How to make money in flat (or even slightly declining) markets

[Thomas Beyer]

Equity upside is always desired. Often the only way to make money in single family houses, raw land or condos realistically is through equity upside, as cash-flow is poor to negative with a 75% mortgage. Hence the focus on strong markets. Let`s face it though: not every market is an up market, and certainly not all the time. Many prices in UK, Ontario, Australia, BC or Alberta have risen to a point where affordability is seriously eroded, possibly for a long long time .. hence significant, fast equity upside it tough to get ..Hence, are there ways to make money in flat to even declining markets ?
Yes, there are, in commercial real estate, storage or multi-family/apartment buildings. These assets are essentially income producers and are usually measured as a multiple of annual cash-flow, also referred to as CAP rates or yield. The CAP rate is the net operating income divided over the price - also referred to as going-in yield. It is the inverse of the P/E ratio used for the stock market. So, in a declining market like Windsor, ON or a flat market like GTA, let`s assume you can get a 10% CAP rate, i.e. 10% yield after operating expenses and realistic vacancy assumptions if you paid in cash. Of course you don`t pay all cash, so let`s assume you get an 80% mortgage (with CMHC usually), so 20% cash down. This is 24% ROI on the cash invested in a flat market and 9% in a -3% negative market !

>>> You do NOT need equity upside in multi-family (or storage or commercial) to make money !

Just the going in price has to be attractive enough / the going-in yield has to be appropriate and the vacancies have to be managed ! The higher the (anticipated) equity upside the lower the CAP rate usually (like AB or BC right now ..) but excellent cash-on-cash ROI can be achieved in flat or even declining markets - if the yield (or CAP rate) is appropriate - see chart below !!

We don`t really care where we make 25% to 70% cash-on-cash !! Do you ?

Conclusion: buy in Windsor (or GTA or London or Calgary or Texas or Detroit or Ottawa or ..) : at the right price/yield .. and manage the vacancies / rents / expenses .. you`ll be amazed ... of course, the higher the expectation for future negative growth the lower the price / the better the yield has to be !!

Cash-on-cash ROI + equity upside using leverage

in 3 different growth markets: + 4%, flat and -3%



Left most column is yield (i.e. CAP rate) .. top line is various leverage level

Equity Upside 4.00% - "Normal" Market

Leverage: 0% 50.00% 60.00% 70.00% 75.00% 80.00% 85.00%

06.00% 10.00% 13.50% 15.25% 18.17% 20.50% 24.00% 29.83%

08.00% 12.00% 17.50% 20.25% 24.83% 28.50% 34.00% 43.17%

10.00% 14.00% 21.50% 25.25% 31.50% 36.50% 44.00% 56.50%

12.00% 16.00% 25.50% 30.25% 38.17% 44.50% 54.00% 69.83%

15.00% 19.00% 31.50% 37.75% 48.17% 56.50% 69.00% 89.83%

20.00% 24.00% 41.50% 50.25% 64.83% 76.50% 94.00% 123.1%

25.00% 29.00% 51.50% 62.75% 81.50% 96.50% 119.0% 156.5%




Equity Upside 0.00% - Flat Market

Leverage: 0% 50% 60% 70% 75% 80% 85%
6.00% 6.00% 5.50% 5.25% 4.83% 4.50% 4.00% 3.17%
8.00% 8.00% 9.50% 10.25% 11.50% 12.50% 14.00% 16.50%
10.00% 10.00% 13.50% 15.25% 18.17% 20.50% 24.00% 29.83%
12.00% 12.00% 17.50% 20.25% 24.83% 28.50% 34.00% 43.17%
15.00% 15.00% 23.50% 27.75% 34.83% 40.50% 49.00% 63.17%
20.00% 20.00% 33.50% 40.25% 51.50% 60.50% 74.00% 96.50%
25.00% 25.00% 43.50% 52.75% 68.17% 80.50% 99.00% 129.8%



