6th Dimension: Instant Equity

By: Mark Frentz
www.akerahomes.com
mfrentz@akerahomes.com

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What is instant equity?

Instant equity is having more equity in a property than you have put into it yourself at the time of purchaser. I'll explain in a clearer way... If you find a 'great deal' where a property is worth 350k, but you are able to purchase this property for 320k, you now have 30k more in the property than you put in yourself with your down payment. In a regular real estate transaction this takes place on a regular basis, but a real estate agent might argue that what you pay for the property is really what the property is worth. On a normal real estate transaction for a single family home the seller (called the vendor) is trying to get as much as possible and the purchaser is attempting to pay as little as possible. They will negotiate and attempt to arrive at a price that works for both parties. If there is an unlimited amount of to time to bargain and both sides want the deal it will usually get done at a 'fair market price'. There are circumstances, however, that work to strengthen the purchaser's position or the vendor's position. Let's look at these in turn.

A seller's market

Most investors don't tend to say 'what a great market' or 'the market is terrible right now'. When the real estate market is up-trending (as it is in Calgary over the past few years) investors call it a 'seller's market'. What this means is that, typically, the seller has some bargain power on her/his side. Why? Because if the purchaser doesn't want to buy the property quickly, it ill be easy to sell to someone else. In supply/demand terminology this is where supply is more scarce and demand is high. The reason I would not call this a 'good' or 'bad' market is because it depends on a personal investing strategy and what you would like to do. Some people call this a good market, but it isn't necessarily great for the people wanting to move into their first home or get a deal on a house. It's good for people who are practicing fix/flip deals; they purchase the house for 100k today, fix it for 20k, and sell it for 150k in a few months. The reason this is a strategy that fits is that it takes out risk. If I want to fix a property before selling and it takes a little longer than I anticipated... no problem, the house will most likely be worth more anyway.

A buyer's market

A buyer's market is what investor call a market that is down turning. Prices of houses are dropping because supply abounds and demand is low. Why isn't this a bad market? Because it is a great time to buy a house for less than it was a year ago as well as what it will be in a few years from now. It's the time to get a 'deal' on a property. This is the perfect time to do a wholesale deal or purchase a house for a long term hold. 

Back to instant equity

If you want to eliminate more risk from a purchase as well as make more money from the property you may have heard the phrase 'you make money in the buy'. What this means is that if you get a great deal at the beginning of a real estate investment, it will most likely make you money later on. If you overpay for a property, you will now have to hold onto the property and make money in other ways to help the numbers work and make a good return on your investment. A quick example: If you overpayed for a property in 2006 in Calgary, you most likely lost a lot of money if you needed to sell the property in 2009. If, however, you under-payed for the same property in 2006 you now may not have lost as much or even any money if you needed to sell in 2009. Also, if you under-payed for the property you will also be in a position to sell the property immediately (if needed) and still make money.

I have made the mistake of overpaying for a property in the past. I will attempt not to do so again in the future! Now that I know much more about investing what I will tend to do is make sure I'm getting a good deal. This doesn't mean I take advantage of other people and make sure they lose. I have no desire to have anyone lose. But the numbers need to work for me to get into an investment and the risk needs to be lowered in multiple ways. I only purchase properties that are good deals because I am looking in places other people aren't, negotiating well, and am willing to understand a market and area better than other professionals in the area. 

A tip for building instant equity

Today's post isn't wide enough in scope to give you every method I use to find good deals, but I will give you one general tip to purchasing a house that is a good rule of thumb as well as a professional that can make a huge difference to any investor. When you are looking at properties you need to be willing to move fast. Be pre approved or have cash when getting ready to make offers so that if the right deal comes up, you can jump on it. Next, have a realtor look through data and make sure you are only putting in an offer to purchase if it is already a good deal. Remember to give your realtor very specific information. The more you tell your realtor, the more your realtor can help you. If you don't have a good realtor let me know and I can put together a future post on how to find a great team to help you in investing wherever you are. 

