The last twelve months brought a wonderful mix of opportunity for those that knew where to look. To the average person on the sidelines who only considers pricing as the indicator of what the market is doing, real estate in Kelowna would've seemed under-whelming to say the least. Prices weren't the big headline; however behind the scenes the right combination of positive economic factors came together to produce some little pockets in the market that yielded amazing returns in the otherwise flat market. So no, the prices haven't started climbing dramatically just yet, however informed real estate investors look for positive cash flow, or potential sweat equity to determine the viability of a potential investment. Following the fundamentals of smart investing, they continue to see their net worth and cash flow grow year after year regardless of average house values. So let's take a look at the Top 3 profitable investment property types and also the 3 big misses of the last 12 months.
1. Buying Cash-flow: Return on equity of 20% or better was very attainable for investors that focused on the specific property types that produce a rent multiplier of 10 or better. (Example: a house that rents for 2000/mo. x 12 is 24000. Using a multiplier of 10 would mean 240,000 max purchase price). Side by side duplexes, half duplex with suites, and even single family homes in strategic neighbourhoods fit this model to a "T".
Here are some great examples of properties picked up by our investors last year:
6 bedroom home near KLO Campus
POSITIVE CASH 1500/Mo
8 Bed Side-by-Side Duplex w/In-law suites
4 suites rented after renovation
4 suites @ $1100/mo.
$4400/mo. x 12mo = $52,800yr
POSITIVE CASH $2200/MO
2. Fail Safe Flipping: For the few that had the gumption to attempt a flip in what was still considered a buyer's market, profits of 30% and more were achieved. By following a simple reverse model template that predetermined; future price, Reno costs, carry costs and a host of typically overlooked soft costs, profits were crystallized at the outset by allowing a formula to guide them before making an educated offer.
The below property was purchased through the courts for $245,000 and was rehabbed for approx. $40,000 and sold 6 months later for $334,000. A net profit of $30k with approx. $90k invested is well above the 30% ROI. This was a great example of what’s possible in today’s market.
3. Investing with Rent to own exit strategy “Empowered Renters”. For many, this is a brand new concept. We were able to produce amazing win-win scenarios for home buyers on the verge of being able to get a home, and investors looking to make a return while empowering others to achieve their dream of home ownership.
Below is an example of a fantastic deal that was put together in 2013.
Tenant-Buyer under contract to purchase house by 2016 for $736,000 pays $3600/mo.
Put up $120,000 deposit
Investor purchased Home for $665,000
1. Speculation buying of condo - There weren't many new condo developments coming to market in 2013. Luckily the ones that did come to market concentrated on filling their properties with people who intended to live there. Gone are the days when a person could tie up a condo with a modest deposit and then wait for a sellout, list for more, and sell for a profit before taking possession. This is a fast track to the poor house and is in no way investing in real estate. This is speculation in its purest sense and is a fantastic way to blow savings and end up in court with a developer.
2. Resort property buying - Unfortunately, there wasn't any money to be made purchasing recreational properties this year. Big White to Osoyoos there was nothing in the market stats that showed these kinds of properties should be purchased for anything other than your own enjoyment and lifestyle. My philosophy has always been to rent these kinds of places. Investment capital is better placed into positive cash flow properties that will pay for your weekends at Big White or Osoyoos Lake and then some.
3. Speculation building - Although home starts were up marginally, we have not yet returned to a time when anyone with a builders license and access to credit could run out, buy a lot, construct something ordinary and presto they sell it and make big bucks. Building on spec is risky business and for the time being should be left to experienced builders with a proven formula that works in all markets.
Where we go from here in 2014
With sales volume forecast to rise again and with inventory on a steady downward trend, it’s not long before prices begin to creep upward. With that said, it is important to remember that market appreciation is really only the gravy in a Real Estate investment. The bread and butter will always be cash flow and sweat equity. The above strategies will still work wonderfully in 2014, but will become increasingly harder to find. This is where an investment focused agent will be your ace in the hole.
To quote the legendary Don Campbell; 2014 will also be filled with opportunity, confusion, excitement, protests, politics, procrastination, predictions, and pontificators… everything we witnessed in 2013 only elevated. Our job as strategic investors is simple: to hack our way through the reeds that obscure our view, to filter the noise that covers the true market signals and to stay focused on achieving our goal of financial independence through real estate.
“It’s been proven time and time again that real estate is the best way to increase your wealth.”
