Fill me in
Looking for a project that’s both challenging and profitable? AJ Hazzi of Vantage West Realty shares an advanced infill strategy that could turn you into a millionaire in as little as five years.
Infill development has become a popular way for small-scale investors and developers to add serious value to a small, manageable plot of land in the urban core.
This works great in cities such as Edmonton or Kelowna.
Some infill developers are looking for the quick return of capital and a tidy profit by selling four-unit projects for a profit inside of 18 months.
These developers will take the hybrid between a short- to mid-term hold and a pre-determined, profitable exit. Both the sale price and the cash flow are amplified by 15-20 per cent due to the rent-to-own component of this deal.
Let’s take a detailed look at both the strategy and the returns it can generate, which should be pretty enticing to most investors.
I operate in Kelowna, so we’ll use the numbers from this still highly viable market lift and move on to the next venture in hopes of parlaying the new equity into another equally lucrative project.
Others are looking at these newly built four-plexes or row houses as a long-term, cash-flow property, aiming to generate wealth from the three-course meal that is long-term real estate investing:
- cash flow
- mortgage pay-down
- capital gains.
There is, however, a third option that blends these two approaches into a sort of as a base.
The purchase of a small tear-down home in an infill area here will run you roughly $750,000. Constructing four new three-bedroom homes on that lot will cost around another $1.1 million, so expect to need a half-million in capital in order to get started.
These four, freshly constructed units will fetch $550,000 each, or $2.2 million in total. After soft costs, the project should net approximately $300,000.
If you were to take the purpose-built rental approach, you could expect each of these well located, newly built homes to bring in about $2,400 per month in gross rent, or $115,000 per year on your $1.85 million investment.
This is a solid cash-flow equation with a gross rent multiplier of 16, which is similar to what you would get by purchasing older rental stock, but with the added benefit of being new without the deferred maintenance of an older building.
As you can see, both are attractive options, but let’s consider a hybrid option – one that stirs in a rent-to-own component.
In a rent-to-own deal, the rents are based on market-value rent plus equity buildup. It’s also customary to tack on a pre-agreed rate of appreciation to the eventual purchase price.
I have had great success creating win-win deals using 3.5 per cent appreciation.
In a five-year deal, using a 3.5 per cent rate of appreciation, the sale price on the four units will be $650,000 each.
During that five-year window, your tenant-buyer will have been paying $2,900 a month, which includes market-value rent of $2,400, plus $500 worth of equity buildup, which will be credited back upon closing.
This will accumulate and become their five per cent down payment when added to their initial deposit of $10,000.
Returning to the three-course meal analogy, the appetizer in this scenario – cash flow – is very good.
You receive $11,600 every month in revenue to pay your mortgage (at a rate of $7,000 a month) and take care of your additional monthly expenses, taxes, insurance and water, which should total approximately $1,600 a month. That leaves you with a net $3,000 per month in positive cash flow, or $180,000 at the end of five years.
Now, on to the second course.
During the five years of your tenant-buyers making their payments, your loan went from $1,387,500 down to $1,197,000. That’s a significant reduction of about $200,000 in a very short period, if you opt for a bi-weekly payment plan and stick to it.
The dessert in this example is the capital gain when you sell: $2.6 million minus your base cost of $1.85 million leaves you with a gain of $750,000.
But don’t forget about the tenant’s equity buildup of $30,000, which was part of their original deal. Multiplied by the number of ecstatic new homeowners you’ve helped create, that $30,000 balloons to $120,000.
That’s not yours to keep – and also prepare to pay another $10,000 in legal and accounting fees. You will still be left with a million dollars in new wealth after only five years.
- Profit from sale $750,000
- Mortgage reduction $200,000
- Cash flow $180,000
- Total gain $1,130,000
This article is written by or on behalf of an outsourced columnist and does not necessarily reflect the views of Castanet.