Newbie Investor Advice

[dogoo]

Hi Everyone,



Great to be on this forum. During the last couple months, I've read many awesome posts and will hopefully meet many of you when I join REIN officially.

I'm a young professional, age 25, with a very steady and stable income(banks would love lending me money) that will increase to six figures in one years time and like all work will be dependant on how much I work like all "jobs". I am self-employed for all intents and purposes but essentially like all professionals consigned to being a one man operation. Thomas Beyer's post explains the 5 types of making money and this is type 1. http://80lessonslearned.blogspot.com/2009/10/five-ways-to-make-money.html



I'm willing to work very hard, but there is a limit to hours in a day. That being said, I've read about developing multiple income streams in addition to salary and think this is the way to go.

I've read alot about various types of investments including real estate and RE seems the way to go. I define investment similarly to Don Campbell and Warren Buffet i.e. with an initial investment of capital you get yearly payouts(and possibly capital upside). Buying gold, undeveloped land, commodities and other things that can appreciate in value but give no yearly payout is speculation for me.



Hence this leaves investments in stocks, RE and small businesses/franchises/gas stations. For a person not involved in any of these in my professional life, RE seems the most intuitive and most conducive to managing while maintaining a job(at least initially). Stocks seem less intuitive, more prone to manipulation, not as tax friendly(depreciation and interest writeoffs not possible), and difficult to use leverage with(except margin but that is a different story). Small businesses/franchises are also more difficult to manage while working.



So for me and my personal Belize, Real Estate is it at least for the start. Multifamily investing seems like something that has the best potential with a good super/prop manager. I've read/listened to Don Campbell's and read Kiyosaki's and Reed's books. I've also read this the following on this blog: http://7million7years.com/2008/09/30/its-the-gradient-of-the-curve/



All these resources point to the fact that RE(assuming 7% cap rate, 6% locked interest rate, 30% down and rental rate increase of 2-3%) can provide cash on cash returns of 9% and total returns of 16-20% per annum from or more depending on the market. REIN provides great guidance on this front. Of course, it can be more assuming a higher cap and more leverage and rent increase(possible in W-Canada, not in Ontario), hence the 30% return annually posted on the blog I suppose.



Now these calculations seem very nice, but quite high at times. My question to the veterans esp multi-family investing veterans is: What do you budget for your cash on cash and total ROI for buying a building for 5-10 years. I know returns vary and nothing is guaranteed in life, but there must be some assumptions for total yearly ROI that are used? Are they different in Alberta, Ontario, BC?

Looking forward to your responses.

 

[Nir]

Good understanding of your options especially being 25. yep RE often generates such returns. Here is the 'catch': you are not really an investor you are in the business of RE investing. see the big difference!? so ROI is really return on your TIME/WORK and investment. Still a great thing, do it! it's an efficient business but remember much more work than stocks. but then much less expected work per dollar earned compared to an employee

 

[housingrental]

Hi Dogoo



To answer your question I think you will get a different answer from everyone person you ask.

Many investors aim for 5% cash on cash return and model different scenario's for appreciation.

At present values, in most sizable markets in those three provinces you will find a very difficult time finding properties at 7% cap rates unless they have extensive deferred maintenance.

 

[Thomas Beyer]

[quote user=dogoo]My question to the veterans esp multi-family investing veterans is: What do you budget for your cash on cash and total ROI for buying a building for 5-10 years.
If 70% or higher leverage, i.e. 30% or less down, I budget 0% cash-on-cash ROI, i.e. all cash flow gets re-invested into asset improvements on tenant turnover or saved for major item repair (new roof, hallway carpets, lights, paving of parking lot, landscaping,..).



At 70% or less leverage you will usually get cash-flow, but an overall lower return.



In your case, assuming your 100K/year is sustainable and sufficient to live on (congratulations btw if this is indeed true at this age.. you must be in sales, correct ?), you could use higher leverage and forget the cash-flow for now. Then, when you're old and grey, reduce leverage and live off the cash-flow. Don't forget to send a post-card from paradise to us once in a while.



The basic math on a smaller asset, on average (scale it up, i.e. add 0's if you have the cash for the down payment), assuming a 25 year amortized mortgage which you pay down about 10% in 5 years and 22% in 10 years, and assuming an inflationary 3% rental/value upside:



using a 5 year scenario with 25% and 30% down:



200K property, 25%
down (i.e. 50K), 3% up per year on average = 30K in 5 years .. plus a
mortgage paydown of about 15K .. thus 45K equity gain on 50K invested ..
assuming cash-flow neutral .. 45/50K = 90% divided by 5 years =
19%/year on average !!





200K property, 30% down (i.e. 60K), 3% up per year on average
= 30K in 5 years .. plus a mortgage paydown of about 14K .. thus 44K
equity gain on 60K invested .. assuming cash-flow neutral .. 44/60K =
73% divided by 5 years = 14%/year on average !!



More on ROI impact about leverage (from 0 to 90%), various CAP rates and property value upside (from -3%/year, flat, and plus 4%) is here in one of my old blog posts.

