The method is the most hands on method of investing.
However, if you do it smart (duh), investing in real estate can generate additional sources of income and grow your savings.
As an individual who has literally grown up and lived in the real estate world, I see first hand the few positives and mostly negatives with property investments. While most endeavours of rookie property managers and landlords fail, there are few who succeed.
Its important to note that if renting is “your thing”, just remember landlords have no rights. Make sure you get the right tenant into your home. Its hell to get them out.
Making Money in Real estate.
There are 3 primary ways to make money with properties. Don’t count on appreciation in Canada.
- Purchasing property and renting it out.
- Buying real estate and re-selling at a higher value.
- Building new properties and selling.
1. Purchasing property and renting it out
This is the most common type of real estate investing. It requires the least amount of money and commitment.
To succeed with rentals, they must be purchased at the right price. A general rule of thumb I use is that the property should be 10% below market value. Whether the seller is going through a divorce or needs to move ASAP, these are scenarios which make the 10% rule achievable.
Second, the property should be able to generate multiple sources of revenue. This can be a basement, garage suite, duplex, or an apartment. By generating multiple sources of revenue you will increase profits. The mortgage payment stays the same and revenue will rise.
Third, the property should be purchased with the least amount of your money down. The reasoning, use the banks money and invest the rest (in equities and bonds). By taking advantage of low mortgage rates (1.5% locked in for 5 years), you are borrowing cash at a rate lower than inflation. Unbelievable. This is what I call free money and should be taken advantage of. Invest the remaining sum and you should be able to achieve a 6% to 8% return with a balanced and diversified portfolio.
Lastly, you must acknowledge that tenants have more rights then landlords. If you don’t understand what I’m talking about, just try to evict a tenant for not paying rent while living in your property. You’ll understand soon enough.
Evicting tenants is easier then you think, but it unfortunately takes time in the courts or with a tenant dispute board. If you attempt to remove the tenant yourself, you will find yourself in a lot more trouble than before.
Note: That is why you must make sure you screen your tenants properly before they move in. Make sure they a reliable, have steady jobs, and salaries that are over 30% of the rent. Don’t forget to call all past landlords and employers.
Pros and Cons of Rentals.
The greatest positive of rentals is that it is a long term and steady investment. You can purchase a property with as little as 5% down and mortgage the rest with the banks money. Properties can appreciate with time (don’t count on it in Canada) and can acquire more rentals if it works for you. You can depreciate your property and can use it for short term rent as well.
If you decide to Airbnb your property, make sure you check your cities guidelines and rules with short term rent. Airbnb properties have profound negative effects on the communities and are becoming more difficult to make profit due to city restrictions.
Take my word for it. Downtown short term rental market in GTA (greater Toronto area) is getting pummelled. Please don’t bank on Airbnb as an investment.
When it comes to the negatives of owning rental properties, the greatest negative is that it is hard to beat a 6% return on investment. Even though the majority is paid for by the bank, an investment account equal to your down payment will grow a lot faster. Because of this, you must use as little cash possible to buy the property. If you can beat 6%, great for you. I aim for 5%
Other negatives of owning rentals includes having bad tenants, buying the property above the market value and having excessive wear and tear and damages. You must make sure that you hire great contractors at good prices. Damage from floods and clogged drains will hurt your bottom line.
Working in real estate, I can truthfully say that the majority of individuals who purchase properties for rent fail. They forget to add in the costs of property insurance, taxes, wear and tear, vacancy rate (use 10%) and don’t screen their tenants properly. Purchasing the property lower than market value will give you some time to figure out the intrinsic principles of rentals.
2. Flipping real estate.
You better know your prices. There is no room for error.
Buying and selling properties can be a more labor intensive and hands on approach for investing in real estate. If you are able to purchase a property below market value and resale without changing anything, good on you. This approach takes the least amount of effort but is rarely done. The reason, a good realtor will pull the past listing and find out that nothing was changed. Unless the area is highly sought after, this method won’t work.
