You might like the idea of investing in real estate after hearing a fantastic story about somebody making a ton on a real estate investment. But keep in mind that most people who profit tend to 'shout it from the roof-tops' while boasting of their good fortune. On the flip-side of the coin (there's always a flip side), those who lose don't usually loudly lament their losses. Where some have gained from taking a risk in this potentially lucrative field, there are just as many or more who have lost their shirt.
Before investing in real estate and even prior to beginning the research, calculations and property inspections, the first step is a little self examination. Before heading down this road, ask yourself a few questions:
... is a great investment because, unlike a corporate stock, bond or Guaranteed Investment Certificate (GIC), you can physically live in it. Simple inflationary appreciation in real estate market values will enhance your investment, but you can also, over time, increase its value through renovation and improvement. Enhance the landscaping or add and upgrade some innovative or trendy features. You get to enjoy the immediate benefits of an improved home, and when it comes time to sell, subsequent owners may pay more because of your extra effort and expense.
Renovating specific parts of your home is an great way to increase its beauty and functionality and maybe, at least in part, at someone else's expense. Wisely choosing the best projects for making your home more attractive may result in a significant portion of the renovation expenses being passed on to the next owner by way of a higher sale price.
If you're planning to list your home for sale, it's very important to properly prepare it beforehand. Ensure it has the basics that a buyer will expect, such as a good roof and furnace, dry basement, fresh coat of paint, minor repairs completed and everything else you'd expect if you were viewing a home. If you don't, then prepare yourself for some possible tough negotiations, or worse - no buyer interest. With expert guidance from their own agent and home inspector, a buyer may offer a discounted price to reflect the cost of doing those same repairs. They may not be able to afford the work because all their ready cash is committed to the down payment.
Another way to enhance your investment is to improve its curb appeal, that is its beauty from a street perspective. You never get a second chance to make a first impression. And since a large part of a buyer's decision to offer on a home is emotional, it's important to provide a favourable first impression on the initial approach to your property. While these improvements may not add much monetary value, they may add a little and will certainly contribute to a faster sale. Invest some time and effort into greening your lawn and planting flowers and shrubs. Fix the driveway and repair that broken screen door.
Regardless of the reno project, remember that when you bought your principle residence, you weren't just investing in real estate by buying a "house" - you purchased a "home". If you intend to live there long term, regardless of how they may eventually affect the market value of your investment, spend time and money on improvements that excite you.
ROI is basically a performance measure used to evaluate the efficiency of an investment. To calculate ROI, the benefit or return on an investment is divided by the cost of the investment, with the result being expressed as a percentage or a ratio. From the gain on investment, deduct the cost of the investment and divide the result by the cost of the investment.
The gain from the investment refers to the proceeds obtained from selling the investment property. That's easy to calculate. The cost of the investment is another matter.
Real estate can create gains from rental income and market value appreciation. Rental income simply has to be added to the gain as it's realized. From this, deduct the initial cost of the real estate investment and any and all expenses incurred while maintaining the investment property. Property taxes, insurance premiums, repairs, improvements, general maintenance and the cost to rent or sell the property would be included in such expenses.
If the calculations of your proposed investment do not produce a positive ROI, or if there are other opportunities with a potentially higher ROI, seriously consider skipping it. For example, if the annual ROI is anticipated to be a mere 5%, think instead about putting your money in an investment vehicle such as a Guaranteed Investment Certificate at your credit union where the return is guaranteed and there's minimal risk, expense or maintenance.
When you hear stories about a real estate investor boasting about a huge ROI after selling their real estate investment, they're often exaggerating or have erred in their calculations. They've probably just used the market value appreciation and possibly the rental income and ignored - innocently or otherwise - all their costs like mortgage interest, property taxes, insurance premiums and improvements.
ROI on an investment property or renovation project is directly related to not only the category and caliber of the project, but also the condition of the local economy and real estate market. Certain projects, such as the addition of a sundeck, or a kitchen or bathroom renovation, a window replacement or landscaping, usually have a greater ROI than, say, the installation of a swimming pool or new roof shingles. I've actually seen homes with pools sell for less than that realized by a similar property minus the pool. Many home buyers don't want pools and discount the price - if they even offer on it - to cover the cost of having to maintain or remove it.
Having said this, in most cases, a homeowner or investor is unlikely to recover the full cost of a renovation project. In my experience, the highest returns (60-85%) usually result from beautifying projects such as kitchen replacement and major landscaping. The moral of the story - don't do the big projects just prior to listing for sale. Do them earlier and have the opportunity to enjoy them yourself for awhile.
The advantage of investing in real estate in your own home is the pleasure derived from the improvement while you're living there. But if you're not planning to keep the property for long, it's a good idea to avoid major projects. Just maintain it well and perform relatively inexpensive upgrades like painting, flooring, counter-tops and minor landscaping. Also, consider the tastes of potential buyers by choosing projects that will have mass appeal. Think neutral colours. Your dream bedroom with padded and upholstered chartreuse walls and mirrored ceiling is probably not a safe bet. From an investment perspective:
Don't Over-Improve for the Neighbourhood
Don't improve the property to the point where its market value excessively exceeds the average market value of adjacent properties. It's much smarter to be the smallest home on the street than the largest.
If you're investing in real estate and plan to remodel a handyman special and keeping it as a rental property, the cost of the renovation may be recovered by a higher eventual sale price. And in the interim, it may also command a higher rental.
