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Real Estate Investing 101: The Basics of Buying a Revenue Property
Many of my clients have seen their investment returns from stocks and the banks diminish over the last year and are curious about putting their money into real estate as an investment to grow their wealth. Here’s a very basic primer on what to look for and what to avoid if you are thinking about investing in a revenue property. Don’t take a chance with your revenue property purchase in Montreal, know the basics before starting your property search. If you’re at the start of investigating how to invest in a Montreal area revenue property, read on to learn the basics.
Learn to Leverage
Investing in real estate is different from investing in the stock market. Stocks cannot be leveraged, meaning you buy with the money you have available, whereas with real estate you can leverage the bank’s money on the form of a mortgage. However the entry-point for typical real estate investing requires more cash on the part of the investor, and the cost to buy or sell real estate involves much higher costs (inspections, broker, notary, etc.). Also the cost to maintain a stock portfolio is limited while owning a property requires both time and money.
However for those savvy investors who have put their money in well-located, well-run, profitable revenue properties, they have done very well for themselves financially over the past 10 years. Many of my clients have built very substantial portfolios of properties since the time I have worked with them and some have even managed to become financially independent since getting started in real estate investing.
When most people think of a revenue property they think of a duplex or multi-plex building that has multiple apartments that will be rented out to tenants, but this is only one type of revenue property. A property that generates revenue for the owner can also be a single-family home, a condo, a summer cottage or even a vacation property. We will not touch on commercial or industrial properties although the concepts are similar.
Besides the quality and location of the property, the most important factors to look for is whether the property will indeed generate sufficient revenue to cover your costs of ownership in the form of rent and whether the return you are getting on your investment is worth the extra time and money to maintain and manage.
The idea is that you can buy a property, leverage the bank’s money in the form of a mortgage and get back monthly payments (ie rent), which we call cash flow.
Cash Flow is King
On a very basic level cash flow can be understood as the cash that will flow back to the owner of a revenue property after all the expenses, taxes and mortgage are paid. As a simple calculation: You buy a property that generates $50,000 in rents every year. You have to pay for heating of common areas, cleaning and some electricity and that costs you $7,000 a year, and you have another $5000 in taxes to pay. $50,000 – ($7,000 + $5,000) = $38,000. Now let’s say your mortgage payments for the year come out to $15,000. $38,000 – $15,000 = $23,000, which would be your net annual cash flow, the amount of money that comes back to you after all operating expenses, taxes and debts are paid for. It’s the foundation for all other decisions that need to be made when buying a property. Either it cash flows or has the potential to, or it doesn’t, in which case you need to evaluate whether you should buy it or not.
Either it cash flows or has the potential to, or it doesn’t, in which case you need to evaluate whether you should buy it or not.
One huge mistake I see a lot of novice investors making is buying into revenue properties that do not generate enough income to cover the costs of owning it. Meaning, they buy with the idea they will pay out of pocket every month to “hold” the property and will be at a net loss every month just to own it. There are several “investment promoters” around Montreal who push these types of under-performing investment condos on unknowing investors, with the idea that they property will appreciate in value and so there is no need for the property to cash flow for the owner. Incredibly they sell the idea that this is a good way for wealthy investors to “show a loss” on their income tax.
Before you buy a revenue property, make sure it generates enough of these.
While that may be true for large investors or in very particular cases, and the property may go up in value over time, but would you ever put your money in a bank that said “We are going to take 10% of your money every month, you have to physically manage your bank account yourself BUT you might get more back when you decide to withdraw your money… or you might not!” At that point you are gambling, not investing. The numbers of small investor clients I meet who have been disappointed by these types of “investments” is astonishing. The same types of investment schemes are often offered to buyers of vacation properties.
If it doesn’t cash flow and you are not receiving a return on your investment, I would generally avoid it unless you indeed want to not just “show a loss” but “experience a loss” of your money
If it doesn’t cash flow and you are not receiving a return on your investment, I would generally avoid it unless you indeed want to not just “show a loss” but “experience a loss” of your money. If a property isn’t making money for you, what investor is going to buy it from you, when you try to sell; who wants a property that is losing money? A good real estate broker experienced in revenue properties can advise you on whether a given property should cash flow for you or not.
A Revenue Property to Live In
However this doesn’t mean that as a starting investor you should only look at cash flow positive properties, many investors began by buying their first duplex where they lived in and rented out the other unit to help cover all or some of the costs. While the owner lives there he is getting the benefit of living in the building, so it shouldn’t be expected to cash flow as well. The same can be said of vacation properties, if you are going to be spending your holidays there, then you are getting the benefit of enjoyment, so it may not be as important to make money from it.
Look at the Fundamentals
As a general rule, look for properties with good underlying fundamentals, structurally sound, in good accessible locations, near services, near transport, in areas that are growing, with heating and electricity paid by the tenants. The property may not be cash flowing currently, but it may cash flow nicely after renovations and improvements.
…do the due diligence that is required before taking on a substantial investment such as a revenue property.
Be aware of market rents and vacancy rates (your broker can provide you with these statistics), and don’t buy just because the price seems low and within your budget. Look at major renovations that are or will be required, and keep your calculator handy, to ensure the property will still make money for you throughout the time you own it. In other words, with your broker, do the due diligence that is required before taking on a substantial investment such as a revenue property.
We’ve barely scratched the surface of the most basic concept of cash flow, there is so much more involved with investing in real estate and many other ways people can get involved with real estate investing without requiring huge amounts of cash to do so.
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