But the real tip and instant equity is made possible when you find deals in creative ways. There are people called 'wholesalers' in every major city in Canada and the US. Find these people! What a wholesaler does full-time is find great deals. Contact this individual and tell them what you are looking for. If the wholesaler believes you are serious about buying a house when it is ready, you will be notified as soon as they have a good deal. You still need to make sure the deal works for you, but if it does... this is a great way to get good deals without doing a ton of work yourself. If you don't know what a wholesaler is you can puruse my former posts. I have one that I wrote late summer this year that explains the process and how this can work well for everyone involved. 

Summary

What instant equity does is take away risk as well as give you immediate money you didn't put into the house you bought. It removes risk by putting you in a place where, if you have to sell quickly, you can sell without taking a loss. It gives you immediate money because the house is worth more than what you paid for it and if you need financing at a later date you will be able to pull out more money than you would otherwise be able to do. 

The way some people build instant equity is trying to cheat other people out of money. They lie about what the house is worth or practice other, unethical, techniques. I find the best way to do business and have a clear conscience is by telling everyone the truth and simply working harder to find the great deals. If I can honestly help a family that is having trouble selling their home while explaining how I make my money (in other words, if I offer something other people are not offering a family) and this works well for everyone, I now have instant equity. If this can't all happen in a deal, then it is often best to simply not purchase the house because there are always other deals to be found if I'm willing to work hard and put in the effort. 

If you would like to learn more about investing in real estate please contact me at the email address listed at the beginning of this article or go to my website at: www.akerahomes.com/investing-in-real-estate.html

Single family investing vs. multi unit investing... which is best?

By: Mark Frentz
www.akerahomes.com
mfrentz@akerahomes.com

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SFH vs. MFH: Is one better than the other?

At time, I hear someone speaking of a certain type of real estate investing as being much better than another type. I know people who would bet their first-born child that Single Family Housing (SFH) will always be a better investment than Multi Unit Housing (MFH) as well as those who will argue the exact opposite. Is one better than the other? In short... Yes. Which is better? That depends.

Why the cryptic answer?

The decision to go into SFH or MFH needs to be one that is informed by your individual investing plan. SFH tends to appreciate faster, so if you are simply investing in real estate for future appreciation it may be the way to do. MFH tends to cash flow better, so if you want money throughout the investment maybe this would suit your needs in a more fitting way. What I hope to do in this post is handle the major reasons why people might choose one or the other. In the end, I hope you work hard on an investing strategy that best meets your individual and family goals rather than investing in the 'shiniest object' at any given time. Before I get into the major points I would like to admit that some of the information in this post came from a book by Julie Broad (More than Cash Flow), but that all of these points are pretty standard and every professional real estate investor should know and understand them. 

SFH

1. I made the statement that SFH tends to appreciate faster than MFH. The reason is that SFH is valued differently than MFH. SFH is valued at current supply and demand and real estate cycles of the centre you are purchasing in and it tends to be an essentially emotional decision more often than not. As an example: The average family that purchases a house in Calgary is doing so in order to live in that house. This family will choose a house that fits their needs, but is also buying because they like the location or floor plan. Families that choose a house do not purchase because it fits their budget perfectly or because it is in a location the city is investing infrastructure into over the next 10 years. SFH is also valued by supply and demand in a city or an area of the city. The Canadian average appreciation of housing tends to be around 5% annually, which is higher than the posted rate of inflation. MFH is valued at its CAP rate. If you don't know what a CAP rate is I will attempt to give a great description as well as the perils of trusting CAP rates in a future post. The brief explanation is that MFH is valued by how much revenue the property generates on an annual basis. In other words, when rents go up and expenses stay low MFH will increase in value independently of what SFH is currently doing. 

2. SFH is more liquid than MFH. If your plan includes purchasing AND selling real estate frequently, then SFH may better suit your plan. If you have a house to sell, there is a huge pool of people who may be both willing to look at it and be able to afford it, not so with an apartment building of 35 doors (they tend to cost more than just a few hundred thousand dollars). 

