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.
- People will stay longer – They might but is it really worth $200 per month to you? For a long time?
- It’ll rent faster – It might, but is it worth $200 per month to you?
- 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.
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.
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 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.