PERFORMANCE OF A "REAL LIFE" REAL ESTATE INVESTMENT
When I first approached real estate investing, I remember how long it took me to purchase my first investment property apart from my principle residence. I recall reading all sorts of theoretical information, but I found it difficult to find real world examples that I could measure potential purchases against. Hence, I’ve outlined one of my investment purchases here so you can hopefully benefit from it.
Here are the details on a property that I bought for my own portfolio in late 2008 just before the banks tightened there lending practices as a result of the financial meltdown in the US in October 2008. As it turned out, my timing was perfect as I bought in August 2008 and hence, was able to still but with only 5% down. I was also lucky in the sense that I bought two such properties on the same street within a month of each other.
This particular example is of a freehold townhouse located in Kitchener, Ontario. The reason I selected Kitchener is that because after years of searching for an investment property in Toronto – East York, Etobicoke, North York, Scarborough - to no avail, and remember that I’m a real estate broker so theoretically I have an advantage with direct access to the MLS and many sellers, I wasn’t able to find a property that was clean, required minimal work, and still gave me a positive cash flow. Those three requirements were a must with me for the investment strategy that I had in mind, as well as because I didn’t have the time or inclination to do any renovations myself especially with a busy brokerage practice. So, if Toronto didn’t work for me I started to explore outside the city and came across Kitchener. My research unveiled that compared to the Ontario provincial averages, Kitchener had a younger, more educated and a higher earning demographics and that appealed to me because that not only suggested a readily available supply of good tenants, but also an above average price appreciation over the long term.
This freehold townhouse that I bought was built in 2002 and having 1,400 square feet, it’s a 2 storey, 3 bedroom and 1 ½ bathroom home. I purchased it for $224,500 with a 95% CMHC high ratio first mortgage. My reasoning was that it was relatively new and so I wouldn’t likely have any major repairs or capital cost improvements like a new roof or furnace for several years. And if I could buy this with the least down payment, and still achieve a cash flow, then I would be able to hold on for the long term and benefit from the 1) cash flows 2) mortgage pay down and 3) price appreciation over time. Here is what the numbers looked like back in 2008 when I bought it.
Total Investment/Cash Required:
Purchase Price: $224,500 negotiated based on an asking price of $232,900
Down Payment of 5%
(with 95% CMHC Mortgage): $11,225
Legal Costs (approx): $ 1,800
Title Insurance (approx): $ 250
Provincial Land Transfer Tax (approx): $ 1,970
Property Inspection: $ 350
Total Investment/Cash Required: $15,595 or rounded to $16,000
Cash Flow:
Recall that the investment strategy is a long term hold and as such, I wanted the property to carry itself at very least, in other words, to break even. This would enable to hold onto it indefinitely through any market corrections.
Rental Rate (one year lease signed): $1,350
Less Expenses:
Mortgage payment: $ 825
Utilities (tenant pays all): $ 0
Realty Taxes ($2,278 for 2008): $ 190
Insurance ($591.73 for 2008): $ 50
$1,065
Total Positive Cash Flow: $ 285
Investment Summary
There are generally three (3) areas that real estate investors benefits from:
1) Cash Flow – on average, from month to month, the cash flow should be ideally positive or at very least, break even. Here we have a monthly positive cash flow of $285. I would even have been content with break even because I’m able to hold onto a relatively new property, in an area with above average potential and the tenants are doing all the work to pay down the mortgage and upkeep of the property.
For sake of simplicity, let’s assume that there are no vacancies, but also no rent increases over the hold period.
5 years $285 x 5 years x 12 months = $17,100
10 years $285 x 10 years x 12 months = $34,200
15 years $285 x 15 years x 12 months = $51,300
2) Mortgage Paydown – the tenant is paying down the mortgage every month. Although at first it’s primarily interest that’s being paid, the mortgage balance nevertheless is slowly being paid off each and every month. These figures are generated from a mortgage amortization table.
5 years $192,459
10 years $159,670
15 years $84,014
3) Increase in Value over Time – from a statistical perspective, the longer the time frame, the greater the predictability of value and the lower the risk. Assuming a conservative 3% annual increase, this property would be expected to have the following values after time:
Initial Price $224,500
5 years $260,257
10 years $301,709
15 years $349,763
So let’s take a look at the combined numbers to calculate the overall potential benefit of this real estate investment:
Now (0) 5 Years 10 Years 15 Years
Cash Flow $0 $ 17,100 $ 34,200 $ 51,300
Plus New Value $224,500 $260,257 $301,709 $349,763
Minus Mortgage Balance $222,291 $192,459 $159,670 $ 84,014
Investor’s Net Gain
(less the initial $16,000) $ 68,898 $160,239 $301,049
Increase on Initial Investment
of $16,000 431% 1,001% 1,882%
or 4 fold or 10 fold or 19 fold
These are projections and as such best estimates. As with any type of investing, there is no guarantee of returns. But I am confident that these returns will exceed the returns I would have otherwise generated from investing in other areas available to me whether it be mutual funds, stocks, bonds, etc. With real estate, I have an asset class that I have direct control over and can take steps to directly impact its value such as renovating, upgrading, re-leasing, change it’s use or zoning, and refinancing – all which give me a lot more options and hence opportunities, than other possible investments.
Some might say that this type of real estate investing requires potentially dealing with problem tenants and phone calls at 2 am because of plugged toilets and sewer lines. The reality is that with a single family property such as this townhouse where the tenant looks after their own utilities, landscaping, garbage removal and minor maintenance, my real work is at the onset in buying the property and then selecting the right tenant. After that, there is minimal requirement of my time and I’d say that in a typical year I might spend several hours at most.
I encourage you to look further into this strategy of investing that utilizes the power of time with a long term hold, and how you might be able to implement it given your particular circumstances. In this particular example, the property is located in Kitchener, however, I am now investing in the up and coming neighbourhoods of Mimico, New Toronto, Long Branch and Alderwood in south Etobicoke which has the advantage of being easier to manage and with the potential for greater capital appreciation.
As always, I’m always available and willing to assist and offer encouragement in any way I can and look forward to your questions, comments and suggestions.
I invite your comments and questions at Edward@AgentAtLarge.com.
Happy investing!
Contact me at Edward@AgentAtLarge.com if you have any questions or to just let me know what you think of this.
