It’s no secret when someone says, “If you want to get rich, you better buy real estate.”. Yeah, for the most part this piece of advice serves true. But there’s more to this than you think. In order to understand why real estate makes such a good investment, you have to understand the real basics of investments.
Investments are broken down to different categories but for simplicity’s sake, we will look into the ones that falls within real estate: capital gain/capital appreciation and cash flow.
An investment that renders capital appreciation occurs when your investment is sold for more than what you purchased it for. The difference of what you purchased it for and what you sold it for, is the “capital gain”. This is what most people refer to when they make that statement above.
An investment that renders cash flow is when you invest your funds into something and it pays you on a fixed period of time. The difference between what you are paid and what it costs to keep the investment is what is known as your cash flow. If it costs more to keep the investment than what you are making from it, you have a negative cash flow. If you are receiving more from the investment than what it costs, you have a positive cash flow.
Now that we have an understanding of the two types of investments, let’s apply it to real estate.
Capital appreciation is what most real estate investors are into. They want a lump sum payout. So how do you get it?
- Real estate flips (see article: Real estate flipping, how to start & what are your mortgage
options?) - Disposing of properties after value increase or during a sellers’ market (see article: What
happens to your mortgage when you sell/dispose of a property?) - Assigning a pre-construction contract to another buyer (this is when you sign a contract
with a builder of a project away to another purchaser)
Now while capital appreciation sounds great, other than the 1st point; real estate flipping, it is a waiting game.
Real estate flips
Real estate flipping is not a new tactic to making some serious appreciation in a short period of time, however, like everything with a great potential to earn money comes the potential to lose some as well. Real estate flipping is all about buying run down or outdated properties, fixing/renovating them and re-listing within a short period of time (typically 3 to 6 months time).
Disposing of properties after value increases or during a sellers’ market
While you wait for the property in subject to appreciate, you do have to hold on to it and its expenses until you are ready to dispose of it. And if you’re like many then you do not typically have all the cash to front to purchase it outright. This would mean you would have to secure a mortgage for this property. Securing a mortgage for an investment property is a bit different than
securing a mortgage for a principal residence. Since you would be relying on the rental income from the property to assist with sustaining the mortgage for that property, each prime lender treats the income differently on an application but a good rule of thumb would that be that lenders only use 50% of the rental income and then add it to your overall income for the
application. When you obtain this mortgage, you want to align it with your timeline and risk tolerance so you would be best to ask yourself the following questions:
- How long do I plan on keeping this investment property for? This would assist with determining how long of a term you want to lock-in for (1, 2, 3, 4 or 5 yrs)
- Do I want the flexibility of being able to pull out equity out of this property? This would assist with choosing the right lender based on their equity product.
- Does my household have the necessary income to handle if my property is in negative cash flow after factoring in rental income against mortgage and other household expenses?
Some other questions to ask yourself that are not related to the mortgage
- Is the area I am purchasing in an area forecasted for municipal development or gentrification? Today we look at developed cities like Woodbridge, ON and Mississauga, ON and say, “If I only I was able to purchase here 25 years ago.” The same holds true for many areas in the Greater Toronto Area, Greater Vancouver Area, etc. As population
grows, people are looking for places to live and if they’re outpriced directly within the city, they will spread into other municipalities. - What are the properties in the area selling for currently? Am I buying on par (same value as everyone else) with the market or on discount? Looking for an investment property should not be a rushed decision, yes, there are opportunities that can jumpstart your investment by allowing you to purchase at a discount such as an estate sale, family downsizing, forced sale, etc.
These are the questions that most savvy or tenured real estate investors typically do not pass down to new investors joining the market and unfortunately, the new investors get taught the lesson the old-fashioned way… experience.
Assigning a pre-construction contract
Now since this revolves around contract law, I do not want to provide too much information as there is a fine line where one should seek out legal advice before making the decision to obligate themselves to a contract in hopes of capital appreciation. The idea of appreciation through assigning a pre-construction is that you would enter a contract with a builder to
purchase a home that is not developed or started in hopes the builder will fulfill their obligations by the timeline stated in the contract. In some of these contracts, clauses are added to either allow or not allow you to “assign” the contract to another party. This means the new party would have to fulfill the obligations of the contract instead of you, however, in most contracts in the event the new party does not fulfill the obligations the builder can still hold the original purchaser (you) liable to close the property. So, what’s so great about this? Well, if you manage to purchase a property during the early phases or at discount for some other reason, your contract would appreciate which you can then sell for a return through an assignment.
Enough of capital appreciation, now what about the flip side to real estate investments? Cash flow properties. Cash flow properties seem to be getting more trendy in today’s era. People are fixated with the idea to not work anymore and create passive income of some sort. Properties that typically garner the most cash flow are multi-unit properties. These properties have multiple small units within them and are equipped with everything a particular unit needs; bathroom, kitchen, bedroom, living space, etc. While multi-unit properties do appreciate over time, the cash flow earned from a multi-unit property is what makes them shine. So, what are some tips to buying a cash flow positive multi-unit property?Enough of capital appreciation, now what about the flip side to real estate investments? Cash flow properties. Cash flow properties seem to be getting more trendy in today’s era. People are fixated with the idea to not work anymore and create passive income of some sort. Properties
that typically garner the most cash flow are multi-unit properties. These properties have multiple small units within them and are equipped with everything a particular unit needs; bathroom, kitchen, bedroom, living space, etc. While multi-unit properties do appreciate over time, the cash flow earned from a multi-unit property is what makes them shine. So, what are some tips to
buying a cash flow positive multi-unit property?
- Buy in the outskirts. That’s right, looking for properties in towns that are small and underdeveloped. People are still ready to pay rent while getting a mortgage on these properties are easier as the value of them are low which ultimately means a lower mortgage. A lower mortgage means lower expenses and lower expenses while you have a good chunk of rent coming in means positive cash flow.
- Buy near developed plazas that include grocery stores, Wal-Marts, entertainment, etc. These are typically areas that individuals are heavily populated in and those without means for transportation want to be in.
- Purchase an outdated home and convert it from an existing single-unit home into a double unit OR add a garden home. As population increases, major municipalities begin to allow the use of garden homes or expediting of conversion to multi-unit permits.
In conclusion, there are many ways to look at real estate as an investment and while it may not be like what it was decades ago there is still potential to earn. It is all about being informed, asking the right questions and doing research.