Equity Upside -3.00% - Declining Market

Leverage: 0% 50.00% 60.00% 70.00% 75.00% 80.00% 85.00%

6.00% 3.00% -0.50% -2.25% -5.17% -7.50% -11.0% -16.83%
8.00% 5.00% 3.50% 2.75% 1.50% 0.50% -1.00% -3.50%
10.00% 7.00% 7.50% 7.75% 8.17% 8.50% 9.00% 9.83%
12.00% 9.00% 11.50% 12.75% 14.83% 16.50% 19.00% 23.17%
15.00% 12.00% 17.50% 20.25% 24.83% 28.50% 34.00% 43.17%
20.00% 17.00% 27.50% 32.75% 41.50% 48.50% 59.00% 76.50%
25.00% 22.00% 37.50% 45.25% 58.17% 68.50% 84.00% 109.8%

Left most column is yield (i.e. CAP rate) .. top line is leverage level

One reason why we see CAP rates rise in AB or BC right now (fall 2009) is the fact the the future equity upside is slightly lower than the last few years .. so anticipated rent growth is related to yield going in .. or as Tim Johnston puts it "sell into the boom" .. i.e. it has the lowest CAP rates !! (but why sell if you can make money in ANY market with cash-flow buildings ??) True wealth is built by holding .. with cash-flow !

 

[housingrental]

Hi Thomas
A great post
Lower LTV, higher reserves, and long term holds are the path any current real estate investor should focus on

 

[Thomas Beyer]

QUOTE (housingrental @ Sep 6 2010, 10:27 AM)
..

Lower LTV, higher reserves, and long term holds are the path any current real estate investor should focus on


indeed .. the times of 10-15% down, make a quick buck in a year or 2 in any market are over in real estate. The new normal is the old normal: steady as she goes, put 25 to 40% down, cash-flow, re-fi or exit in 5 or better: 10 years .. make a comfortable and reliable high single to low double digit on your cash invested .. become a millionaire .. but not overnight !! Not a get rich quick scheme .. but a "get rich for sure scheme" .. but it will take a bit more time than we saw from 1995 to 2007 .. quite a bit more time in fact !



More here including Don Campbell's view:



http://myreinspace.com/rein_members_only/Members-Only_Discussion/81-18040-Buying_First_Property_--_Need_help_on_how_to_proceed.html

 

[Berubeland]

I also wrote a blog post about this issue.

Making Money in Real Estate
Written by Guest Blogger on Mar 24, 2010 filed under Real Estate Print This Post

You’ve asked for more real estate posts, and here it is. Rachelle makes a living in investment real estate and will share with you some trade secrets.

It is possible to make lots of money in real estate, but it can be difficult to get basic information. American information is abundant but much of it does not apply to Canada.

There are people who have outperformed the market time and time again. In many cases they’re not really sure how they’ve done it themselves.

Here is a list of 6 different strategies that you can apply to make money in real estate. You can apply a strategy to any real estate purchase you make and it will serve you well. Combining approaches will increase your chance of success.
1. Area Appreciation

Area appreciation is when you buy a piece of real estate in an area or neighborhood that outperforms the rest of the city. Implementing this strategy requires inferring which area is going to be the next hot place to buy.

Since I have been in Toronto I have seen many areas rise exponentially in value. I remember driving along Dundas St West a decade ago, almost every storefront was abandoned and the prices reflected that. During that time trying to sell a building would have been very difficult. A drive along that strip 10 years later and there is no vacancy, tons of franchises and established local businesses and the entire area has probably doubled in value.

Another example of that same phenomenon happening is Oshawa. A short commute from Toronto, you can buy a 3 bedroom bungalow from $100,000 and 3 bedroom townhouse for even less. In my opinion this is one area that will see very high appreciation. Buying in areas adjacent to a major city is an excellent strategy that provides higher returns.
2. Buying Opportunities

This scheme involves taking advantage of unfortunate circumstances happening to the seller of a property. Real estate is not very liquid. A desperate seller may have to reduce their price.

