How To Invest Successfully In The Real Estate Market

April 25th, 2011 · 13 Comments · Buying or Selling Your Property, Commercial Property, Property Management

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Creative Commons License photo credit: Yossari

I get this question with on a regular basis from investors… they’ll send me the numbers on income properties and as you saw in a previous example about analysing income property they are virtually guaranteed to not make decent money. Unless these investors are incredibly lucky for an extended period of time they will find that real estate is a very expensive business.

Real Estate Business Plan

Like any business, to succeed in real estate you need a plan. If your plan is wrong, you fail and this costs you money. Real Estate is a business with very low margins of profit and significant entry requirements.

Low Profit Margins

In residential real estate you’ll be making low profit margins on your investment even if you calculate your expenses properly and buy very wisely, it doesn’t take much of an unexpected expense to eliminate your profit for years. One really bad tenant who parks their non-paying butt in your property for 4 months and causes damages will do it.

Increasing Your Cash Flow

As a landlord you must never be complacent about increasing your rents. Unfortunately I see this a lot. There are several misconceptions about having lower rents that are just plain wrong, in my opinion.

  1. People will stay longer – They might but is it really worth $200 per month to you? For a long time?
  2. It’ll rent faster – It might, but is it worth $200 per month to you?
  3. I’ll get better tenants –  If you think that less education, less income and more dysfunction makes for better tenants, good luck!

You owe it to yourself to rent 100% of your space at the highest price possible. Yes it’s more work initially in the rental process but selling something worth $1000 for $800 is hardly the work of a genius. Believe me you’ll appreciate my advice when you need to replace your furnace 4 years from now and the money’s in the bank.

In Many Provinces Tenants Have Tenure

This means that your tenants who rent today don’t have to renew their lease, they can just live there forever month to month. This brings me to a question I often hear from people who are buying a building these days.

Rents are below market…how can I get rid of the current tenants? You can’t unless you want to hire your friendly neighborhood mafioso to go visit your building. Most people don’t have the stomach for this (including me) so you’re stuck with the tenant that’s paying $500 per month for an apartment worth $1000. If you’re the tenant paying way below market rent for an apartment…you’re unlikely to want to leave right?

Guess how much extra you the investor should pay for a building that’s rented under market value? Not one cent extra. Pay for the current income, not some weird premium for someone who’s done a lousy job keeping up the rents on their building.

Investors Should Not Pay Extra For…

For some reason, I’m seeing that buildings with these problems are being marketed as good investments and new investors fall into the trap of paying more for them. This means that you are paying extra to the previous owner for the fruits of your hard labour. Not exactly a master plan is it?

Rents Under Market Value

Great, I’m going to pay extra today in case tenants decide to leave. What if they decide to stay? How are you going to pay the mortgage? The deal with renting for more is that you’ll usually have to paint and fix stuff. I still think you should get paid for your smarts.

Location

The location is gentrifying too, so this is worth more money… uhmm no, call me in 10 years when it’s a premium location after you’ve dealt with years of so-so tenants while the area was up and coming. Then I’ll pay more.

Vacant Suites

There’s a few suites empty and the owner hasn’t rented them for some reason, you have to rent them and get tenants in. Let them do the work to rent it for the price they claim they can get and get back to you.

Potential

Potential of any kind is just that… potential. Until someone does the work to make the potential real…it’s nothing. Don’t you deserve to be paid for your hard work or do you want to pay the previous owner for the work you’re going to do?

Real estate agents are famous for flogging these kinds of things as reasons why you should pay more today for work that hasn’t been done yet. Let’s say for instance that there’s a lot attached to the property that could be severed and sold. You’ll have to go to city hall and see if it can be done and then next thing you know it’s not even possible but you paid extra… Are you going to get money back?

No Such Properties Exist…

Well if you’ve been following the news you’d know that interest rates are likely to rise, Canadians have the highest ever level of debt, the rent/buy ratio is lower than it’s ever been, ratios of income to housing prices sit at all time highest level and prices of properties continue to rise. Bubble or no bubble arguments rage endlessly. Should you invest? or not?

Keep Looking Until You Find A Property That Pays or Keep Your Money In The Bank

If you can’t find an income property that generates “gasp” income then don’t buy one. It’s that simple. Walk away or be forever doomed to keep feeding your property money. It’s virtually guaranteed that market conditions will change eventually because all the indicators point in that direction. The only thing we don’t know is when.

Walking Away Is A Skill You’ll Need

You’ll need to be strong to look into a number of properties and walk away from unprofitable ones. It’s a little like looking for a needle in a haystack. There are many people who will urge you to complete the deal, after all they only get paid if you buy. Realtors, brokers and bankers fall into this category. When it’s all said and done you’re the one trying to make the property generate income for you. Avoiding investments that are extremely unlikely to break even or make you significant profits is a skill. You may lose hope after a while and I suggest you don’t settle. Live to invest another day or next month or next year.

