Graduating from homeowner to real estate investor is a major decision that requires thorough research and careful planning. Once you’ve decided to take this step to enhance your property holdings, what next? Suzanne Sharma reports
March 23, 2009 – Property investing is a tricky business to get involved in if you don’t understand the market or have a strategic plan in place. Homeowners should be well-versed in the investment aspect of real estate, keeping their emotions intact because it’s a different ball game altogether.
Buying a primary residence is driven by emotion, say Marnie and Ryan Griffiths, owners of Insumo Property Solutions Ltd., Calgary. “It’s your home and emotion needs to be part of this purchase.”
However, property investors are advised to eliminate emotion, treating the purchase as a business transaction. Focus on the local, provincial, federal and global economic fundamentals, which drive the investment in a positive direction.
The financial considerations between a personal property and investment property vary. A primary residence requires the purchaser to put a down payment on the property and secure a mortgage. The latter involves a thorough evaluation of the unit and the lender needs proof it will stand on its own, financially, before granting approval.
“Disclose everything to the lender – good, bad or otherwise in regard to your financial position,” says Griffiths. “Working with a mortgage broker who understands real estate investing and your long term goals will be of huge benefit to you moving forward.”
Also, if you put less than 20% down on a residential investment property there is mortgage insurance similar to a primary residence. However, the rates for insurance on investment properties are typically much higher, says Tom Karadza, broker and co-founder, Rock Star Real Estate Inc., Burlington, Ont.
The insurance rate depends on the down payment and the amortization period. According to Karadza, it can range anywhere from as low as 10% to as much as 70% higher. Rates are constantly changing as banks and insurers adjust their mortgage product offerings. Be aware of these fees when factoring in carrying costs.
In order to succeed in property investing, the key is to research the market, property and area, look at the numbers, surround yourself with an experienced team and learn from certified experts.
“Education, proper guidance, market research, due diligence and picking the right people to assist you is one of the largest investments of your life,” says Navtaj Chandhoke, founder of Professional Real Estate Investors Group (PREIG) Canada, Toronto. “Seek information only from experts instead of neighbors, co-workers, friends and relatives.”
It’s also critical to research where to invest. Rent control regulations vary from province to province and can depend on the age of the building. Some markets are more restrictive, for example, on when and by how much you’re able to raise rents. As an investor, if you’re not able to apply an increase to help keep pace with rising property taxes and other costs, it could negatively affect your cash flow and bottom line.
Getting started
A novice investor should analyze the reasons behind their decision including short and long term goals. Not everyone has the same objective in mind. Griffiths suggests asking, “How many properties will I need to own to reach my goals and vision?” With the end result in mind it’s easier to work backwards and formulate a plan.
“Decide how many properties you want by what date and write it down,” says David Sandbrand, vice-president, business development, Cobblestone Investments, Calgary. “Then, you need to take action – just having the goal is not enough and analyzing properties day after day won’t change your situation at all.”
Speak with other investors for expert advice, attend seminars and research the market to get an idea of where to invest.
Also, know how much capital is available to begin with, advises Karadza. “These decisions made early will help you decide what types of transactions you want to get involved with.”
Short and long term
Initially, focus on cash flow then decide how many assets are needed free and clear to produce the desired income.
“No matter how you do the math, if the property costs you money to carry then it likely isn’t a very good investment,” says Karadza. “Many beginners convince themselves that a negative cash flow property is a good investment because the appreciation of the property will more than make up for the monthly losses.”
Often times, this strategy backfires because appreciation of a property is never guaranteed.
Further down the road, investors should focus on how large of an asset base they would like to own. As positive cash flow produces monthly income and pays down the mortgage, the property will eventually be mortgage free.
“You can then refinance and pull out substantial amounts of capital or use the cash flow for other investments,” says Karadza. “If you do pull out some equity on a rental property, your tenants will help pay the mortgage down again.”
Flips versus buy-hold-rent
The most common types of investment strategies include property flipping and buy-hold-rent. While the first includes purchasing, renovating and selling in a short period of time, the second is about finding a tenant to pay rent that covers your mortgage costs, with the aim to make cash flow on a regular basis.
“Flipping properties has gotten a lot of media attention lately, especially on TV,” says Sandbrand. “Flipping is a huge amount of work, and takes a lot of time – and that’s true even if you’re not doing the work yourself.”