Homeowners may just want to dispose of a house. Why? Financial problems, divorce, out of town transfer, estate sales and illness can all present motivations to sell as quickly as possible. What used to be a treasured asset becomes a burden.

Patience is the key if you are looking for this type of deal. Spread the word far and wide that you are a buyer. You must be ready to buy and close quickly. A significant discount is available for these savvy buyers.
3. Adding Value

This method of real estate investing involves buying a property that is run down and fixing it up. This is easiest for the person who is handy or in the trades but if an opportunity presents itself, you can hire a contractor. Dirt, disgusting smells, bad paint choices are all easy fixes and money in your pocket. You pay dearly for polish, cleanliness and staging.

For intermediate projects you can install new kitchens, baths, flooring and more.

Then there are advanced level projects like houses with structural, mold, electrical, heat or water issues. At times you can find a property that is in the midst of a major renovation that has been interrupted.

Making money by adding value is not for the faint of heart. Anyone who has ever done renovations will tell you that once the walls are opened up there are likely to be expensive surprises. For the right person this can be a gold mine.
4. Time

This way of making money in real estate is so simple anyone can do it. Buy a house and wait. Real estate can be a hedge against inflation.

Buy a house and stay there for 50 years. As inflation affects the price of your house and your house stays at the same intrinsic value. The buying power of a dollar goes down continually so in the future you will get many more dollars than it cost you to buy the house. The elderly lady down the street paid $30,000 for her house in 1952 and now it’s worth $300,000, much of that increase is just due to time eroding the value of a dollar.

You benefit from the compounding effect of inflation on the dollar value of the house.
5. Cash buying

This method involves having a lot of liquid cash on hand. The pool of buyers able and willing to buy a property outright is small. Cash is king and you can get great deals just because there is no competition for the property.

Unfortunately the reason banks won’t lend is because of significant problems. You will have to address these problems to profit.

Some of the reasons the banks will not lend are vacancy, no well, no electricity, no septic and no insurance.

There is a condominium in Toronto that has been unable to insure the building. You can buy a unit there at an amazing price. In the future when they become insurable again your unit would triple in value.

An important point about this strategy is that when the obstacle to financing is removed the property can be appraised and you can get your capital out. An exit plan is vital otherwise all your money will be stuck in a substandard, illiquid investment.

This route is risky but success brings unbelievable profits.
6. Other Opportunities

This usually applies to more advanced buyers but you can find houses with large lots that can be divided, small houses that are double brick (put another floor on it), buildings can be converted to condominiums, and farmland to sever into lots. The permutations are almost endless and can net you a nest egg in the bargain.

Real estate can be a road to riches for the buyer with insight and vision. I urge you to think out of the box and search for opportunities that less informed buyers have overlooked.

In my experience it is difficult or impossible to convince others that you’re not insane when you see promise in a much abused unloved project so be prepared to go it alone psychologically. After all if everyone wanted these properties they wouldn’t be a good deal.

About the Author: Rachelle specializes in renting property on behalf of landlords. She also works with investors to find good investments in Toronto and surrounding areas. Her passion is bringing multi res properties back from the brink and maximizing profitability.

Properties that are victims of bad or negligent property management can be very profitable. In today`s market raising the rent $100 equals $20,000 (at a 5% cap rate) so if suites are underented and you buy it and the market can support raising the rents you can make great profits, end up with a great cap rate and a building worth much more. You`ll need to have the cash on hand to fund these improvements as suites turn over. You can even do improvements in stages, and gradually improve the suites and the tenant profile.

In Toronto this year in spite of the very competitive market here I have seen some potentially very profitable properties that were distressed sell at reasonable prices. I saw a 4 plex on Runnymede go for $550,000, 7 apartments and seven stores in very good condition go for $1,200,000 at 100$ per square foot of space. The first property was very run down, the second was sold by the receiver when the owner died. I just saw a property on Lakeshore walking distance to Port Credit for sale for $700,000, the apartments need a complete revamp and smell of cats. Manager claims turn over is horrible but the suites are in such poor condition I can`t imagine anyone decent ever living there.

