With a white-hot market and macro signals that point towards a market shift, what strategies and tactics can savvy real estate investors use to make it out on top and protect their newfound wealth?
First, we must draw a clear distinction between speculating and investing. Speculation is a gamble that property values will increase in the short-term. Investing is buying a property for the positive cash-flow, mortgage buy down, and tax advantages
In 2022, 30% annual price increases have made a lot of local real estate speculators feel like geniuses. Even if your cash flow situation is negative, the $200,000 in property appreciation totally eclipses a negative cash flow of $500 to $1,000/mo.
But after a few years of unsustainable growth, now might be the best time to capture your gains and get your portfolio ready for the next phase of the market.
Payments are as low as they are ever going to be right now. To help tackle price inflation, The Bank of Canada is expected to increase interest rates in the coming months, which has the potential to decimate some mortgage holders.
As we’ve shown, even a 1% increase in the prime rate will have a major impact on mortgage affordability. Combined with other economic factors, this could be the tipping point where certain investments don’t make economic sense to hold through a downturn.
To show you the hard reality, let's run the numbers on a common investment property in Kelowna.
The investment equation of a two-bedroom apartment in Kelowna
Right now, a median two-bed apartment in Kelowna will cost you about $525,000. Based on the Vantage West Market Rents Grid for Q1, a two-bedroom apartment in Kelowna will command $2,100/mo in rent payments.
Your mortgage payment, with 20% down and 30-year amortization at 2.5% interest will be around $1,650/mo, netting you $450/mo before any other expenses.
After paying strata fees around $350/mo and property taxes around $200/mo, you can see how this investment is already underwater by $100/mo.
It’s no big deal if the property’s value is increasing by 100x that per month. But what happens if you carry this mortgage into a recession brought on by rising interest rates?
If you stress test this apartment through a 20% drop in rent and a 1% increase in interest rates (while factoring in some vacancy, repairs, and maintenance allowances), you’ll arrive at a negative cash flow situation to the tune of minus $10K/year.
One could argue that if the mortgage is being paid off at approximately $10k/year, you’re technically offsetting that loss. The reality is that cash-flow in a recession is everything. Negative cash flow can be the kiss of death for many investors who lack the necessary staying power.
My advice to many of our investor clients is that they should consider selling any property that could become a cash flow drain in an economic recession.
Right now the market right now is likely as favourable as it’s going to be for the next decade. If your plan was to cash out sometime in the next decade, now is the time to act.
We recently conducted a survey of homeowners and found nearly everyone held an optimistic view about the housing market.
• 72% believe the market still has some runway left
• 20% believe that the market will level off this year
• Only 3% believe we’ve reached the top
In the U.S., Fannie May conducted a recent survey that asked people if they believed now was a good time to buy. Their results represent the lowest buyer sentiment in recorded history.
• 25% of Americans said that now was a good time to jump into the market
• 75% of Americans said no
Is there a clue here? Why would two different surveys ask the same question show inverse results with three-quarters of Canadians thinking now is a great time to buy, while nearly three-quarters of Americans believe now is a good time to pump the brakes? Something’s got to give.
If you are looking for a way to capitalize on what potentially little time we have left of this historical seller’s market.
You will find the appropriate strategies being discussed at the Free and informative Seller’s workshop March 7th. Register here
This article is written by or on behalf of an outsourced columnist and does not necessarily reflect the views of Castanet.