Several variables need to work in the investors favour, including the right property, location, time, upgrades and team. If everything goes well, flipping can be a good way to make a decent profit quickly, but it’s not that easy, Sandbrand warns.
Instead, many investors prefer the buy-hold-rent method because it allows them to control the asset and acquire cash flow through rental yields. The main issue that typically arises is tenant related. Tenant screening, including a referral and credit check, is mandatory in order to ensure reliability.
Build a team
As with any business, having a supportive team is essential. Megan Parkman, CEO of Advanced Investors and Downie Investments Ltd., Mission, BC, notes she made the initial mistake of trying to do everything herself when she started investing.
“I soon learned after flipping my first property that there are so many variables that I could not solve,” Parkman says. “As one person, I didn’t have all the answers or the energy to do it myself.”
Be sure the team includes a mortgage broker, lawyer, realtor and insurance agent, as well as a contractor for investors planning on doing renovations. Before employing their services, however, interview several candidates and check referrals.
Financing
It’s important to pay close attention to tax deductibility and mortgage needs. In a principal residence, the long term strategy is usually to pay the mortgage down to zero. However, with an investment property, the goal is to find one with positive cash flow after all expenses are paid such as maintenance, vacancy and property management fees.
“To get this cash flow, you may need to have a longer mortgage amortization, use creative financing such as a second mortgage, or work with a seller that is willing to carry some of the financing,” says Sandbrand. “For investment properties, the mortgage amount is a secondary concern as long as the investment carries itself.”
For example, if the investor purchases a property for $320,000 and puts 20% down or $64,000 to avoid mortgage insurance fees, the mortgage will be $256,000. Assuming a 4.25% interest rate on the mortgage and a 25-year amortization, the monthly payment will be $1,381.53. If the amortization period is changed to 35 years, the monthly payment drops to $1,166.42 – a savings of $215.11 per month in expenses and therefore an increase of $215.11 in positive cash flow. Use a 40-year amortization and the expenses drop an extra $62.36 per month, compared to a 35-year mortgage.
“In other words, if you find an investment property that only breaks even using a 25-year amortization mortgage, you can easily turn this into a positive cash flow investment by increasing the amortization period,” says Sandbrand.
Also, when dealing with rental properties, it’s imperative to acquire rental property insurance and the tenants should consider contents insurance. “That way you have insured the property yourself and the tenants have insured their belongings inside,” says Karadza.
For properties with five or more units, investors will be dealing with commercial mortgages, which may carry higher fees such as broker and property appraisal fees.
According to Walter Koziej, broker, Mercury Mortgages Inc., Mississauga, Ont., appraisal fees on a residential mortgage run anywhere between $250 and $400 and on a commercial property $1,500 to $2,500.
Broker fees are entirely up to the broker on both residential and commercial deals, he says. A reasonable fee would be between one and two per cent.
Also, commercial mortgages face lender fees, which range from 1% to 3% and are charged simply for processing the deal. “As opposed to residential mortgages, where the rates and fees are pretty much set in advance and everybody knows what to expect, with commercial mortgages each deal is always priced individually as there are many more risk factors than with a residential mortgage,” says Koziej.
Lastly, for investors planning to purchase a property and rebuild it, a construction loan might be required. “This type of loan product allows you to draw more money from the lender at pre-determined stages of completion,” says Karadza. “You’ll want to get a complete understanding of when you will have access to the funds so that you can plan accordingly.”
Managing your assets
First-time investors gain valuable experience when managing a property on their own. However, as assets continue to accumulate and the portfolio grows, many investors agree it’s advisable to hire a property manager.
When managing a property, investors must be able to screen the tenant, move them in, attend to maintenance issues, collect rent and keep abreast of all tenancy act regulations which are province specific. It’s easier to tend to these tasks if the investment property is in proximity to your primary residence. Also, even if the property management fees aren’t being outsourced, be sure to set them aside anyway.
Always include a property management line in your pro forma, because even if you are managing your own property now, you may have to hire a property manager in the future. When it’s not in the budget, the property may become a negative cash flow, says Parkman.
Typically, management fees vary between $100 to $200 per property per month, or 8% to 10% of the rental income for a single unit, according to Al C. Dodimead, certified property manager at ACD Realty Corp., New Westminster, BC.
If you manage on your own to start, says Karadza, then when you do eventually hire a property manager you will have an intimate understanding of how the property should be run.
From the December 2008 issue of Canadian Real Estate
