Until a few weeks ago I had never really thought of investing in real estate. By far the main factor in my refusal to think about purchasing an income property is the Pain In The Ass (PITA) factor. See, I’m not much of a handyman and it’s all I can do to keep my own place up to snuff. I definitely don’t want to have to deal with idiot tenants breaking stuff that I don’t have the time or the inclination to fix. In fact, dealing with clients and mortgage brokers in general kind of scares me. I hear these horror stories about renter’s rights and nightmare tenants and I think that no ROI could be worth that headache! When you combine the PITA factor with the relatively high cost of Canadian real estate right now and high land taxes, it was never an attractive proposition to me. I figured that a few REITs in my investment portfolio would be about all the exposure to real estate I’d ever want.
My Friend the Math Genius/Handyman
So what changed? Basically, my buddy presented me with an interesting thought (and that’s all it is for the moment, a mere thought or consideration with nothing solid in place) about how I could invest in real estate and almost completely eliminate the PITA factor. Now I can already hear the groans in the peanut gallery about taking investment advice from a friend and why that can often lead to trouble. The vast majority of the time I would be saying the same thing, but in this case, I truly believe him. Here are a few reasons why I think my friend James (all names changed for privacy purposes) and Steph (his common-law wife) would make much better landlords than myself, and why I think their plan has a lot of merits.
1) They’re really good at math. This might sound simplistic, but I find that many Canadian investors don’t have a solid grip on financial realities. This can lead to all kinds of errors and miscalculations concerning profitability. James works in agribusiness and had a math minor in university. Steph is a high school teacher that specializes in advanced math.
2) They’re both very even-keeled. I try to stay level, I really do. I know it’s better for my heart and that people would probably like to be around me more. It hasn’t really worked yet. I prefer to think of myself as impassioned as opposed to being too emotional. James and Steph have the whole low blood pressure thing down. If anyone could deal with a little property manager-related stress it’s these two.
3) James is very handy and has valuable experience. During the summers James used to do repair work for the Ontario Provincial Government. His job was basically to go into low-income housing that the government-owned and fix everything that needed to be maintained. This is in addition to the fact that the guy is just pretty damn smart and can problem-solve things that would stump me in perpetuity.
4) Family Connections. James’ dad is an electrician and his Father-In-Law is a plumber. These are obviously very valuable skill sets to have at your disposal.
5) Great Work Ethic. I’ve known James for a long time and his work ethic is second to none. He will not hesitate to put in the time necessary to make the whole landlord deal work.
6) Location. Location. Location. James and Steph live in Saskatoon. If you’re not familiar with the small city, it is located in one of the most economically vibrant parts of Canada. Not only is there a booming economy in the area, but also a fairly diversified one. Oil is a major factor, but so is potash and other resource extraction, as well as an agricultural industry that is as healthy as it has been in a long time. Rental rates for multi-family units in the 900-1,000 sq. ft. range typically rent for $1,500-$1.800.
Four Times the Fun?
While James and Steph have modest initial plans for dipping their big toe into real estate (renovating a basement suite on a newly purchased house) their eventual plan would be to own a fourplex, and possibly to expand from there as they build equity. Just for information’s sake, they have kept an eye on the market for multi-family units for a while now and they reported that nothing has even gone to market for some time in the high-demand area (admittedly private deals could have been done with no public record). Consequently, they are tossing around the idea of building a new fourplex 3-4 years down the road.
Obviously, there are advantages and disadvantages to building a new structure with the goal of making it an income property. First and foremost, James and Steph have found out that it is much harder to secure financing for a new structure as opposed to buying something that is already in place (this might actually work to my advantage as a silent partner who basically can only provide capital and some grunt labour in the summers). Even when you consider that there will be far fewer repairs on a new building, the initial building cost will likely mean that it will just be more expensive (re: less profit margin) to build a new structure than to purchase an old one.
Related: Rent Versus Sell Condo: The Low Down
On the other hand, James raised an excellent point that he would be familiar with his fourplex in a way that most landlords never could be, having helped build it from the ground up. We reasoned that as long as we could secure the services of a decent contractor for a little while, we could provide a lot of the raw horsepower needed for building ourselves. James’ father and FIL would obviously be valuable resources to tap into as well and would likely provide their services at a steep discount off of the market rate. The massive energy efficiency advantage that a new structure would provide should not be discounted over the long term either. James and Steph love the Saskatoon area and want to stay there for the rest of their lives, so they will be able to reap the benefits of building new structures for several decades.
After chatting with each over beers a few weeks ago (don’t all investments sound better after a few cold ones?) we’ve each done some reading and tried to put some extremely preliminary numbers down on paper. Then we thought the best way to see if we were on the right track was just to make the figures public and see if people agree that they were realistic or if they would poke holes in them. I had supper with an old teaching mentor a couple of weeks ago (shops teacher) and in his “retirement” he’s busier than ever putting up a four-plex this summer in Western Manitoba. He says it’s going to cost between 600K and 620K. It sounds like the units being built are pretty similar to what our thoughts were, so I think this is a good starting point. James’ thoughts were that he lived a little out of town and that Saskatoon was expanding out his way. Just for preliminary numbers, let’s say it’s going to cost 650K to buy the lot and house (remember, this isn’t right in Saskatoon and we’re getting cut rates on our tradespeople).
For kicks, let’s do the fun part first. On the revenue side of the equation, let’s say we can get $1,600 a month for each 1,000 sq. ft. multi-family unit with a one-car garage and is located 10 minutes out of town. That’s $6,400 a month. I think that’s a pretty accurate number to start with.
While it’s a nice thought to imagine that money pouring in, let’s take a look at what we figured the ballpark monthly expenses would be:
Mortgage: $3,200 (500,000 mortgage, 150,000 down, 25-year amortization mortgage calculated at 6% since interest rates aren’t likely to stay low forever)
Taxes: $900 ($11,000 yearly)
Vacancy Rates of 10%: $640 (most guides said to estimate 10-15% vacancies, but this is a pretty hot market and looks to be for some time)
Repairs: $540 (I know most real estate guys will say 2-3% for repairs, but I used 1% since these will be brand new units for at least a few years)
Total Estimated Monthly Costs = $5,580
Total Estimated Monthly Profit = $820
Total Estimated Yearly Profit = $9,840
Estimated pre-tax ROI ($150K down) = 6.56% (This is without considering the increased monthly equity)
Obviously, with an ROI of 6.56%, this isn’t a get-rich-quick scheme. I do know that there are other considerations such as the sweat equity and the headaches James and Steph would have as property managers. The increased equity and tax write-offs would help shelter some of our profits from the taxman, but clearly, this would have to be a long-term investment to be worth it from an investment standpoint.
So what’s the verdict? Do any of you have some real estate experience and feel like helping a couple of rookies out? Do these numbers appear sensible at first glance?