investment!
Do that twice this year and you create the magic $100,000 per year that you wanted to make only in this example you aren’t spending it as it comes. You are building an impressive net worth.
This is an important distinction and to be candid, a life lesson I learned from watching my dad in his real estate dealings over the years. To his credit, he was an amazing flipper, he made well into the 6 figures renovating ordinary homes every year that I could remember even long before I became a realtor. He was masterful at adding value and creating equity, but because he didn’t hold any of the properties, he never realized the full promise of real estate investing. He needed his profits to live so nothing ever accumulated.
By adopting a Buy – Fix – Hold strategy you can have your cake and eat it too. You will utilize your god given talents to design wonderful spaces adding all kinds of value to your properties, but you will also realize the dream of building a portfolio of rentals that will, before you know it, be paid off providing a steady stream of cash-flow that will truly allow you to quit your job, not just trade it in for a more stressful one without the guarantee of a pay check.
A quick tip for knowledge thirsty folks out there, of the hundreds of books and courses I've devoured over the years, the book HOLD remains the authority on the strategy discussed in this article.
In addition, I always keep a short list of fixer upper investment properties for anyone ready to take the next step and actually get out there and see some Kelowna Investment properties.
With a returned confidence in the market due to record low borrowing rates and prices trending upward, many people are turning to real estate investment once again to reach their financial goals. As a realtor it’s interesting to observe would-be investors as they watch the MLS and constantly lament that there are no deals out there. Many even become discouraged and abandon the goal all together.
From my perspective, the problem is that they want this red hot deal to just leap out of their iPad and say, "Buy me stupid, I represent the exact return you are after!” Experience shows it just doesn't work this way. In actual practice, whenever a home is priced so low that it represents obvious profit to the buying public, the competition for the property becomes so intense that it generates multiple offers, resulting in it going for more than it really should have anyway.
What people fail to realize is that, real estate being a commodity, has very little inherent profit built into it. Nearly all of the profits in a deal are created by skilled negotiations. Things like negotiating with sellers to sell for less, negotiating with contractors to renovate for less, negotiating with banks for better rates and terms, negotiating with tenants for premium rent or negotiating with future buyers for premium sale price.
A deal is what a person makes of it. With the right team in place and some uncommon sense, almost any home listed on the MLS could represent a substantial profit, provided you negotiated it to be so.
Many are content to use a very vanilla, buy and hold strategy, you don’t need to do much other than buy property, let the rent pay the mortgage off, and passively enjoy inflation doing its thing. Many ordinary folks have created multimillion dollar net worth doing just that. It just takes time. The kind of profit most investors I speak with are looking for the sexy profit, more of an instant gratification. We call this “walk in profit.” This takes a lot more finesse and perhaps more importantly, patience.
It is equally important to have a proven model that you can measure each property against to determine whether or not it makes financial sense, leaving nothing up to chance. The real estate investment network (R.E.I.N) just launched their new member site which has sophisticated online tools that you can use to analyze the viability of a property you are considering. As useful as this is, I have always found that having a couple quick-math short cuts you can use to give a property a pass or fail within 30 seconds has been the real key to being able to spot opportunity. The power lies in the simplicity.
So with that in mind, consider the opportunity that lay within the ordinary listing inventory, the aging inventory, the neglected inventory, the vacant inventory and the under developed inventory. In my experience, for every 10 sellers out there, there is one that would entertain a win/win deal that gets them what they want, be it a fast closing, long closing, or an “as is” sale, in exchange for a reduction in price to the point that it fits your predetermined investment model.
So in conclusion, knowing that the profits of any deal depend solely on your ability to negotiate, your mission becomes this. Be crystal clear on the kind of property or project you want, the exact price range and the neighbourhood. Once you have a clear picture of what you want, ask your real estate professional to create a custom search for you for this exact kind of property and from there it’s all in the negotiations!
Since I’m at the age now that starting a family has become a frequent topic of conversation, having a sound financial plan to make sure one’s child has the option and privilege to get an education, seems like a wise thing to consider. We are going to discuss real estate (surprise coming from me I know) as a viable alternative to RESPs for funding your children’s education. This strategy I stole from one of my best mortgage professionals Jason Henneberry, Owner of Mortgage Pal. A few months back he had this exact strategy featured in “Canadian Real Estate Wealth Magazine”.
You may or may not be aware, the Canadian Education Savings Grant was initiated to help families save for their children's post secondary education. The federal government “tops up” your contributions to a maximum of $500 ($2,500 x 20%) per child per calendar year, to a lifetime maximum of $7,200.
