Question around purchasing my first investment property?

[Mellon17]

Hello,



I am a regular reader of this REIN forum and I find the information to be fantastic. I have a question which I'm sure many people deal with when looking to buy their first investment property. I would love to hear some advice or recommendations from your past experiences. I am looking to buy my first investment property but I do not have enough for a 20% down payment. I am looking in the Calgary market for a single family home and obviously Calgary prices are not cheap (maybe I should be considering lower priced markets). I am a home owner and make a good salary but with houses or even half of a duplex that I would consider buying being in the mid $300k and up range and up, I dont see myself being able to save $70K + anytime soon. Here are the options that I feel I have



1. Purchase a new primary residence for my family and I, then rent out my current house. The pro's to this are I could pay 5% down on my new residence since I will be renting out my current residence. In looking at comparable home's in my community I feel I would be get positive cash flow from this rental after everything.

The cons to this scenario are that to purchase a house in the area of Calgary that we want to stay in, price's have gone up quite a bit so I would be taking on a more expensive mortgage, plus still carrying my current mortgage.



2. Take out a HELOC to purchase a rental property at 20% down. My only concern is that I wont be able to find an investment property with positive cash flow after adding my monthly HELOC payments to the equation.



3. Sell my current house which has about 100K in equity. Purchase a new primary residence at 5% down (which will cost more than my current home due to prices going up), and put the rest of the equity towards the 20% down on an investment property.



Any advice that you could share is greatly appreciated!

 

[Tootse]

Thoroughly run the numbers, and get a complete understanding of the financial advantages/disadvantages of each scenario. Others with much better knowledge and experience than I will hopefully chime in about the financing side. However, I have found, having recently just gone through what you are contemplating, another consideration just as important is what effect it will have on your family. Perhaps this will be the opportunity to move to a new neighborhood that will improve life for you and your family. Keeping your existing house as a rental, you can take your time and choose the type of property in the location you want which will improve your family's life, and pay with 5% down.

Hope this helps.

Good Luck.

 

[Thomas Beyer]

Renting your existing home may make sense if (and only if)

a) rent is sufficiently high to cover debt and other expenses such as property taxes, and

b) you have some reserves for three months vacancies, and

c) you are familiar with the rental business ( both from a legal, marketing and emotional point of view).



Don't buy more rental real estate if you do not have 20% down in Calgary. It is too levered and very hard to cash-flow, especially if the 20% is from an LOC, too.



Look at the overall debt and income picture with two houses.



Consider cheaper cities such as Red Deer, LLoydminster or Edmonton.



Educate yourself in how to find renters and market to them, and how to hang in financially and emotionally.



Weigh the chance of negative cash-flow with the potential upside, based on sound assumptions and in-depth market research.



Related posts here, including how to get started: http://myreinspace.com/public_forums/Real_Estate_Discussion/62-10689-121574-Educational_REIN_Posts_by_Thomas_Beyer.html

 

[Mellon17]

Thanks Thomas & Tootse,



You both have great points! Thomas thanks for all the links, I spent most of my night reading them. There is some really useful information in there which you don't find in most real estate investment books. I look forward to reading your book, its on order from amazon.



Thanks again.



Adam

 

[Thomas Beyer]

[quote user=Mellon17]which you don't find in most real estate investment books.


thanks.



That is the plan for book 2 .. in (slow) progress right now.

 

[invst4profit]

Lots of good advice provided, lots for you to think about.



Your option to move and rent out your present home is probably a bad decision. This is how many investors start and end their investment career. I have yet to see a personal single family home converted to a rental produce significant cash flow to warrant the work and stress to hold on to it. My guess is you have not crunched all the numbers related to a income property, in fact I doubt you know all the numbers, but if you did you would not consider that option. Off the top the rental amount will be too low based on the value of the property and generally 50% of the rental income will go to expenses before paying your mortgage. It will probably be a money pit.



In my opinion you should either wait till you save enough money for a down payment on a purpose bought rental or sell and purchase a new primary residence that has a separate rental unit in it already.