You Won’t Be Alone…

Many many old time landlords are just waiting in the sidelines until prices reach a level at which they will make money. They’ve been unable to resist the foolish amounts of money that they’ve been offered for their properties and they’ve sold. They’ll buy back in when they can have a reasonable expectation of making a profit. They know that no matter how much they plan, they’ll need breathing room to pay for the unexpected. I suggest you learn to do the same.

Hey Investors! Seen anything lousy lately? Walked away? Please share…

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13 Comments so far ↓

  • sami

    great article.
    discipline is very hard. It is so important to know and practice walking away. There is always going to be next deal.

    • Rachelle

      It is when you have that sense of urgency…I need to buy it now. An argument can be made that you need to buy a home because you need to live somewhere.

      Income properties are not like that, if it doesn’t make money what’s the point? It’s just a giant albatross in that case.

  • jesse

    So to be clear, do you think certain tenants deserve discounts compared to others? I don’t buy that landlords are necessarily being “lazy” or bad businesspeople by refusing to raise rents; it may be a rational move to give certain high quality tenants a discount compared to market rates.

    So here’s the question… you have two identical units, one with a stellar tenant (no issues), and another with a mediocre tenant (late payments, doesn’t maintain the place well, neighbour complaints). Should these two tenants pay the same rent?

    • Rachelle

      The problem is that there is no way to tell which tenant is which before you rent to them… the least of the costs is the pain of having a high maintenance tenant. Most of the reason that landlords have to keep the rents up is based on external costs.

  • jesse

    It just occurred to me — managed properties have an incentive to raise rents because they are typically paid a % of gross rent. Why not try to give yourself a raise? In addition, from an investor’s perspective, what type of property manager would you be if you weren’t raising rents? What are they paying you for?

    An “amateur” landlord, OTOH, is both investor and property manager. They see the “big picture” and trade off their personal time according to a different equation. No surprise, then, they would rather have a “sure thing” even if it’s at a lower yield. (To wit, check out bond yield spreads for the fungible difference between “sure thing” and “more risk”.)

    • Rachelle

      Well Jesse,

      The real problem is sustainability. If you don’t raise your rents over time as you go along it becomes impossible for you to maintain the building. In one building I used to work in we had 6 elevators that cost 3 million each to replace. We just didn’t have the money to do it even thought they cost a fortune to keep running and were broken all the time. Boilers, chillers and roofs all need replacement.

      It has nothing to do with good or bad tenants, if you want to stay alive in the landlord business you have to keep your rents up, your maintenance up and keep the owners happy by paying them some money. Losses from bad tenants are huge as well.

      You get to the point where it just doesn’t work anymore, bedbugs is another huge expense that is rearing it’s ugly head.

      Just in the last few years these are new expenses that landlords are having to pay, garbage fees, tax increases, bedbugs, longer wait times at Landlord & Tenant Board, hydro increases, gas prices up, HST. This is on top of regular maintenance…

      Housing is a valuable service, and to continue to be in business and provide good service landlords must protect the financial health of their business. Some condo building the same age as rentals have to charge $600-&700 maintenance fees and I’ve even heard of one building with $1100 monthly maintenance fee. This reflects the cost of repairing the building. Landlords get by on much less…they have to be extremely frugal.

    • jesse

      Hi Rachelle, no disagreement that ongoing bottom line cost increases regardless of tenant are important. I would not suggest a rational landlord refuse to raise rents in perpetuity just to keep a good tenant. What I am stating is that a tenant with a lower risk profile, which is verified after tenure begins not up-front, will, all things equal, demand a lower rent than one with a higher risk profile. This is the bond market analogy. So the question is, how much of a discount would a good tenant offer?

      I see it all the time in “amateur” landlordsville: a good tenant sees below-average rent rises for a few years, then at-market rises after that when the rents are adequately discounted to “incentivise” the tenant to stay. In my view that’s completely rational depending upon the investor’s risk profile.

      • Rachelle

        There’s no doubt about that Jesse, in fact that tenant who’s suing me for not having his storage key in time and claiming $500 in pain and suffering at the Landlord & Tenant Board is living in a unit that was built after to 1994 and not subject to rental increase legislation. How much do you want to bet that he’s either going to give me all that money back or move at the end of the year?

        I don’t usually increase rents in apartments with good tenants when they are paying market rents already. So if I’m renting apartments for $900 and tenants are already paying $900 then the rent stays the same, but if a tenant is paying $740 they have to get an increase.

      • jesse

        So out of curiosity, how do you convince a property owner that her suite’s rent should not be raised and she won’t be seeing increased revenue for the next year?

  • daigoumee

    Pretty nice post. I just stumbled upon your blog and wanted to say that I have really enjoyed browsing your blog posts. In any case I’ll be subscribing to your feed and I hope you write again soon!

  • Barrie Real Estate

    Buying pre-construction makes more sense for the investor than for someone buying for personal use. Thanks for this article, I found numbers of information that I can use in my tips of investment.

  • Japanese Language Birthday

    I like. Respect. Keep it up.

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