On the surface, this sounds like a great deal, and it’s hard to pass up an immediate 20% return on your money. But it’s up to you to make ongoing investment decisions that will affect the long term performance of the portfolio. If we assume a 6% annual rate of return and you invest $2,500 per year and take full advantage of the CESG program, your child’s education fund will be worth approximately $83,000 in 17 years.
And as with most government initiatives, there are a lot of rules that dictate under what circumstances, in what amounts and for what purpose the money can be used. What happens if your child decides not to attend post secondary education? What if they have a brilliant idea and prefer to use the money to start a small business instead?
Perhaps there is a better way to spend your $2,500 per year and give your child more options and better control over their financial future.
The best student loan that money can buy…
Now let’s take a look at what would happen if you chose to forego the government grant of $500 and invest the $2,500 per year (or $208/month) to service a small equity loan on your primary residence in the amount of $39,195 based on 6% interest. Many people have access to much cheaper money against their home currently but this gives us a nice, long range cushion.
You decide to use the equity loan as the source of your 20% down payment for the purchase of a one-bedroom condo near UBCO valued at $189,900. The condo is new construction and comes with a waiting list of students willing to sign a one year lease at $1200 per month in gross rental income. After property taxes, condo fees and management expenses, you net $125 per month which covers the payments on the $156,782 mortgage that you obtained to buy the property. Use the positive cash flow to make two additional payments per year and at the end of 17 years, assuming an average interest rate of 4.50%, the mortgage will be free and clear!
The 80 year real estate price index tells us that Canadian real estate historically appreciates at a rate of about 6% per year. But even if we half that number and assume an average growth rate of 3%, the property will have increased in value to $323,920 by the end of the 17th year. And you own it free and clear (400% more than the $83,000 RESP).
Your child now has the option to sell the property and use the cash to pay for school, or take over ownership and refinance to create a self funding student loan which their tenant will pay off for them while they complete their education and eventually enter the work force. This second option has the added benefit of “staying invested” during those years and allowing the property to continue to appreciate. Remember, the RESP would have to be liquidated to pay for school and your child loses out on potential growth of the asset over time.
The gift that keeps on giving…
It’s important to remember that the rental income from the property should more or less keep pace with inflation over the years as well. Assuming an average inflation rate of 3% per year, the rental income will have increased from $1200 to $1925 per month.
Let’s assume that your child decides to go to school and refinances the property to $210,500 to access the same $83,000 that would otherwise have been available in the RESP. At an average rate of 6% and monthly payments of $1,052, using the positive cash flow to accelerate the mortgage, it will be fully paid off in 11.2 years. That includes 4-5 years for school and a half dozen years getting their career of the ground.
Provided our assumptions hold true over the course of time, your child (now 28 years of age) will be the proud owner of a clear title property worth approximately $448,381 which generates NET cash flow of over $21,000 per year. Show me the RESP that even comes close to delivering that kind of long term performance!
And in terms of education, your child not only has a degree (hopefully!), but they might also have learned a thing or two about how to manage real estate during their formative years. And now they can leverage their asset as they move into the next phase of their lives, perhaps to pay for a wedding, or to help them with the down payment for their own home, or maybe even to do the same for their kids and pass the knowledge along to the next generation.
For a full PDF analysis showing the performance of the one bedroom units under construction right now at UBCO over time just drop me a quick line to [email protected]
Strategy and much of this content provided by Jason Henneberry of Mortgage Pal.
What you are about to read is a true story about a frustrated investor, who for the sake of privacy I will change his name to Tom. Tom had always been very risk averse and being this way had allowed him to put together a nice nest egg of about $500,000. Half of this was in Registered Retirement funds (RRSPs) and the other half was in low risk stocks, bonds and GICs. He was about three years away from retirement from his job where he earned a nice salary of 75,000 per year and he had kept his credit clean. Following the conventional "wisdom" he had diligently paid off nearly his entire mortgage on his $500,000 home. He had only $100,000 still remaining.
By most people's standards, Tom had done it, he had secured a safe future for himself. The thing keeping Tom up at night was the fact that he had busted his hump his whole life to get to this point, but was now confronted with the reality of soon being on a fixed income of less than $30,000 per year...for the next 20-40 years! The $30,000 is a combination of his 4% return on his portfolio ($20,000 annually and his pension of $10,000). Tom and his wife want to travel, they want to spoil their grand kids and have the freedom to start crossing items off their bucket list. Tom wondered if there was anything he could do over the next three years that would change the outcome of his golden years.