3. SFH tends to be easier to manage if you only have one building. In MFH you will often need to manage many people, not just one family. If your plan is to self manage, this may be easier. If you have a full time job, it may be difficult to self manage MFH (even just one building with 12 doors). 

4. There isn't a lot of tenant to tenant problems with SFH. When tenants aren't sharing a building there simply isn't as much friction (this is another management consideration).

5. It is so much easier in SFH to have your tenant pay for all utilities, which is difficult to do with even an up and down duplex. 

6. Financing is much simpler and easier to obtain than MFH. By the way... if you are having trouble financing an investment please give me a call or email. I work with a few fantastic mortgage brokers who may be able to help you much more than your current broker (and definitely can help you more than any bank). If you haven't financed a lot of properties, this may be less daunting at the beginning of yoru investing plan. 

7. There are fewer big ticket maintenance costs. You don't have a huge parking lot on your property that needs snow removal in the winter by a professional contractor. Worst case scenario is that you go over and shovel the driveway yourself a few times a week, but tenants will often be responsible for this upkeep. If big ticket costs scare you, it might be better to stick with SFH (where the biggest cost tends to be a new roof for $5,000).

8. There tends to be less turnover with tenants in SFH. I currently have a family who has signed another 2 year lease after already living in our place for 2 years. Our next door neighbours have rented their current house from their landlord for 18 years! Again, this is a management issue... if you don't want to deal with renting out a place consistently, SFH can be simpler.

MFH

1. I wrote about the appreciation of SFH... well, MFH has a decent advantage for forced appreciation. Either investment will be worth more if you fix the place up, but MFH will be worth more by simply managing the property more efficiently. If you purchase MFH that is only 50% filled and hasn't seen rents increased in a decade you can appreciate the property by simply filling to capacity and increasing rent. What I'm saying is that if you know how to properly manage property and aren't afraid of the work, you can easily force the appreciation of your property. 

2. Continuing with the theme of management... if you are hiring a company to manage your property for you, the companies will typically give you a discound per unit on MFH because they have 25 units all placed together and it is easier to manage than 25 separate houses. 

3. MFH tends to cash flow better than SFH. If you purchase a house in Calgary right now it is very difficult to have rent cover all expenses as well as put money into your pocket at the end of the month whereas MFH will, in a good scenario, cash flow quite well and, in a worst case scenario, not lose as much money each month. Rent to value ratios are higher in MFH than in SFH. Here I need to bring up something I have a strong opinion on... If a property, or any 'investment' does not put money into your pocket consistently... it isn't an investment, its a liability! Don't ever purchase property that costs you money each month. It is both highly risky and unwise for future growth. 

4. There is less vacancy risk in MFH. When you have SFH and your tenant leaves for a month you will have 100% vacancy that month. In even just a 4plex, when a tenant leaves for a month you only have 25% vacancy. The advantage here is that you still have 75% of the normal rental income to cover that month's expenses. You can also wait for a vacancy and reno one unit without high risk because you are still bringing in rental income from 3 other units!

5. It can be easier to find tenants because of the lower rental costs (you will have a larger pool of tenants to draw from). 

6. Maintenance costs are lower per unit than in SFH. When you replace all the windows it is a large cost, but cheaper per unit because you can get a discount on the amount of work you are doing. An aside.... you should always be including future replacement and renovations costs in your month expenses! That way you will have money sitting in the account ready to be used when the costs comes up rather than scrambling to come up with the money on short notice. I only ever calculate cash flow (money in your pocket after all expenses each month) after including these extra maintenance costs. IF you aren't planning for the future, you aren't an educated and risk adverse investor. 

7. MFH is often built closer to major population areas like malls and universities, so accessibility tends to be easier/better, which helps with filling vacant units. 

