Buying Residential Rental Property?

Don’t be Lazy

Here
are a few tips for readers who are thinking about acquiring some residential
rental property to consider before they do:

a) Get
a property manager who
carefully vets tenants. You are far better off to leave the place vacant than
to rent to a bad tenant. If you do have a poor tenant, an experienced property
manger will know how to navigate the RTA process to evict them.

b) Don’t
ever buy a property that doesn’t cashflow. The idea that you
can make up for monthly cashflow deficiencies by capital appreciation is
flawed. It will crater your IRR, Internal rate of Return.

c) Buy
low/sell high. You
make money in real estate when you buy not when you sell. So if you get in a
competitive situation and get carried away and pay too much for that cool
triplex or duplex, you’re sunk.

d) Try
to use all the leverage you can— financial institutions in
Canada will still lend to people with good credit (i.e., good Beacon Scores)
with just 5% down. So rather than buy one res unit with 25% down, buy five of
the suckers with 5% down on each.

e) If
you own five units and one becomes vacant, your vacancy rate
has jumped from 0 to 20% but if you only own one unit and it becomes vacant,
your vacancy rate has leaped from 0 to 100% which is bad.

f) By
using lotsa leverage, you actually will have way more cashflow and way
more forced savings and way more wealth effect provided you live in a stable
economic environment (like, say, Ottawa and not Arizona, Nevada or California)
and provided you followed my earlier rule–buy low.

g) You
or your property manager should visit each of
your rentals, once per month. Tell your tenants in advance (some jurisdictions
require you do this in writing) that you will visit once per month to collect
rent personally, to inspect the unit every time you visit and to fix any
problems immediately. Don’t be lazy, do it. If prospective tenants don’t want
this, no problem. They can rent somewhere else. Friends of mine owned a
5-bedroom home near Algonquin College in Ottawa that they rented out to students
for $500 per room per month. They visited every month bringing dinner with them
(kids are always hungry). They developed nice relationships with their tenants,
monitored the condition of the place, never lost a single month’s room rent and
even helped them with homework and personal problems when warranted.

h) When
I owned a rental property in a tough neighborhood, I co-opted the localsincluding
teens by hosting a FREE BBQ and blocko (short for block party) every summer. I
gave all the kids (some of whom were gang members no doubt) free burgers and
flying discs and told them if they needed anything to let me know. In the years
I owned the place, I had zero graffiti and vandalism– local guys looked out for
it for sure. The few hundred bucks it cost was way less expensive than higher
insurance premiums. (Note: you can often get a permit to close a street for a
blocko from your local municipality. They’re usually free. You can invite
everyone in the area by the simple expedient of a flyer drop (in some neighborhoods
like the one we were in, websites/mobile
apps/email/facebook/twitter/linkedin/online invitations just aren’t gonna
work). Free food and beverage with some music and games (we liked Ultimate
played on the street and Paddle Tennis) will bring people out for sure. But
don’t serve any alcohol– this leads to fistfights and opens you up to huge
liability.)

i) You
can add an in-home residential apartment to your principal residence. This has the useful advantage that you
don’t have to travel very far to keep an eye on the place plus part of your
mortgage (if you still have one) becomes tax deductible since you are earning
income from your place. In Canada, your principal residence is still capital
gains tax exempt as long as the apartment is contained within the original
footprint of the building, i.e., in the basement or attic say. There has been
government support for the cost of doing this in the form of CMHC grants/loans
(up to $25,000) but most of the in-home apartments that I’ve seen added over the
years make financial sense even without soft loans or grants. Also, many cities
and towns (e.g., Ottawa) have legalized these. Ottawa’s zoning by-laws were
relaxed last decade to permit in-home apartments pretty much anywhere except
for the Village of Rockcliffe Park where Ottawa’s upper crust live. We
developed some innovative plans for new homes built with ready-made in-law
(separate) suites. I lived in one of those when I was at UCSC many years ago
and one of the granny flat plans we developed is a riff on that cool little
place, located I still remember, at 1011 and ½ Seabright Avenue in Santa
Cruz, Calif. If you would like to see some of our work, let me know via
@ProfBruce or @Quantum_Entity.

j) If
you build or buy a duplex/triplex/multiplex, make sure you sound, smell and
fire separate your units and they comply with building
code, health code and fire and safety code. If you are purchasing an existing
building, make sure you have a building inspector that knows these codes and
can provide you with advice and costs estimates to make your units legal. If
you discover any surprises, it’s best to find these out during your conditional
period when you can either abandon the deal or ask for a price abatement from
the Seller. Fire separation is improved by adding an extra layer of drywall. If
you add it so that sheet boundaries do not line
up, you will improve not only fire protection, you will limit sound
transmission and smells between units. There are lots of simple, inexpensive
things that you can do that not only improve safety for your tenants, they make
their lives more enjoyable. By not venting one unit into another one, for
example, automatically reduced sound, smell and fire issues…

k) Res
real estate returns come in three pieces: monthly cashflow (aka cash on cash
return) from rental and other income (like parking revenues) exceeding
expenses, forced savings (every month you pay your mortgage, actually, where
your tenant pays your mortgage, you end up paying a bit of the principal off)
and wealth effect (which comes from capital appreciation– i.e, when you sell
for more than you paid).

Almost no one I know can save their
way to wealth but many can invest their way there. (See my fictional story
about an imaginary world called Grassel made up of Grasshoppers, Squirrels and
Ants plus Mensa Ants: https://www.eqjournal.org/?p=2760.)

My
pals who owned the home near AC made about $400 per month in free cashflow in
the three years they owned their place. (The students all accepted 12 month
leases even if they were from away so they would be sure to have place to live
when they came back each Fall.)

Their
mortgage was paid down by $18,000 during that period (remember, it’s really the
students paying off their mortgage for them) and they made a capital gain (the
wealth effect) of about $38,000 on the sale after all expenses were paid (eg.,
legal and REALTOR fees on completion of the transaction).

They
originally financed 85% of the purchase price, so the cash they put down was
around $40k of their own money.

Thus
over three years, they made $14,400 from their monthly free cashflow (cash on
cash), $18,000 from paydown of their mortgage and $38,000 from capital
appreciation. This represents a tidy $70,400 (before tax) profit/gain in three
years on an initial investment of $40,000. Try to match that by investing the
same $40,000 in the stock market (at the same level of risk) or by buying GICs
or T-Bills which pay 0.5% to 2.5% p.a. There’s just no comparison.

But
what’s also interesting is that they don’t have $70,400 at the end of three
years– they have $70,400 (assuming they did not spend their free monthly
cashflow) plus their original equity of $40,000. So they actually have $110,400
of cash in hand (less whatever taxes they owe on the money they made– part of
which are incomes taxes and part of which are presumably less onerous capital
gains taxes.)

Now let’s assume through some kinda
modern miracle, my friends managed to save the
same amount during those three years that they made by investing in their
rental property. They woulda saved it by deferring gratification except here’s
the thing– people don’t like deferring
gratification so they woulda probably spent the
dough. I mean most people who have a few bucks saved can’t resist the
opportunity to buy a new iPad 7 or iPhone 40 or new hybrid car or take a neat
vacation to the DR or whatever so even good savers are generally broke from
time to time. If you read my Grassel story, you’ll see that the Mensa Ants, who
are really good investors, own just about everything while savers have much
less and Grasshoppers (who spend everything they make) have zip, de nada.

@ProfBruce
@Quantum_Entity