Tom came into my office after reading various articles I'd written in this column and asked if I had any bright ideas that could help him on his quest to avoid his fear of being trapped inside a fixed income barely adequate to stay in Kelowna, let alone travel. He shared with me that he had always been afraid of buying rental property because of the risks. He had heard horror stories of tenants doing the midnight dash and leaving the property in bad shape. Also because Tom still works full time, he didn't have time to be running ads, screening tenants, handling maintenance items or chasing people for rent. What he did like about his current portfolio was that it was hands off.
We spent the next hour going over his finances and I explained an investment vehicle to him that we have been using that not only removes all of the risks associated with buying a rental property but actually gave Tom a totally hands off investment with a predictable rate of return more than five times what he was getting now. Tom asked me to sketch up a plan for him over the next couple of days and present it to him and his wife. I welcomed the challenge.
With Tom still working and earning his nice salary, banks like him. We will take advantage of this for the next three years while Tom still has the income to qualify for mortgages. With Tom's cash, the plan is to buy three properties through the Empowered Renter Program in the 350-400k range. This is using a rent to own strategy to maximize the cash-flow, eliminate management and mutually agree on a fair rate of appreciation for the property, in this example it's 4%.
Each of these properties will be positive cash-flow of $10,000 per year and each will have a pre-determined rate of appreciation of approximately $15,000 as well as a mortgage pay down of approximately $7,000 per year with each deal representing $32,000 per year in total upside. When the properties sell he has to pay real estate fees that give him an annual return of 22% on the roughly $80k in each property.
Over the next six months we will execute the plan to invest the liquid portion of his portfolio into three properties that have a cash on cash return of 20-22%. He now has his $250,000 spread out as down payments on his three properties; $400,000 x 20% = $80,000 (multiplied by 3 plus taxes).
This $250,000 is now earning $52,000 per year on the money that was returning $10,000 back when it was in a low risk stock portfolio. It is backed by real estate that he is the titled owner of - something he can see and touch. His tenant has provided a large deposit of fifteen to twenty thousand, and is caring for the home like it is their own. When these properties sell to the tenant buyer, Tom plans to empower other tenant buyers using the same strategy, and will continue to see 20-22% returns on his capital for another 3 year term.
The plan went beyond just the three rental properties. Tom conservatively has $250,000 in available equity in his existing home. He can have access to this on a line of credit for less than $8,000 per year. The plan with this equity is to purchase a long term multi-family holding property like an 8-plex. I showed him one he could buy for $930,000. He would need to invest his $232,500 for down payment and the property would return to him after all management cost and expenses, an annual net revenue of $25,000 including the interest on his credit line.
The last piece of the puzzle in Tom's quest to move from non existing returns into the land of double digits and possibility, is to put his RRSPs on steroids as well. I shared with Tom that he could invest his RRSPs into a self directed RRSP account and become his own bank. With this he would be free to lend his money against real estate and again expect a 10-12 percent ROI. There are many successful Real Estate Investment Trusts that will pay a 10% dividend and allow you to be totally hands off. With Tom's new plan, he can expect to earn $25,000 per year on his registered funds.
So now let's take a look at what Tom will have three years down the road when he decides to pull the plug on work and set his sights on that bucket list.
- His Rent to Own investments produce $52,500
- 8-plex from equity in his home makes $ 32,000
- RRSP's in a well managed REIT makes $25,000
- Canada Pension Plan max amount is $10,500
Tom's Total Earnings = $120,000 per year
This is more than Tom has ever made, and the best part of it is he doesn't have to trade his time to earn it. All of his hard earned equity that he worked so hard to get over the years is doing the heavy lifting. Each of those dollars has been given a healthy quota of returning an average of 14.6% per annum. He has $750,000 of his cash in the real estate market to earn him his dream income. To replicate that in what he was doing before, he would need close to three million dollars!
In addition to the amazing cash-flow, Tom's properties are appreciating further adding to his returns. The best part of this entire process was helping Tom see what's possible for his retirement years. He left my office filled with hope and excitement for the future. That was a good day for everyone involved.
For a Free E-book that illustrates in great detail each of the deals we did for Tom, explaining the Empowered Renter Program, Self Directed RRSP and Multi Family investment pro forma, just drop me a quick email to [email protected] and we will send it off.
Read more Investment Real Estate articles
- Apartment buildings: absolute gold mine Nov 10
- Become a millionaire in 7 years...this time Aug 15
- Cash flow or flipper? Jul 15
- The power of 10 May 20
- 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
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