 

[Mellon17]

Hey Greg,



Thanks for your response! I do have my concerns with the option of renting out my current home and purchasing a new home as well. But my concerns are more around the overall cost since I will be carrying two decent sized mortgages. If I were to have any months of the rental not being rented it would definitely be an impact financially. However I'm not sure your correct about the rental being to low based on the property value, let me explain and see what your thoughts are. The house is located in a sought after neighborhood with not many properties for sale and a very fast turnaround on any that do go for sale. Since purchasing it the sw line of the ctrain has come this way and the last stop is a 6 minute walk from the property. There are very few rentals in the neighborhood and the few that are available are much larger houses, renting anywhere from $1000 to $1800 more per month then I would be asking. The only recent comparable rental to mine is a neigbor around the corner who I spoke with last week. He advertised his house for a little over 3 weeks and locked in tenant for the $2800/month he asked for. I believe I would be able to rent mine for $2700/month. I am currently paying $2050/month for mortgage, property tax, and home insurance. The house is 7 years old and has needed little to no maintenance up to this point. If I can in fact get a renter for $2700/month I don't see how those numbers wouldn't work, even with maintenance and expenses.



The option which is sounding best for me right now is to sell my current property and purchase a new property at 5% down. Then with the equity I received from the house (after down payment on the new house), I will purchase a rental property at 20% down. Your suggestion to purchase a property with a separate rental unit is not an option for us, just personal preference of a pregnant wife.



Thoughts?

 

[Thomas Beyer]

[quote user=Mellon17]get a renter for $2700/month


I am always amazed what risk people take with a single tenant $400,000+ asset. What is the approx. value of this home if you sold it ? $500,000 ?



You are aware that a bad tenant can cause $50,000+ in property damage ?



What person rents a house paying $2700/month in rent ? Why does he/he not buy one ?



Personally, I'd stick with houses less than $250,000. I own two houses, rented, valued at over $300,000 and decided to sell them both as I find the risk to reward too high.

 

[Mellon17]

Hey Thomas,



Yes, the property is valued at just over $500,000. You raise a very valid point about the risk or renting a higher priced home.



As for who rents a home for $2700/month I am not totally sure but it seems to be common in Calgary. There are places in my neighborhood that have rented for $3500 to $4500/month. In speaking with my neighbor he mentioned his renter was an executive working in Oil and Gas and not moving here long term. He mentioned the companies often pay their employees a living allowance so they are able to rent nicer houses and not have to pay for all of it out of pocket. I suppose they rent if they are here in the short term (1 year), or until they decide they want to buy.



I agree that the risk to reward ratio is not great. I think selling, and using my equity to purchase a lower priced rental is the best option.



Thanks,

 

[Thomas Beyer]

It may make sense, especially if the house is close to LRT as it may go to $600,000+ in a few years. I am not saying what you should or should not do. I just want to alert you to the various facets to be considered. You are the master of your own fate, the CEO of your life, thus you have to decide what works best for you and your family.



Two houses at $250,000 each, or three at $167,000, or four THs at $125,000 each may, or may not, make more sense for $500,000.



Perhaps rent the house first, aiming for an oil executive with a corporate lease at $3000+, then move out and buy elsewhere with a pre-approved mortgage !



Keep the stress level of a pregnant wife to a minimum, though. There will be houses to buy a year or 2 from now !

 

[Tootse]

My house that I moved out of is 7 years old also, however, it is valued much less than yours at about $300000 and is a duplex (legal basement apartment). Brings in $1900 in rent total. After mortgage, insurance, taxes and water (which you may have missed in your calculation) it cash flows about $500. I manage it myself, and of course there are maintenance costs which eat into that $500. The numbers are good enough for me to sleep well at night. Keeping it as a rental worked for me in my situation and for various reasons, all of which outweigh the financial risks of only cash flowing as described above. I have a bit of a buffer against vacancies as it is a duplex. I have to manage it and choose tenants extra dilligently to prevent damages, etc. I know the property and condition of it, compared to a poorly renovated property which may look nice at the surface that may present a lot of issues for you to deal with in the future. Living in the neighbourhood and getting a feel for what type of people like the neighbourhood and what they like about it makes it easier for me to market it. There aren't a lot of properties (that appeal to me) to choose from in my part of the country and by keeping this one I can continue gaining expertise in this neighbourhood with this type of property.