In my opinion in the current market you have 2 options, buy and hold for a very long time or buy assets that you can add value to without adding any appreciation.

 

[housingrental]

Hi Berubland
For sure... looking for properties in need of repositioning, adding value to them through solving their problems, and then having a more profitable building vs alternate purchases or being able to pull out funds on re-fi is a great strategy.
Both myself and Thomas above have had a lot of success with this and constantly aim to find suitable purchases where this is possible.

 

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[gwasser]

QUOTE (ThomasBeyer @ Sep 6 2010, 11:21 AM)
Equity upside is always desired. Often the only way to make money in single family houses, raw land or condos realistically is through equity upside, as cash-flow is poor to negative with a 75% mortgage. Hence the focus on strong markets. Let's face it though: not every market is ........



We don't really care where we make 25% to 70% cash-on-cash !! Do you ?



Conclusion: buy in Windsor (or GTA or London or Calgary or Texas or Detroit or Ottawa or ..) : at the right price/yield .. and manage the vacancies / rents / expenses .. you'll be amazed ... of course, the higher the expectation for future negative growth the lower the price / the better the yield has to be !!



Cash-on-cash ROI + equity upside using leverage

.......



One reason why we see CAP rates rise in AB or BC right now (fall 2009) is the fact the the future equity upside is slightly lower than the last few years .. so anticipated rent growth is related to yield going in .. or as Tim Johnston puts it "sell into the boom" .. i.e. it has the lowest CAP rates !! (but why sell if you can make money in ANY market with cash-flow buildings ??) True wealth is built by holding .. with cash-flow !






Right On! This is the investment philosophy that will make you money over the coming decade. I have been looking at the term `appreciation`. There are basically two forms of appreciation:
[list type=decimal]
[*]Asset inflation (as we experienced over the last decade and something that will be a lot less over the coming decade)
True value increase (by increasing NOI, renovations - asset improvement, repositing of asset)
[/list type=decimal]
Whether it is improved net cash flow that increases a property`s value by the inverse of the cap rate (every extra dollar NOI increases the value of a 5% cap rate property 20 times) or by the increased earnings of a public company. Microsoft has improved its earning by nearly 20% per year over the last decade. It is currently trading at a Price-Earnings ratio of 11. If next year`s earnings increase 20% from $2.10 to 2.50 per share, the stock price should also increase by 20% provided the P-E ratio remains the same. This is a true value increase. On the other hand, Microsoft may also increase in price because investors realize that many other companies whose earnings grow as fast as Microsoft`s are trading at a higher P-E. Say Canadian banks that grow earnings by 20% trade at a P-E of 14. Thus instead of trading 11x2.50=$27.50 it would trade at 14x2.50 = $35.00 per share. This price increase is purely based on changed investor perception and is asset inflation.



So for the next decade focus on the numbers more than ever. Earnings x P-E or Earnings x the inverse of the cap rate. That is where the profits will come from. This by the way is what made Warren Buffet so successful. He is capable to forecast an investments earnings as well as valuing those earnings (determine what the cap rate or P-E should be).



As said earlier: Asset inflation is passe but improving your operating marging will not only improve your cash flow but also your asset value. No matter in what you invest. So when using leverage, it is more important than ever to have a cap rate that is higher than your mortgage rate. If not your net cash flow will decline if not turn negative.

 

[Thomas Beyer]

QUOTE (gwasser @ Sep 10 2010, 11:10 AM)
... So when using leverage, it is more important than ever to have a cap rate that is higher than your mortgage rate. If not your net cash flow will decline if not turn negative.


indeed .. and that is not the case with most single family house investments .. thus be very careful that you follow the system REIN lays out and don't overpay, buy too large a house or one where the rent-to-price ratio is too poor !