8. MFH has financing perks as well, they're simply different. Did you know that with SFH you have to personally qualify for financing (ie. the lender will determine if your annual income can support the mortgage payments). With MFH over 4 units the property can qualify itself (ie. if the net income is stisfactory, the lender will be quite willing to qualify the mortgage). There is another qualiification for MFH; lenders are typically looking for the purchaser to have a networth of over $100,000. 

So... who is the winner?

Maybe a mix of both can work best in Calgary. An example is up and down suited detached houses. This has the MFH benefits of less risk with vacancy (50%) and rental income that covers expenses while retaining a lot of the SFH benefits (liquidity, appreciation, time commitment of self management). 

Here are some questions to ask yourself when it comes to deciding which strategy will work best for you:

-Who will manage the property and respond to late night squabbles and maintenance issues?

-Can I carry vacancy costs?

-How long do I plan on holding the property? Is the purpose to keep it forever or sell each property every few years?

-Do I more value appreciation or cash flow?

Before you invest in any type of real estate do a ton of research and make sure you have a strong and specific plan put together. Investing without a plan is never recommended by anyone as it is similar to taking a road to travel somewhere without understanding where the road leads. I will leave you with a quote I have often heard. It is attributed to Lewis Carrol and I have paraphrased. 

"If you don't know where you are going, any road will get you there"




If you would like to learn more about investing in real estate please contact me at the email address listed at the beginning of this article or go to my website at: www.akerahomes.com/investing-in-real-estate.html

5th Dimension: Leverage

By: Mark Frentz
www.akerahomes.com
mfrentz@akerahomes.com

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A quick definition

The first image that comes to my mind when I think of leverage is a picture of using a crowbar to pry a nail out of some flooring. I don't know why this is what comes to mind, but it is great example of one type of leverage. With the use of a tool like a crowbar I am able to do very difficult things without very much effort. To pull a nail out of a floorboard is extremely difficult with my bare hands or finger nails, yet with a crowbar I don't break a sweat, I use about 5 seconds of time if the crowbar is handy, and I do no damage to my body or the crowbar itself. A simplified definition of leverage is: The use of a tool to maximize the assets available to you. In the case of the crowbar I am maximizing my strength and understanding of leverage (2 assets) through the use of a crowbar (tool) in order to get a lot done with very little expenditure. 

How does this apply to real estate?

Real estate is THE investment that makes best use of monetary leverage. The only other investment class I can readily think of with leverage of any real kind is the stock market, but only when investing with calls and puts (options) and the greatest leverage potential I can think of with these is about 3:1. Also, as leverage is more used in stocks (ie.futures or even options) the risk factor tends to skyrocket. When I was learning about futures the mentor teaching me said the rule of thumb is... IF you haven't lost EVERYTHING you have invested after about 6 months you may have a chance of doing alright in the future's market. 

Compare what I just stated with real estate. First, you can quite easily make you first investment using 20:1 leveraging, but even after this first investment you can fairly easily receive 5:1 leveraging. Secondly, the risk does not need to increase with increased leverage. Real estate covers its own risk in many ways if it is done properly (as discussed in previous blogs... I will cover this more fully in a future blog). Thirdly, when investing in stocks, you are paying everything off with your own money when all is said and done. If you make money, you can pay off debt with your earnings and if you lose money you need to come up with more of your money yourself. With real estate your debt is paid off by others. That original investment is, typically, the only money you need to put into the property if you have done your proper due diligence because the tenants will not pay off all taxes, insurance, financing (mortgage), management costs, and even future vacancies and maintenance expenses (like your roof, furnace, and hot water tank replacement). This is why I refer to real estate as 'magical'; it far outpaces other investments when all considerations are taken into account. 