Tootse

 

[invst4profit]

Thomas makes valid points that anyone thinking of renting their personal home should consider. In addition renters are very hard on a property and you will always have some vacancies.

Generally if the annual rental income on a property is not close to 10% of the actual value of the property it is not worth while as a rental.

The mistake most novice landlords make is always underestimating expenses. A new landlord happily moves along, sleeping well at night, believing they have a few hundred dollars a month cash flow when in fact their property in the real world would never produce postive cash flow. They ignore the fact that vacancies do happen and will total several months over the period of 5 years, they forget that every dime that has to be spent on re roofing, painting, hot water tanks, new furnaces, new flooring, cosmetic repairs between tenants, new appliances etc, etc will all happen and will chew up the previous 10 years positive cash flow. They also ignore such costs as accountants, income tax, advertising, evictions, hydro when vacant, and intentional damage done by a single bad tenant that can amount to 10s of thousands of dollars.



If inexperienced landlords had any concept of the real financial risks they were taking when renting out a high value single family home not only would they not sleep at night they would probably end up with a nervous breakdown.



Calculate 10% of your homes value, divide by 12 and if you can not rent the place for very close to that amount you are making a big mistake that will become evident only when it is too late. That is one of the primary reasons single family homes rarely cash flow over the long term.

 

[Angela123]

I think `Purchase a new primary residence for my family and I, then rent out my current house.` Will be the best variant for you and your family. Calculate the income you can get in case of renting, it will satisfy you. You can save money that you get from renting your current house and then (of course not in some month, maybe even years) you can change the new primary residence for you family for something better. In any case, mortgages are available, however, for prospective homeowners at all different income brackets, some offering down-payments as low as 3.5% of the value of the home.

 

[MrsWalks]

Hi Adam, I just purchased my first rental property in October in AIRDRIE - a brand new 1100sqft 3 bedroom townhouse, hardwood flooring, granite countertops, master bedroom ensuite, no garage - $244,000 and I rent it out for $1650/month plus utilities.......it took me a year of looking at properties to find this one and it cash flows enough to allow me to sleep comfortably at night (over and above all expenses, R&M, PM and Vacancy)....look outside of Calgary for lower priced properties while you're saving up your downpayment.

 

[Mellon17]

Thanks MrsWalks, I appreciate the advice and congrats on your first rental. I agree the surrounding communities of Calgary offer way more bang for your buck. $244K for a 3 bedroom in Airdrie is a great price, I hope to find a similar deal when the time comes. Thanks

 

[invst4profit]

[quote user=MrsWalks]Hi Adam, I just purchased my first rental property in October in AIRDRIE - a brand new 1100sqft 3 bedroom townhouse, hardwood flooring, granite countertops, master bedroom ensuite, no garage - $244,000 and I rent it out for $1650/month plus utilities.......it took me a year of looking at properties to find this one and it cash flows enough to allow me to sleep comfortably at night (over and above all expenses, R&M, PM and Vacancy)....look outside of Calgary for lower priced properties while you're saving up your downpayment.


This is a ideal situation to show how an apparent cash flowing property would in reality be cash negative.

If we assume a mortgage of $170,800 at 3% the monthly cost is $808 (at 5% = $993)

Return on downpayment of $73,200 at 3% is another $183 (at 5% = $305)



Long term expenses on a rental property range between as low as 30% to above 50% . The average long term expenses on a rental property are generally 50% of monthly rental income.



In this example if we assume a 3% interest rate and expenses at a low of 30% we have: $1650 - ($808 + $183 + $495 ) = $164 positive cash flow/m.



If interest rates rise to 5% we have the following: $1650 - ($993 + $305 + $495) = -$143 negative cash flow/m



With expenses at the normal average of 50% of monthly income subtract an additional $495 from the cash flow. Not an attractive investment scenario.



Provide a few years of service on the property which will involve increased repairs, upkeep, vacancies, etc and the expenses will climb bringing the expenses on a long term investment to 50% of monthly income (extending back to point of purchase).

Realistically this property minimally cash flows as long as low interest rates hold (even with annual rent increases) but it must be sold before it requires any long term capitol expenses.



I would not be comfortable with a rent of less than $2000/month on this property.

