This is the third articles with respect to investment housing being
purchased as being a hedge against the lack of proper pension plans being
kept in place by your Government. As a novice, you must realize that
cash flow is the most important determination of the value of the investment.
"Why investment in real estate" is the most common question being asked
from this series of articles. Let me re-iterate my explanation of
a couple of weeks ago. When one seeks a sound financial retirement
package from any respectable financial planner, this individual will ask
a multitude of questions to determine how much money your will need to
generate the lifestyle you have today. Then the financial planner
will ask you to deposit a certain number of dollars every month in order
for your portfolio of investments to grow to a level that upon retirement
from your normal job, your portfolio can now start to pay you back.
If you ask these financial planners the most common flaw to their analysis,
they will tell you that the Clients failed to contribute (cash) as agreed
to the plan. Why would one fail to invest in one's retirement?
Lack of cashflow is the most common answer. It is all well and good
to plan for that retirement day, but if there are still bills outstanding
at the end of your pay cheque each month, it is kind of difficult to set
extra money aside for retirement, let alone a rainy day. It has been
said that the normal Canadian is two pay cheques away from financial ruin.
It is also a well known fact that Canadians pay their bills.
My system of purchasing investment housing is based upon this fact, and
upon the necessary cashflow to come from the investor, and not necessarily
from the tenant. It is my opinion that a new investor in real estate
should not have to pay more per month than his/her present budget.
It is within this budget that realization of pension income will indeed
bless you upon retirement. If one does not own a house now, buy one!
It is that house that will support you retirement. For those who
already have a home, the equity in that home should be used as early as
possible to use as down payment on your investment property. If you
have not finished paying for your home mortgage yet, last week we learned
that we could do an equity draw (for the down payment) and keep our payment
the way they were. This week we will look at an example of a potential
Investor, let's call him Bob, trying to utilize equity without have the
necessary cashflow to buy something new.
Bob sees a triplex being offered for sale in his neighbourhood for
$205,000. The income from the building is $2400 per month.
Each tenant pays their own water, heat and light, while the landlord is
responsible for property taxes and insurance. Bob just recently increased
his payments on his own house mortgage to $2000 per month plus taxes, heat
etc. to pay it off completely in 5 years. Bob has about $70,000
of useable equity in his residence but cannot afford to pay out more than
the $2000/mo he is presently paying. Then and only then will he be able
to afford to buy anything else. Taking this into account, what we
propose to do is buy the unit today and involve the Vendor of the property
in the financing of the triplex. Don't dicker on price because you
need that Vendor. Bob knows he can't carry more than his present
debt load, but if we use a little creativity, Bob can afford to buy the
unit today, but not worry about cashflow for five years. The deal goes
something like this:
Bob offers to buy the unit for $205,000, telling the Vendor of the
property that the purchase price is made up of new Bank financing for 75%
($153,750) and Vendor financing for the other 25% ($51,250), all at the
first mortgage rate. If we follow our own rules from last week, we
must commence our calculations from the investment side. If the property
taxes and insurance on the new unit (triplex)amount to $350 per month,
and reserves for replacement at (5% of rentals) $120 per month (that's
$2400/mo X 5% = $120), it leaves $1930 to carry the debt. That $1930,
at 6.45% (five year term mortgage investment rate), will easily carry the
whole debt ($205,000) amortized over 15 years. Bob offers the Vendor a
second mortgage on the property being purchased, as well as equity in his
residence. For the Vendor, he/she will get the full asking price
on the property, gets to put off some capital gains tax for 5 years, and
get collateral security by way of a second mortgage on Bob's residence,
so there is little chance of loss. For Bob, he buys the triplex today,
but his cashflow remains the same as yesterday. The triplex pays
for itself, with room to spare. In five years time, when the triplex
mortgage is down to $146,000, and Bob's house is now paid in full, Bob
can re-borrow against his house to pay back the balance owed to the Vendor.
At the onset, when we looked at Bob's situation, he could not afford
to increase his payments, and yet he wanted to get in on investment housing
as early as possible in his career, we achieved both with a little creativity,
and a willing Vendor.