That is why the most common method to flip a home requires renovations. Whether minor or major, most people don’t budget in the costs of the renovation properly. They are inaccurate with the sale price and unsure on which renovations should be completed (the greatest return on capital). Many individuals forget holding costs, property taxes, and the realtor fees that the buyer pays when selling down the road.
Realtor fees are almost always paid for by the seller to both parties. Unless changed in the contract, this is 99% of the cases in property sales.
Positives and negatives with flipping properties.
The biggest positive with flipping properties is that you have the opportunity to make money fast. Restoring real estate takes on average 5 months. Building new however can take at 8 months and upwards until the final product is sold. If you get the property 10% below market value, you will have added 10% into your pocket.
Fixing it up on budget is key to success. My favourite reason why I favour this type of real estate investing is that you don’t have to deal with tenants. It requires slightly more capital then rentals and traditional mortgage are still used.
The greatest negative with fixing up properties is that most people struggle with restoring the home. They are unexperienced in trades and don’t have the skills to fix the investment. Most people will come in over budget and find the entire process extremely stressful.
Good news, with the boom on “how to” videos, almost any skill or trade can be self taught. Take a look at videos on YouTube. Most trades can be learnt quite easily.
Lastly, here are some tips I use when flipping properties.
See if you can convert a 1 or 2 bedroom home into a 3 bedroom house. Converting properties to 3 bedrooms is more desirable and usually very easy to do. Most of the walls around current rooms will be empty. This means there will be little costs associated with moving plumbing and electrical. Second, see if you can add or fix up existing bathrooms. More bathrooms will increase your resale value. 3 bathrooms is a number to be aimed for. Furthermore, its been shown that kitchen and bathrooms add the most value a home. They are the most labor intensive and if done right will give you high profitability in the sale.
Never forget that new paint and carpet is the best bang for you buck. Changing these two items can increase the wow factor in when people are viewing your property.
3. Building new properties and selling
The greatest risk equals the greatest reward. This is how I would explain home building.
Building a new home takes the most amount of invested capital. Traditional mortgages will not apply to this type of real estate investing. A mortgage draw (my article) must be used in its place and will require more money down than the latter.
If you decide to undertake this ordeal, you really must understand build costs and maximum resell prices.
Most people think that if you build a home that costs X, you should be able to add profit and cost of the land to make Y. Unfortunately, most neighbourhoods and properties will have a maximum value. For example, if the highest a new home sold for is $800,000 in an area, it will be tougher to get anything greater than this number.
For build costs, I would reach out to multiple builders to get budget pricing for the construction. Ask them about their views regarding resell pricing and make sure their reviews are satisfactory. Don’t forget to talk to your realtors before you purchase the lot.
If you choose to build the property yourself, you better make sure you know what your in for. No free time, increased management of trades and potentially alot more stress. I would not recommend this method. However, if you are unsure if building your home home is something for you, take a look at how to build your own home to get a general understanding. This article will give you a summary on the process that takes place.
Pros and cons of new home construction.
Selling a newly built home comes with the greatest risk in real estate investing. While it gives you the best chance for great reward, you can also loose your shorts and a lot more. Building homes first hand gives me an in-depth knowledge on why people fail, and how they can correct their actions to prevent significant loss in capital.
- They really don’t understand build cost, maximum property value for the area, and how to choose the right builder.
- They choose to build themselves and truly have no idea on the amount of work it takes. They become complacent, make mistakes, which costs additional capital.
- They don’t have enough capital for errors and additional costs. The bank approves the mortgage draw for too much money and you build over budget. Make sure you have the funds to increase build costs from 5% to 10% worst case scenario.
How to make money in real estate.
In the end, there are multiple ways to make money in real estate. Whether it’s by flipping homes or purchasing rentals, each method has its pros and cons.
I can’t emphasize enough that the greatest rule to remember is that you must use as much of the banks money as possible doing rentals. The leftover cash will handily beat your return in real estate by investing in the market.
If real estate is your forte, building new homes can offer the greatest reward but come with the greatest risk as well. Whatever method you choose, make sure to start out small and progress as you become comfortable investing in real estate.