-Why do you think someone should spend the money in the 2016 Alberta economy to develop a legal secondary suite?
A legal secondary suite may be the only way to get a SFH to cash flow now that the rents are down. Since there are a limited number of legally suited properties available in the Calgary market that also means there are niche opportunities for legally suited properties.
Cash flow matters less than
yield. Yield is the maximum productive capacity of a property. R - E = NOI. NOI / cost = yield. This allows you to compare
any asset. Cash flow is not a good comparison metric.
Let's take your property that costs / is valued at $440,000 and makes $4,000 gross a month. $4,800 / year property tax, $1,200 insurance, $1,600 maintenance, $7,218 property management, $450 marketing, $880 bookkeeping and accounting, $4,010 for vacancy = NOI of 27,962. NOI / property value = 6.36%. That is the return on the asset. That is the productive value of the asset.
Now, the operating budget is fixed. It does not exist as a percentage of revenue. We can't just say that our operating expenses are 45% of gross revenue. The operating expenses are a
set budget of $13,304 per year no matter how much revenue we are able to generate. The only exception is that property management fees are driven by revenue. Usually property taxes do not drop (even if the city lowers assessed value they have an operating budget and will just increase the mill rate to collect the same amount of taxes. Let's say rents come down 10% from what you achieve. Now the yield is 5.52%. What if rents are more in light with
today's market averages? Up = $1,500 with utilities and down $1,200 with utilities. The yield on this property is actually 3.62%. Now, what if rents come down 10% from the actual market average? Now your yield is 3.05%.
The thought that a legal suited property is worth more on both floors than the rent on a Calgary penthouse is a bit ridiculous though.
- Calgary vacancy rates increasing and rents decreasing
Depending on the type of property, location and tenant profile, demand is different. When tenants have lots of choice having the option of a legal suite is an advantage to the landlord since they will be preferred. Very well written ads and referrals from existing tenants are also going to be key.
Name
one type of property with increasing rents in Calgary. Obviously better ads are going to get more tenant selection. But no one is bigger than the market. Anyone can get lucky once. Selling one super high unit is not the market. Tenants are going to shop that. I watch this very, very carefully. Vacancies are up, rents are down.
Remember, you are only new once. After the new effect is worn off and everything is not new-sparkly you are with everyone else in the market. Old stock.
- Sales volume down, total listings at 5 year highs, and much more inventory available for buyers
That means there is buying opportunity for properties that may easily have an existing illegal suite legalized or building a new legal suite in a property that would then provide net cash-flow
- Home prices are very likely to fall in Calgary this year
Certain price market segments will be more adversely affected than others. If buyers only focus on average prices then they will not understand what is happening in the different market segments and communities and miss opportunities. Even last year prices in some areas increased.
Even in Edmonton, we have seen huge falls in the prices of legally suited homes. I think they are actually the most affected market segment in a market downturn. Compared to 2014, prices are down for legal suites 10 - 15%. I am not joking. Even good investors are selling a few good assets to ensure they have strong cash reserves. I am not recommending not to buy. I am saying BUY. Just don't develop. Market prices are
falling. Especially for already developed and rented secondary suites.
- with equity underwater and property values falling, you will not be able to refinance to pull out secondary suite development costs
With proper preparation, and planning investors/owners should be able to obtain refinancing. Legalizing the suite might be the only thing that will bring your value up compared to other properties. For some a legal suite may be the way in which they avoid foreclosure and are able to stay in their house or they may need to create a safe private living space for family.
For individuals with absolutely zero options in a foreclosure situation, yes develop the suite. But to buy a house in Calgary that is not developed right now is ridiculous. Total waste of cash.
No, you will not obtain refinancing. With 20% down and a falling market you will end up putting more cash into the suite for developing than you will see out of refinancing. Further, you lose money due to carrying costs and having the undeveloped suite in the basement vacant. You will likely also have to reduce rents upstairs. Once you appraise, market value likely be lower than the total cost of the property. So you are overinvested because you could have bought something fully developed and had no initial vacancy.
- for the exact same yielding property (NOI / property value), you will need to have 75% more cash equity invested if you develop right now. This doesn't make sense to me.
I am not sure how you have come up with 'you will need to have 75% more cash equity invested'. For them to be the exact same yielding property as you say then comparative properties would have to have a legal suite along with many other similarities. If you are comparing yield on a single family home in Forest Lawn versus a legally suited property in Capital Hill then that is apples and oranges. They have different demographics, buyers and tenant profiles. The key is knowing how to maximize the leverage of your capital.
"Leverage" is meaningless. Yield is everything. Cash flow is something you choose after you find the property with the best yield. You choose how much debt you want to ensure you have the level of cash flow to afford R&M and provide the liquid cash return you want. Every house cash flows. Every single SFH in Calgary below about $600,000. The difference is yield.
You will have 75% more cash invested because you need to pay for all the renovations using cash because you are cash for all suite renovation costs. Since you are already 80% LTV, and you must now put up about 75% of your initial equity cost into renovations you have 75% more equity cash invested. That is after you consider the loss from rent during renovation. I’ve build
many secondary suites. The cost is closer to $40k on average. Furnace is $12k with ducting. It just is. Windows are $2k. Ceilings with Roxul insulation $3k, interconnected smoke detectors and electrical sub panels plus electrical for kitchen and dryer $4k, plumbing $3k, flooring $4k, appliances $4k, finishing and painting $3k, kitchen cabinets and countertops $5k. It is not possible to get super-utra 60% over market rents and have a poorly developed suite. That is not going to work. If you want premium rents, you need a premium product.
It is up to you to choose whether you are going to run and hide and wait and see or get active and look for opportunity. As Don has always said these types of markets are great for finding opportunity. Many will only listen to the negative rhetoric of the news get ready to bail out and not take the time to dive deeper for themselves to seek out opportunity. For those that want to run there are many sophisticated investors waiting for opportunity.
All I am saying is match the strategy to the market cycle. When people panic and want to sell their well-developed properties with legal suites, buy them. Don’t develop! Waste of time and money. Better yields are available that are easier to achieve.
