The secrets to buying investment Real Estate

Like all investments, real estate as an investment poses some form of risk. There are very few investments that are so dependent on your management skills, yet most people do not understand this and as a result end of selling what would be the best investment in the long run. 

For example, in 1997 I purchased and investment property for $195,000 put $25,000 as a down payment and got a mortgage for the balance. Today this investment is worth $500,000 and the outstanding mortgage is approximately $120,000. In a nut shell over a 1,400% return on my capital. 

This is not an isolated situation and many people have become millionaires buying real estate. Compare this to the stock market where the TSX grew by 300% since 1994 and the S&P 500 by 179% not including this year where they shed 40% of their value. 

So why isn't everyone buying real estate? The simple answer, most people don't understand how to buy, how to evaluate and most importantly how to manage this investment. They would rather give their money to a mutual fund company and turn over the investment and all their future to someone else based on past performance. 

When buying an investment property, the first basic rule is not to buy a property unless it can cash flow, in other words when you calculate the income subtract the expenses including the mortgage that there is a little left over. If you have to add money every month to pay for this investment say away! 

The second rule of buying an investment property is to be wary of listings showing a great rate of return on projected values. Many realtors simply take the information provided by sellers without verifying if it is correct. If you find an investment property ask for the income and expenses for the past 24 months. This includes asking for actual bills to verify that the expenses are real. Also allow for a reasonable vacancy rate as no property will be 100% occupied all the time. Don't forget about maintenance as many listings do not include maintenance so make sure that you allow for this. 

Now that you are getting the idea, the next step is to calculate the capitalization rate otherwise knows as the cap rate.  This is the rate of return that you would be happy with if you paid 100% cash for the building. Traditionally cap rates for investment properties were around the 10% range, however, in recent times this rate has been reduced to 6- 7.5%.  Below that is generally not a great idea unless the investment has some real upside, i.e. it has additional land or it has been extensively renovated or the leases are very long term. 

A good indicator would be comparing the return to what you can earn if you invested the money in a GIC, if you can get 4% for a 5yr GIC with no risk, and then perhaps you might want a higher return for the risk of buying Real Estate. Don't allow the low investment rate of today move you away from this strategy as the market moves in cycles and interest rates will not remain this low forever, nor would the GIC rates be as low as they are today.

Another, factor to consider, is the current mortgage rates. If you can buy an investment property at say a 6.5% cap rate, but put 25% down payment and get a mortgage in the 5% range. Then on the money invested you will earn 6.5% but on the money you have borrowed and additional 1.5% thereby increasing your return on investment ROI to well over 11%. 

In addition to the above, you need to consider Depreciation as well as appreciation but this is where it gets complicated and the need to seek the advice of a seasoned Real Estate advisor. However, the most important rule is patience. Do not rent your property to anyone unless you have checked them out fully and by checking them out, you have investigated their references and you have pulled their credit report. Then and only then, should you consider renting your property to this individual.

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