Ok, I just used a lot of jargon so I'll make it a little simpler for those who are new to investing and/or investing in real estate. Many people don't have enough money buy a house to rent out. For a smaller starter single detached house in Calgary you need to come up with around $250,000 at the time of writing. The way you leverage the money you do have is by asking a lender (banks as well as other companies... there are about 25 lenders in Alberta) to come up with most of the money. If you don't yet own a house or want to move into another house (that you can rent to others in the future) you can borrow 95% of the money needed for the purchase! That's crazy! For that $250,000 rental property, if you want to just make a start in real estate and are willing to live in it for a year or two, you only need to come up with $12,500! Now, if you are living in the house you will be paying off the mortgage yourself, which is a potential hurdle. Even this can be changed, however, if you are also willing to buy a house with a suite and rent out the basement to someone else (who will give enough in rent to take out your monthly mortgage payments). If you don't want to make the inconvenient sacrifice of moving into a 'future rental property', you can still borrow 80% of the money needed for the property. In the example above you would only need $50,000 to purchase the $250,000 house. Then the tenants will make all the rest of the payments for you (Please recognize I am making simplified statements to make my point). 

What is one of the perceived advantages the stock market has over real estate? That you need less money to get into a deal. This is mostly true. Yes, you can get into stock investing for less than $10, but remember you will need to pay fees every time you sell or purchase more stock (often the cost of even one trade can be around $15, but easily higher). If you don't have the $50,000 needed for a rental, you can always invest what money you do have with a professional real estate investor. I will cover this topic more fully in a future blog, but be extremely careful before you invest your money with someone else. Nobody cares about your money and its growth as much as you do. The three dangers with investing your money with someone else are: 1. They could be a crook and steal some or all of your money, 2. The could be a fool and simply not invest your money well, or 3. Even if they are honest and competent, they will be making money by investing your money (same as mutual funds or most people you go to invest your money in stock markets) which means you won't be making as much return. The best option for making an incredible return on your investment is always to control everything and manage everything yourself. The best option when you don't have the time, energy, understanding to do everything yourself is to make sure you have someone who is honest and competent. The beauty is that there is so much money in real estate that you can find a trustworthy person to do all the work and still make much more than other 'safe' investments (no investment is 100% safe; each carries some kind of risk). 

A summary

Basically what I am saying is that you can use a small amount of money to make a large purchase in real estate. This is called leveraging your money. If you do it properly, you will not be taking on a lot of extra risk and the return on your investment will go way, way up. I'll give a final, quick example: If you use cash to purchase a property worth $250,000 and the property appreciates in value by 5%/year (the Canadian average), you will make 5% on your investment plus the cash on cash return from rent (in that property you make another $10,000, a conservative number after expenses, each year which would give you a total of around 9% total return on your investment). With the same house, if you used $50,000 of your own cash and borrowed the other $200,000, the house would still appreciate at 5%, but that $12,500 will give you a bigger return on your money because you put less money into the deal. Yes, the house appreciated at 5% in both cases, but in the second case you would be making a 25% return on your invested money. There are two other advantages... you are still making money from rent (not as much now because you have a mortgage payment each month), but part of the money you are paying toward the mortgage debt will be put back in your property (the principle payment) which will be, on average over the course of the mortgage, about $7,200. In total, if you are using the bank's money to help purchase your rental property, you will be making almost 40% return on your money, on average, year after year after year! I haven't even included other ways you make money with this type of investment. If you read my last blog in this series, you know you can also be paying less in taxes, which is similar to paying yourself more money each year. At the end of this series on the multitude of ways to make money in a normal real estate deal I will break down a typical deal and how much you tend to actually make on your original investment. I'm convinced it will blow your mind.

Are you beginning to see that very high rates of return in real estate are possible if you do everything yourself, without taking on very much risk? If you went to your financial planner and told them you wanted a 40% rate of return on an investment that also gave you tax breaks they might first laugh or choke on their saliva for a few minutes and then inform you that you would need to take on extreme amounts of risk in order to make that kind of return. With real estate these numbers are not fantastic... they are average. The ways you can make money in real estate are so varied and great that you can hire someone to do all of this for you and even after they are paid well for their services, they can still offer you a really good return on your money. 

If you would like to learn more about investing in real estate please contact me at the email address listed at the beginning of this article or go to my website at: www.akerahomes.com/investing-in-real-estate.html