Sylvia’s Dilemma—turning a $3 million commercial portfolio into a $9 million commercial and residential portfolio
By Bruce M Firestone, PhD
I recently met with Sylvia (not her real name); she’d reached out to me about helping her sell her well-located 11,000 square foot retail plaza in west end Ottawa.
Sylvia is an elder with one child in her 50s (Kim) and three grandsons, all in their 20s.
“Why do you want to sell?” I asked Sylvia after settling down on her comfortable condo sectional sofa in an upper tier apartment in a ritzy downtown neighborhood.
“Why do you want to know?” Sylvia responded in a direct manner that I was to learn is typical for her.
“Well, I’d like to do more than just give you a listing presentation. I’d prefer to give advice instead…”
“Don’t need advice. Just do your thing,” she said.
So doing my best to channel Jerry Maguire, I made my pitch as a real estate broker. It wasn’t lost on Sylvia or Kim that our brokerage is more expensive than any of the other agents who’d already stumped for the listing earlier in the day.
“Why would I pay you 5.5% when I can pay other brokerages 4%?” she asked after my 15-minute living room histrionics were over.
I was tempted to say, “Because I’m worth it,” but instead I said, “For two reasons. Firstly, I have clients who will buy this type of investment product, which is in short supply. You just can’t find great plazas like this… ones with just four long-term leases, easy to administer, a building that produces a reliable 6.5% pa cap rate, and a site that is close to everything that matters—excellent transportation, fast growing residential areas, massive employment nodes—meaning it’ll increase in value probably for as long as there is a Canada.
Secondly, as a brokerage that belongs to organized real estate, we freely share information with every other agent out there. We’re not trying to double end every deal. I believe we’ll get it sold for you sooner and for more money.”
Instead of saying, “Where do I sign?” Sylvia replied, “We’ll get back to you,” which is client code for, “Never going to sign with you, loser.”
Before they could shove me out the door, I added, “But here’s the thing! I don’t think you guys should sell at all.”
That caught their attention so I was allowed a few more minutes to explain what I meant.
I am a build and hold person. That’s what I teach.
I believe in it the way that some people think that Back to the Future’s Marvin Berry & The Starlighters was a real band and that Marvin was Chuck Berry’s actual cousin who taught the rock ‘n’ roll icon the chord changes to Johnny B Goode.
I coach people in what I call a Warren Buffett methodology applied to real estate investing, which means you buy well-located property for the long-term, manage it well and animate it (adding differentiated value and additional revenue streams), driving up its value over time. Then, as you pay off your mortgage, you are able to refinance it after a few years, pulling money out of your property, tax free. After that, you rinse and repeat until you have a portfolio of the desired size and profitability to suit your needs.
Here’s what I suggested to them instead—
1. Put a new $2 million mortgage on your existing property (which was recently appraised at $3 million so this is a pretty low LTV, loan to value ratio, mortgage); remember, this money comes out tax free—no income tax, no capital gains tax—after all, it’s just a loan.
2. Take $100,000 and blow it on a nice family trip; in fact, don’t come back until the money is gone. (Seriously, Sylvia isn’t getting any younger and what’s the purpose of life anyway?)
3. Place another $400,000 in a rainy-day, high interest bank account, and, every once in a while, look at it but don’t spend it.
4. Give our brokerage permission to go out and buy 15 residential rentals at $400,000 each with 25% down on every one.
5. Each house we purchase on their behalf will have at least two units in it—the main home and a basement or side yard apartment.
6. They’ll be in great areas that are appreciating fast, close to transportation, shopping and employment so decent tenants will want to live there.
7. Ottawa passed (in November 2016) a new coach house bylaw so that, at some point in the future, the family can further animate their new portfolio by building small, backyard “granny” flats if they want to.
8. You don’t pay our brokerage anything at all but don’t worry… as buyer agents we’ll be paid by sellers.
9. Let us be your lifetime real estate investment advisers instead of a one-time, transactional, drive-by stopgap.
So what do the numbers tell us?
Well, after Sylvia has her portfolio restructured, she’s initially gone from having free cashflow (NOI, net operating income) of $195,000 per annum to around $142,500 so not that great a result. But she has $400,000 of cash in her bank account, which is something.
However, look what happens after 20 years—once her mortgages are paid off, her family’s cashflow jumps to $585,000 per year and that assumes that her rents (both residential and commercial) don’t increase one whit for a generation.
And if her portfolio increases in value at 3.5% pa (which is entirely possible in towns and cities that are well-positioned to compete in a global economy because they are livable places with multiple engines of economic growth), it’s worth an astounding $18.3 million (including the $400,000 still sitting in her bank account) at the end of the period. Wow.
I also ran a second case for them—by increasing their amortization period from 20 years to 24 years, the family’s NOI remained stable at $195k per year so if Sylvia wants to keep her income constant, she can.
This is how families in Europe, the US and Canada as well as South America have been building and then passing on wealth for generations; it’s something we can all learn from and imitate in my view, which also means that Warren Buffett didn’t actually invent it, he reinvented this approach and then applied it in industry after industry with great discipline over many decades.
And yes, we got the job.
Bruce M Firestone, B Eng (civil), M Eng-Sci, PhD
Real Estate Investment and Business coach
ROYAL LePAGE Performance Realty broker
Ottawa Senators founder
MAKING IMPOSSIBLE POSSIBLE
POSTSCRIPT: you can download my spreadsheets and experiment with them yourself—
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