To address the question of what stress levels would be tolerable for you, consider what's involved in the long term picture. It's not all champagne and roses. Being a landlord can be stressful. And unless you've got sufficient cash flow to hire out the administration and drudge work, it can be a full-time job.
Now, I'm thinking only residential here, as that's where my experience lies. It could be single family dwellings - detached, semi-detached, townhouse or apartment homes. Or it could be multiple unit residential buildings (MURBS) with rental apartments.
To learn more about renting a property and becoming a landlord, visit CMHC website prior to making the leap.
Unless your real estate investment generates sufficient positive cash flow to hire a property management company to look after the myriad details of the on-going daily business of maintaining the building and grounds, as well as tenant concerns, you'll have to do this yourself. Generally, the responsibilities of a small real estate investor who buys, for example, a condominium apartment or townhouse, where all exterior and building maintenance is taken care of by the condominium corporation, would be limited to renting the unit, collecting rent cheques, occasionally inspecting the unit and performing interior repairs and maintenance when necessary. Of course, your tax return will look a little different, but your accountant can handle this aspect of investing in real estate.
On the other hand, unless you're retired, because of the larger volume of responsibilities, MURBS usually require the services of a management company. Therefore, when you're doing the ROI calculations, don't forget to factor in this added expense.
The next question is regarding your motivation for getting into real estate investing. Are you looking for a short term commitment and a speedy return?
The advantage of the "quick flip" is the quick part. You can earn a nice annualized ROI with a few strategic improvement projects and without the responsibility of a long term commitment. But you must have the right market conditions, buy a property in poor condition at a bargain price and do most of the remodeling yourself. If you must hire a contractor, it's less likely your real estate investment will be profitable. Carefully choose the renovation work that will provide the most value for the least amount of effort and expense.
New siding, kitchen and bathroom remodeling, paint, floor replacement or refinish, new windows, sundecks, new sod and driveways and living space additions are some of the most beneficial projects.
Also, you don't want to carry it empty for long as this would not only increase your stress level, but also reduce your ROI. And remember - unlike a principle residence, any capital gain is taxable.
Another advantage to the flip is you'll not have to deal with the Ontario Residential Tenancies Act or its counterpart in other provinces or the USA, and all the ramifications of being a landlord. Aside from the legal implications, in my experience, tenants often don't take the same care of a property as an owner does. So, by flipping the property, you get to avoid the potential heartache and repair expense of a damaged property.
There are possible disadvantages, though, to investing in real estate of this type. In a normal balanced real estate market, prices don't rise through the proverbial roof over-night. And since you may own it for an extended period of time while renovating and awaiting a sale, the accumulating carrying costs could take a serious bite into your ROI.
Let's assume you 'stole' the property and it didn't require much repair work. You'll still have purchase and sale expenses. Investing in real estate involves various closing costs such as legal fees and disbursements, land transfer tax(s) on the purchase and real estate commission on the sale. You'll have to carry it until the closing date of the re-sale. Therefore, factor in payments for the mortgage, property taxes, utilities, insurance, maintenance and, if it's a condominium, monthly condo fee.
Since you're hoping to sell it quickly, you'll not easily be able to rent it. Most tenants want a lease for an extended period, like a year. Thus, there will be no revenue to off-set the expenses. If you succeed in renting it on a month-to-month basis, that's great! But keep in mind that not only will you require the tenant's cooperation with showings to prospective buyers, when you accept an offer to sell it, the buyer will most likely want vacant possession. You must then rely on the tenants cooperation to vacate on time. If you're unable to provide vacant possession on completion, and the buyer presumably doesn't want to assume the tenancy, you're in default of the contract. Hmm - trouble.
No Vacant Possession = No Closing
The advantages of the longer view are basically two-fold. You can create (taxable) income, that is a positive cash flow (which is the difference between income and expenses). If you invest sufficient equity into the property, a tenant will, by default, help you carry the investment. And if you keep it long enough, you'll likely create a sizable capital gain when you eventually dispose of the property. And the best part? Your...
Tenant Will Pay Off the Mortgage
The possible disadvantages of investing in real estate for the long haul are that you're responsible for long term management, including maintenance, repairs, replacements and improvements. The furnace, air conditioning, roof shingles, electrical and plumbing systems will all need attention from time to time and at considerable expense. The same goes for rural property, but with a few other items added to the list. Plus you'll have the responsibility of regularly collecting rent cheques, dealing with defaults, evictions and replacement of tenants. Think about midnight phone calls in the winter from a tenant when the furnace breaks down. And don't forget about the potential physical abuse of the building by disrespectful, uncaring tenants. You may some day regret ever investing in real estate. Or you may celebrate.
Investing in real estate requires sufficient cash for a down payment to allow a revenue neutral cash flow, unless you're looking for some type of tax deduction. With rental properties, lenders usually want a larger down payment as well.
If you're investing in real estate in the form of a single family home that contains a secondary dwelling, such as a basement apartment, keep in mind that many of these essentially two-family homes are in violation of local zoning bylaws, and almost always fire and building codes. If you buy one that is 'illegal', you may be surprised with a municipal order to evict the tenant or at least bring it up to code. This can lead to more trouble.
Consult with your legal advisor and/or accountant before heading out with an agent in search of the perfect investment property. And before taking the plunge into investing in real estate, consider what return on investment will satisfy your needs.
Investing in real estate can be profitable, but sometimes it's not. Is investing in real estate for you? Absolutely, at least in your family home. Unless, of course, you want to be paying rent when you're 64.
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