A story of one lonely 1960’s bungalow looking to make it big in Kelowna
So how far can an investor get on $100,000 dollars in today’s changing real estate market? I’m often asked to consult on what is the most profitable move a person can make in spite of limited capital. There are definitely many ways to skin a cat but in my humble opinion the Holy Grail has to be the fixer upper home, with a legal suite, on a good sized Ru6 lot. For those that have no idea what I just said, this is a property with the zoning that allows two residences on the same parcel. For this example we will concentrate on the economics and the steps to take so that you can fully develop this type of property, bringing it to its highest and best use without having to go into your pocket after the down payment is made. Sound interesting?
Let’s start with an example property. I’ll use the one we sold to a first time investor this month. A decent sized, 1644 sq.ft. bungalow in the Capri area. Listed for $319,000 the home is currently 3 bedrooms up and a one-bedroom suite down which could be two if the unfinished area were developed. The house is in serious need of some updating and TLC. It has shown the wear of years from rentals and has a 60’s vibe and smoker smell that would turn 9/10 people around at the front door.
Not our savvy investor though. To her it’s a little golden goose waiting to be polished up. The backyard is large and could easily handle a second residence without sacrificing too much green space. The only trouble with this plan is the client has access to only 100K. The down payment, renovations and eventual build of the carriage home would require closer to 200K. Is the dream dead? Only for the amateurs - this requires a little confidence but will in no way put you at risk thanks to the stellar cash flow potential of the existing home.
Step 1- Strategically purchase the property with the right lending product. Most banks have a Step product, which is a combination of a mortgage and a line of credit. For this program the maximum loan to value is 80%, (65% will be in the form of a mortgage and the other 15% of the value is an interest only line of credit). This line of credit will be instrumental in executing our plan. Since you have the ability to put approximately 35% down on the home you purchased for $300,000 you would simultaneously open up a line of credit for access to the remaining 15% or $45,000.
Step 2- Renovate to add value and boost cash-flow. Our first project as new owners is to immediately bring the cosmetics of the home to a place where we can attract good renters and get the home's value up to match comparable properties in the area. In this example there were 300 sq.ft. of unfinished basement that quickly became an extra room. This room added $250/mo to the cash-flow. The entire 1944 sq.ft. property is getting a $13/sq.ft. make-over for $25,000 (that’s flooring, paint, bathrooms, light fixtures, new doors and hardware throughout). The best part is, the 25K is coming off the line of credit and costs only $80/mo.
So let's take a look at what we have now. A totally refurbished, 5 bed home with legal suite, easily rentable for $1300 up and $1000 down. The new appraisal of the property would be approximately $380,000 based on comps in the neighbourhood. Your 65% mortgage is costing you approximately $800/mo and the 25K on the LOC is costing 80/mo which combined is still less than you get for just your legal basement suite. Either you live upstairs mortgage free or you are elsewhere collecting huge positive cash-flow. Pretty sweet, but we aren’t done yet.
Based on the new appraisal your credit limit on the Step mortgage is now $304,000.
You have a fixed mortgage of $195,000 and have a balance of $25K on the Line. This leaves $84,000 available to you to continue developing this property. Do you know what just happens to be possible for just that amount? A value adding, revenue producing carriage home! This home can be built in three months and will immediately boost your cash flow by $1200/mo and bring the property value up to $500,000 or more.
So now let's step back and see what we’ve done. We started with a tired old 60’s house that might rent for 1600/mo. and worth a modest $300,000. We took some sweet equity and the handy line of credit, and created a half of a million dollar estate, one that rakes in $3500/mo. of cash flow! Your payments after all the renovations are still only $1200/mo. total. To put this into perspective for us, the net monthly income is the equivalent of $14 dollars per hour in passive income. Now this is very impressive, and one could stop there after taking a huge step towards securing their financial future. The only trouble is, now that the place is worth 500K, there’s this pesky 100K left available on your line of credit. Hmm isn’t that what you started with? Do you think there might be other 60’s beaters that would appreciate a make-over?
And now you see my personal problem with real estate, once you start, how the heck do you stop?
