This guide outlines an aggressive real estate investment strategy which maximizes working capital and takes advantage of loan programs available to Canadian home buyers.
In this example, we share how an investor with $50,000 can build up a $4-million portfolio over 20 years.
Starting out with $50k: A Real Estate Pros Guide to Empire Building
I met with an aspiring real estate investor in my Kelowna office for a planning session last week and the young man asked me a great question:
“If I have $50k in working capital to begin investing, what should I do and where would I start?”
I took some time to seriously consider his ambitious question and came up with a relatively simple plan to maximize his $50k of working capital while making the most out of the loan programs available to Canadian home buyers today.
This strategy takes advantage of the high ratio financing available to purchasers moving into a primary residence.
You will incur some Canadian Mortgage Housing Corp. fees, but the benefits of being able to control a $500k asset with as little as $25k plus closing costs is where the magic happens.
Finding your first investment property
We are looking for a property valued around $500k that has a suite — or could be renovated to have a suite — and needs some basic cosmetic help.
Once you’ve found such a property, I recommend taking advantage of the Purchase Plus Improvements Program (PPIP), which lets you invest up to $40k of the bank’s money to make value adding improvements to the property.
The additional loan funds from the PPIP get rolled into one easy-to-manage mortgage. Things such as suites, kitchens, bathrooms, floors, and paint are the go to renovation items.
The PPIP lets you to build sweat equity — or what we call ‘forced appreciation’ in the real estate world. This increase in your home’s market value will come in handy in the future when we’re ready to withdraw equity and use it to expand our real estate portfolio.
Renting out your first property
Once your first property is fixed up — perhaps with multiple suites — you’re ready to move out and find quality tenants. With two tenants renting your property, you should be cash-flow positive, which would allow you to reinvest all cash-flows into reducing your mortgage debt.
This slashes the amount of interest you’d pay over time, shortens the amortization period and rapidly builds up your equity.
With this strategy in play, it becomes a waiting game. Over the next few years, the combined effects of the mortgage buy down and natural property appreciation can quickly increase your portfolio value.
Expanding your portfolio
Your first property investment will eventually give way to your second investment as you’ll be able to borrow equity using a Home Equity Line of Credit (HELOC).
For example, let’s assume your first property was purchased for $500k with a 10% down deposit of $50k. You then utilized the bank’s money to do a full cosmetic renovation to the property, which increased the property’s value from $500k to $600k.
At this point in time, you’d owe $450k on your original loan plus $40k for the home renovation loan for a total of $490k.
$600k - house $450k - mortgage
$40k - renovation loan
Total Equity: $600k Total Debt: $490k Net Equity: $110k
As you can see your net equity position is now $110k.
While this is a handsome figure, $110k is not yet enough to utilize your Home Equity Line of Credit to finance a second investment property. The HELOC only lets you borrow on up to 80% of your home’s value, which in our example is $480k ($600k equity * 80%).
But let’s see what happens in three years. Assuming you top up your mortgage by a couple hundred dollars every month, you would cut the amortization period down to around 20 years. By year three, your mortgage balance would be about $435k.
Let’s assume the property value appreciates by 10% in this same three-year period — a very conservative estimate based on long term averages, but it does pay to be conservative here.
Now, the property would be worth $660k, which means your HELOC would let you borrow up to $528k ($660k * 80%).
Here is how the math works on a potential home equity line: the bank will lend you the difference between your maximum available HELOC balance (in our case $528k) and your outstanding mortgage balance (~$435k), which nets to $93k.
You would then use this $93k loan as a down deposit on your second property — ideally repeating the exact same process as before: moving into the home, completing renovations, and then benefiting from both forced and natural price appreciation.
For the second property, I would consider moving up in price point and putting 10% down on a $750k suited duplex. After renovations this property could be worth $850k and you would owe $715k ($750k less your 10% deposit of $75k).
With two properties in your portfolio producing positive cash flows while increasing at the typical market average of 3.5% per year, you should have enough equity available to repeat the same process again — but this time in two years instead of three.
I’ll spare you the math, but I will point out that with three properties under your belt with a combined value of
$2 million, your net worth would now be approximately $500k and you would have used no additional savings along the way.
This is the power of real estate investing and the leverage available to us.
This post describes the journey the vast majority of residential real estate investors take — myself included. It will feel like slow going at first but after about five years in this game things really start to take off.
After 10 years and with multiple properties under your belt, you’re off to the races and will have essentially created a bullet-proof future for yourself.
Most people don't realize that by owning just three good rental properties, you can bring in enough cash flow to fund a very comfortable retirement.
Let’s say your three investment properties have a combined market valued of $2 million today and are bringing in $10k/mo in rental fees. Assuming 3.5% yearly price growth, in 20 years, these properties would be fully paid off, worth over $4 million, and bringing in $20k/mo in cash flows.
Not a bad retirement by most people’s standards.
This article is written by or on behalf of an outsourced columnist and does not necessarily reflect the views of Castanet.