 

[invst4profit]

[quote user="Thomas Beyer

using a 5 year scenario with 25% down:



200K property, 25% down (i.e. 50K), 3% up per year on average = 30K in 5 years .. plus a mortgage paydown of about 15K .. thus 45K equity gain on 50K invested .. assuming cash-flow neutral .. 45/50K = 90% divided by 5 years = 19%/year on average !!





Different assumptions on the above example would provide the following:



200K property, 25% down (i.e. 50K), assigning a minimum required 3% return on opportunity

money = -7500K in 5 years..

a mortgage paydown of about 15K.. thus 15K equity gain on 50K invested.. assuming cash flow neutral minus the 3% return on a opportunity investment on the 50K ($7500) .. 15-7500/50K= 15% divided by 5 years= 3%/year on average



Obviously the appreciation value has been left out of this example. Appreciation is a unknown variable for any future 5 year period and depending on the location and economic times could range anywhere from a negative up to double digits.

It should not be considered today in estimating a future ROI without accepting the fact that the number is entirely speculative considering that a 5 year time period is far to short to accurately apply a 40-50 year historic value.

I have also included a required return potential on the 50K invested as it should/would earn a return invested elsewhere. The 3% return is of course a arbitrary number but illustrates the fact that all costs, including paying down a mortgage, need to be considered as they all have a impact on a individual's overall investment returns.



Also keep in mind this is only equity growth that is being used to calculate returns as this example assumes cash flow neutral. Actual returns could not be calculated until time of sale and would be subject to the economic conditions at that time minus real estate and legal fees associated with that sale.



Two entirely different perspectives one being based on a combination of investment/speculation without including loss of the opportunity return on the 50K and the second based on actual, although still uncertain re sale vale at a future date, and including a expected return on the cash invested.



The only way to semi accurately calculate return on investment would be to re mortgage every 5 years to the maximum the bank would allow. By doing so you would experience a actual return on investment as opposed to speculating. The cost associated with a sale of the property as well as the actual sale price would need to be factored into these returns at a future point in time.



Another scenario would be to borrow the 50K down payment and through remortgaging every 5 years and applying the money to pay off that loan once paid off the ROI would be a infinite value.

 

[stevegwhite]

Keep in mind that these formulas are all numbers on a spreadsheet or the back of a napkin. There have been many an investor who lived by the assumptions of these calculations without factoring a few important details.



1. You may hate being a landlord after you tried it and if you try and get out too quick you'll take a huge loss.

2. You may get stuck with a horrible tenant and suffer major losses in your first few years.

3. You may become emotionally attached to your first property and overpay without the benefit of knowing what hidden structural or zoning problems may lay around the corner.



That being said, I love bricks and mortar and always recommend to everyone I talk to to at least look into it. But to be a the starting gate and trying to decide whether the industry is right for you based on a cap rate might not be the best idea. In my experience, cap rates have gone to hell with very low lending rates and owners not being too motivated to sell and put their after capital gains profits into a .25% interest account. So prices are very high for those starting out without contacts or cash to jump on a dime.



By the way you talk, I get the feeling you would be happier as an investor with joint venture partners who have established systems in place to ensure payouts as well as appreciation.



You might also want to look into some real estate income trusts, although everyone here will probably suggest you partner with a solid partner who will manage the properties.



Just my thought.

 

[invst4profit]

I am actually at the end of my investment acquisition life time. I am holding my last multi unit property and will likely sell in about 7 years at age 65.

I am no longer a investor I am simply a landlord and enjoy that aspect of ownership in spite of the fact that I am at LTB hearings every second month or so. That is the down side of investing in Ontario. On the upside the positive cash flow nicely supplements my employment pension and I have all the income I need now and into the future.



It's been a life time of hard work that has paid off with a comfortable income stream.

 

[johnsu]

I usually base 3% compounded appreciation for value.



Thomas comment "If 70% or higher leverage, i.e. 30% or less down, I budget 0% cash-on-cash ROI, i.e. all cash flow gets re-invested into asset improvements on tenant turnover or saved for major item repair (new roof, hallway carpets, lights, paving of parking lot, landscaping,..). " is REAL DEAL advice. ALL CASHFLOW on residential real estate should remain in an account to finance the property until sale occurs. This is usually the biggest mistake many investors do, have a 3 month reserve fund which disappears faster than a bandit in the night!

 

[bizaro86]

[quote user=ThomasBeyer]In your case, assuming your 100K/year is sustainable and sufficient to live on (congratulations btw if this is indeed true at this age.. you must be in sales, correct ?), you could use higher leverage and forget the cash-flow for now. Then, when you're old and grey, reduce leverage and live off the cash-flow. Don't forget to send a post-card from paradise to us once in a while.





The OP said his income was highly sustainable and stable, so it's probably from a professional endeavor (doctor/lawyer/engineer) as opposed to a sales type job. That income is certainly possible by the age of 25 from any of the mentioned professions.



Regards,



Michael