1. Take Pets - It always amazes me how few landlords are willing to take tenants with pets. There are two main reasons why ALL my rentals are pet friendly and full for that matter. For starters, tenants with pets have very few choices so not only does your phone ring off the hook from a carefully crafted ad with “Pet Friendly” in the headline, but they are way less likely to try and brow beat you on price when they come out. Tenants with pets also tend to stay longer for the same reason. Secondly, you get twice the deposit. BC tenancy laws say you can only ask for half a month's rent as a security deposit. Welcoming “Spot” sweetens the pot with an additional half month. My experience with tenants is it’s not the pets we need to worry about damaging the place. In the event of a midnight dash or non payment of rent situation, you’ll be thankful for the additional two weeks revenue cushion.
2. Learn to spot the BS - A prime example of the kind of stuff you need to watch out for is the phony reference. This is where they put down their buddy as a past landlord. A simple way to counteract this little scam is to phone the number provided, but instead of announcing yourself as a landlord looking for a reference, call as if you were a prospective tenant. Say, "Hello I’m calling about your place for rent.” The friend that’s been prompted to tell you what you want to hear won’t see this coming and will respond with some kind of, “What the _____ are you talking about? “I don’t have a place to rent dude, wrong number.” - click. You see a real landlord would respond with one of two answers, either: “I’m sorry we are presently fully occupied” or say, “Yes what can I tell you about it?” At that point you know at least it’s a real landlord you’re dealing with and can quickly switch gears to get the info you are after.
3. Use TVS - Tenant Verification Services is the best thing to happen to landlords EVER. It creates some much needed accountability for tenants. Essentially it is a credit reporting agency that allows a landlord to report tenant behavior, good or bad. Delinquent tenants will find their score diminished while diligent tenants will have their scores rewarded and even receive a certificate of successful completion at the end of their tenancy, which is a reference on steroids. The best part of the entire system is the initial meeting with the client when you share with them that you belong to TVS and that their tenant habits are being recorded. They sign an acknowledgment and immediately realize you mean business. This one step alone prevents 9 out 10 issues from even occurring.
4. Have an on time payment “discount” - Sounds a whole lot better than a late payment penalty doesn’t it? Essentially it’s the same thing but it has one major advantage. Discounts can be taken away without increasing the rent. Landlords are restricted to very small annual rental increases. Sometimes in a good economy, the local rental market would bear a $200 dollar rental increase just to stay with the market. Unless the tenant vacates on his own, good luck raising the rent to what it’s worth. This could take 3-5 years depending on the price point. Now if at the outset you had set up your tenancy like this, you wouldn’t have that problem.
For example: Tenant responds to an add for a suite for $1100/mo. When it comes time to do the paperwork and before the deposit is taken, you introduce the fact that the advertised rent was taking into account your $200/mo on time payment discount. “You do intend to pay on time correct?” “Absolutely!” they will respond. “Great, because $1300 is actually the amount I rent this suite for, but for all payments timely made, I am willing to extend this discount and you can see here on my agreement that I’ve put this in writing for the length of our term.” They will now be made aware that late payments do not benefit from your discount and the amount on the lease agreement is due for all payment made after the 1st. It is also noted that after two late payments, the discount is eliminated and the lease reverts to its $1300 amount. I’ve been using this strategy for two years now since learning about it through my involvement with REIN and have never had a single prospective tenant balk at this. In addition I have almost never had to impose the penalty. It works that well.
5. Learn how to advertise your properties properly - Now more than ever a basic understanding of where people go to find rental ads will be essential in remaining rented. Firstly, where to post your ads. This can be a zero cost endeavour that literally puts thousands of eyeballs on your property in the first week. Castanet is by far the cornerstone of any local rental marketing campaign. Next, Kijiji works extremely well and captures people moving to town from elsewhere. Craigslist does have a lot of horse power as well but definitely a distant third. After that a post on Facebook with a five dollar promo spend will yield about 1000 impressions. The social nature of the site will cause it to be spread to anyone looking for a new home. So that’s the where, now let’s speak in terms of how. There is a lot that goes into a well crafted ad, but for the purposes of being brief here are the 3 main points that are easy to implement:
- A strong Headline. This could be your only opportunity to capture your prospects' attention. Don’t waste it with a dull headline. Humour works well here - anything to stand out a bit from the crowd. List your main differentiate in the headline too (huge fenced yard or steps to the beach, or pet friendly).
- Describe the property in terms of benefits to the customer. (ie: Unwind at the end of a long day in your soaker tub or, never hear your roommate snore with bedrooms on opposite sides of the home). You get the idea.