 

[Thomas Beyer]

[quote user=invst4profit]Return on downpayment of $73,200 at 3% is another $183 (at 5% = $305)
That is not cash-flow, nor proper math. It certainly is opportunity "profit" but should not be counted in a real estate purchase. It could be used at best as a benchmark ROI.



[quote user=invst4profit]normal average of 50% of monthly income
True for older assets managed by third parties. Not true for brand new ones, especially if self managed.



Here is the approx. math on this TH:



Annual rent of roughly $19,500

minus 5% vacancy = $18,500

minus mortgage payment of roughly $10,000/year

minus insurance and property taxes, say $1800+ $2200 = $4000

so roughly $4500/year cash-flow before occasionally covering R&M

add back mortgage paydown of roughly $4000/year and, assuming self management, you get roughly $8000/year in wealth creation, perhaps $2000 less if you pay a property manager 10%.



PLUS value upside, say 2%/year or $5000 thus a wealth building opportunity of roughly $13,000 a year (minus say $2000 in R&M or $10,000 in 5 years for the usual vacancy or new carpet or fridge or paint job on tenant turnover) .. so let's call it $10,000/year .. on an investment of $50,000 or 20% down. 20%/year .. give or take i.e. $50,000 in 5 years or well over $100,000 in 10 !



NOT BAD.



btw: change the very conservative 2% annual appreciation assumption to only 3% and it is $25,000 more in 10 years .. and if 4%/year $50,000 more in 10 years. True wealth creation, tax free until sold.



The trick is to hang on emotionally (due to debt and the odd vacancy and tenant headache or property issue) and to hang on financially (i.e. have reserves due to R&M and vacancies) .. and true wealth of $1M can be built with only 3-5 average townhouses !



As such: keep on buyin' (if you can hang emotionally and financially)

 

[invst4profit]

Thomas a considerable amount of your numbers are based on "speculation" something that I as an "investor" do not include on my calculations. I do however include all costs and necessary returns (equity in home) as I have posted. Income investment properties in my calculations have two income streams. The income from the rental of the property and the income generated by the equity in the property. If equity in the home does not generate an income then a home purchased with all cash would have a returned calculated to infinity.

To each their own but defiantly not how I do business epically in light of 2008, the fact that all real-estate in Canada is greatly over valued and it inevitable that interest rates will rise.

Personally I see an adjustment coming that will seriously impact speculators calculations.

 

[Rickson9]

[quote user=MrsWalks]Hi Adam, I just purchased my first rental property in October in AIRDRIE - a brand new 1100sqft 3 bedroom townhouse, hardwood flooring, granite countertops, master bedroom ensuite, no garage - $244,000 and I rent it out for $1650/month plus utilities.......it took me a year of looking at properties to find this one and it cash flows enough to allow me to sleep comfortably at night (over and above all expenses, R&M, PM and Vacancy)...





Only speaking for myself, this is a poor investment. I couldn't get myself to spend $244k to gross less than $20k. But that's me. Different people have different criteria.

 

[Thomas Beyer]

[quote user=invst4profit]ch their own but defiantly not how I do business epically in light of 2008,


I agree that leverage adds risk to the portfolio, however it allows you to make far more money in at least flat markets, and especially those that are rising, such as GTA's, Alberta's, SK's and pockets of BC.



[quote user=invst4profit]that all real-estate in Canada is greatly over valued
I disagree here. Some areas are indeed overvalued, but not many. Compare even GTA's or Vancouvers expensive condos with other large cities like: Hongkong, Dubai, Singapore, Munich, London, Paris, New York, Chicago and you will see that they are not all that high actually.



[quote user=invst4profit]it inevitable that interest rates will rise.
You may be surprised how long it will take for them to rise substantially. I see about 20 to 30 years, namely until most baby boomers have died and burned off their entitlements in CPP, EI, pensions, healthcare etc.



Canadian prime rate is among the highest of the G8 and may actually go lower !



[quote user=invst4profit]speculators calculations.
2% annual appreciation, on average, is far below the last 30 or 40 years, and quite conservative. Hardly speculative. I'd call it prudent. Many US or Canadian markets have gone up 20% the last 3-4 years alone, many far more than that say in AZ or FL or CA, after a correction from 2007-2009.