- Use Keywords. Weave into the headline and body of the ad some search friendly keywords so people using search engines will find you. People will “Google” in terms of what and where. (ie: Condo for rent downtown Kelowna). Put this phrase into your ad and it will rise to the top of Google very quickly. Kijiji especially is an SEO rock star for classifieds.
6. Preventive maintenance - It’s a part of the business, maintenance items will crop up. So now you have two options. You can wait for the disgruntled tenant to call you with the news that their _____ stopped working or their _____is leaking. These kinds of calls always seem to happen on a Saturday morning when you’ve got a day of boating planned with your friends or at 11 at night after a long day's work and three glasses of wine. Never a good time. The other and much better option is to check in with your tenants about potential up and coming issues to get ahead of the issues. Inspect your properties regularly and take inventory of things coming up. As things reach the end of their lifespan you can pro-actively address them rather than being reactive. It's counter intuitive, but preventative maintenance is actually easier on the pocket book. Emergency repairs often require additional service costs because they need to be done ASAP and you don’t have the luxury of shopping around. Where this really shows up on your books is the prevention of vacancies. Tenants of well-maintained properties tend to stay. Tenants that have things failing on them all the time tend to look for greener pastures. I learned this one the hard way.
7. Match your tenants wisely - This is applicable in the up and down or side by side duplex or suited house scenario. Anytime when two separate tenancies are sharing a wall or floor/ceiling you need to pay attention to how they mix. Sometimes just in an effort to get both of your suites full you will just take the first to come along. This kind of short term thinking can cost you nothing but headaches and create bank breaking vacancies. The single guy in his 20s beneath the family of five with three young kids bouncing, running and screaming will go together like oil and water. The older gentleman living above a couple of 20-something, girl roommates may seem like a great plan except the fact that the girls crank their Rihanna until 2 AM on weekends, and their friends cars block the poor guy's driveway.
8. Treat them like a client - Start off on the right foot. Get them a welcome present. Remember their birthday. Check in to see if they need anything. Communication is key. When you honor your tenants with respect, they will reciprocate by taking care of the property and watching out for your investment. They will stay longer and if they do decide to move on they’ll give you plenty of notice and leave the suite in great condition. This is a huge piece of the puzzle and one that is missed 90% of the time. Far too often Landlords and Tenants take this adversarial approach and miss out on what can become not just a mutually beneficial relationship in business, but also a personal relationship as well.
9. Use a GOOD laminate floor - Don’t fall victim to the temptation to buy the 89 cent bargain laminate you see on sale at Home Depot. This stuff will spread, bubble and chip, and replacing it is a huge hassle. Invest a little more upfront in something that will pay off huge in the long run. There’s a great product at Costco for 1.74/sq.ft. It’s a 13 mm laminate that looks great, clicks together easily, comes with its own under pad attached, and best of all, stands the test of time. Not having to replace your flooring every other year is equivalent to eliminating two vacant months every year.
10. Understand Rent to Own - Funnily enough you can eliminate the need for any of the first 9 tips if you simply implement this final one.
The best way to eliminate all of the risks associated with owning investment real estate is to utilize a rent-to-own strategy on any of your rental properties. Rent to own executed properly will yield a large deposit, higher monthly cash-flows and eliminate all maintenance and management. You almost completely remove the risk of vacancies. This enables you to achieve a premium sale price into the future that makes your return on the investment very worthwhile. The best part of the strategy is that you are helping people on the brink of success, people aspiring to become home owners that just need some time to get their down payment together or take care of some small credit challenges. As a licensed brokerage, Vantage West specializes in structuring win/win deals for investors and tenant/buyers that accomplish the dream of home ownership for one and a healthy return on investment for the other.
I learned all of these strategies the hard way - through years of making mistakes and paying the price. As a result I have a very expensive education that finally led to a practical intelligence not taught in any classroom. My purpose now is to share what I have learned so that other Kelowna investors can experience all of the amazing aspects of owning investment real estate and immunize themselves the kind of thing that makes you want to sell in a down market. It doesn’t take very much additional effort to implement these strategies and making the choice can be the difference between an investment providing you with a 20% or better cash on cash return or an embarrassing headache that turns you off real estate forever. Good luck and of course feedback is always welcomed!
What is Leverage? By definition it is; A method of financing an investment by which an investor pays only a small percentage of the purchase price in cash, with the balance supplemented by borrowed funds, in order to generate a greater rate of return than would be produced by paying primarily cash for the investment; the economic benefit gained by such financing.
So why is Leverage such a dirty word?
Canadians have been pounded over the head lately with this concept of being over borrowed. Our debt coverage ratio is the highest it's ever been - oh my! The debt ratio is based on the notion that a person’s debt should not exceed what they earn in a year. On the surface that sounds like conventional wisdom, good, safe, I only pay cash mentality that many Canadians have adopted. Can we really lump all debt together? Isn’t there a difference between mortgage debt and consumer debt?
What happens when we examine the debt coverage ratio of Canada’s wealthiest real estate investors? People that own multi-million dollar portfolios, the ones we should be taking advice from. You will find that almost all of them strategically employ mortgages on each property they own. In fact they have it down to a science in that as soon as properties get too high in equity, the return on that equity falls below their acceptable level and they refinance. They then take the cash, get another loan, and invest in more property. Funnily enough, the highest net worth people you will encounter have debt coverage ratios so far out of whack that it would make your head spin. Ask them how they sleep at night. Let me tell you, they sleep like lumber in $3,000 dollar sheets.
The real ratio people need to be focused on is debt service ratio, meaning how much income we allocate towards the servicing of our debts (payments). This is the real stat that economists pay attention to. It just doesn’t sell nearly as many newspapers.
To illustrate, let’s consider a very normal Kelowna scenario; homeowner of a $400,000 home with a $360,000 dollar mortgage on it. This hypothetical Kelowna couple probably makes a combined annual income of approximately $90,000. According to the fear mongering statisticians they’d have a debt coverage of 4:1 or let's say we're trying to sell news papers - Kelowna couple has put themselves 400% beyond the nations safe debt ceiling…will they survive? Hmmm…
Let's run the numbers quickly. Their mortgage payment would be approximately $1700/mo - this equals 20% of their household income. This is approximately half of what their maximum borrowing ability would be based on CMHC guidelines. I’m thinking they’ll be okay. Remember CMHC is the one holding the bag if Canadians default, so they certainly have an interest in keeping Canadians afloat.
REIN Canada shared a stat that as compared with year 2000, Canadians have a lower debt service ratio. They also pointed out that our mortgage default rate has gone down a considerable amount too. Imagine that, the important stats say we’re in better shape now than year 2000? Interesting…
So let's say for a minute I’ve managed to temporarily neutralize the effects of this month’s news headline long enough for you to take an innocent peak at the wonders of applying leverage to your portfolio.
An investor is eyeing a side by side duplex for $400,000. It’s attractive because it is renting for $1500 per side or $3,000 per month. The CAP rate is strong, almost 9%. So does the investor pay cash and receive after property taxes and maintenance, a return of 6-7% per year on his money? Or….
Put 20% down ($80,000). Carry a $320,000 mortgage ($1327.28/mo), leaving net operating income at $20,072.64 per year. Less the same expenses I used for the example above leaves a net of $15,072 on an investment of $80,000. That’s 18.8%, which is almost triple the return of the unlevered. But wait, there’s more! What about the fact that the tenants have been paying down the mortgage? In one year they’ve increased his equity by nearly $7,000. That on its own is 8.75% ROI. Combine the benefits of positive cash flow and mortgage reduction, the leveraged investor is raking in 27.3% on his $80,000 investment.
And there’s even more to the story! This investor still has $320,000 dollars of the 400k he contemplated placing in the duplex. What ever will he do with that, another duplex or two perhaps? Let's just say he wants to play it safe and put the remainder into a blended real estate fund offering 8-10% known as a REIT. Now he’s making approximately $30,000 in dividends from that investment too. Is this making sense?
I’m thrilled to share that Kelowna residents have decided that it's time to come up from the bomb shelter and take whatever money they survived the recession with and put it to work again. Since this time last year we have seen a steady increase month over month in the percentage of real estate transactions that were purchased for investment. This is encouraging not just for the economy but for my firm specifically as we have carved out a niche in the Kelowna market as Real Estate Investment Advisors.
Recently clients have come to us looking to make a real estate investment, well done! Great choice! However many have been adamant that they pay cash for the property. Try as I might to explain the benefits of all time low interest rates and the powerful effects of leverage on their ROI, still they choose to stay away from this scary debt monster. My job is to educate and inform however, I fear consumers are far too influenced by the media and don’t make the pragmatic decision to learn how leverage works. I hope this helps a few.
Read more Investment Real Estate articles
- 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
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