You might be asking yourself why buy-rent-hold strategies are a good investment? The recession has made many investors in Alberta nervous about buying residential real estate investments in Canada.
Although the economy and jobs are uncertain, the flip side is that mortgage rates and housing prices are the lowest they’ve been in a decade.
But is buying Canadian real estate a good investment?
There are several factors to consider.
First of all, think of residential real estate investing as a strategy to build equity slowly.
To illustrate my point, let’s take a brief historical snapshot of housing prices in Calgary, Alberta.
Real estate appreciates in value
Since the1950’s, Calgary’s real estate has increased on an average of 3% per year, compound (meaning the interest made on the interest).
Example #1 Brentwood / Charleswood area / Built 1950’s / Single Family Home (SFH) – $30,000 / Today’s value: $500,000
Example #2 Glenbrook area / Built 1998 / Townhouse – $98,000 / Today’s value: $280,000
Condominiums are a different animal, and unless you buy an exclusive million-dollar condo with a waterfront view in a coveted location, they are typically not good investments. Why?
When you buy a condo, you don’t own land; your investment is similar to owning shares in a property. Plus, there are condo fees utilized to service numerous building costs, including;
- Elevator maintenance
- Interior hallways
- Heated underground parking
- Gyms, pools, onsite security, etc.
Are condos a good investment?
Factor in the multiple levels of bureaucracy such as condo management companies, condo boards comprised of conflicting personality types and interests (translation; petty tyrants), and neighbors who may or may not pass sanity tests that can make your stay less than tolerable.
Adding insult to injury, Insurance rules for condos have changed drastically in 2020 which means condo owners may have to absorb anywhere from a $25,000 – $100,000 deductible. Currently, there is a ton of competition in the condo market and condos are not easy to either rent or sell.
If you want to own condos, own the whole building, but then you’re getting into commercial real estate – a different ball game for another article.
Single Family Homes
Back to SFH’s…
Single Family Homes (SFH’s) Questions to Consider
Let’s consider three questions:
If your SFH costs $100 in cash flow every month for 12 months (loss of $1200/year), would you still invest in this property?
If your SFH were to cost $100 in cash flow every month for 12 months x 10 years (loss of $12,000), would you still invest in this property?
If your SFH costs $100 in cash flow every month for 25 years (loss of $30,000), would you still invest in this property?
That leads to the MAIN question: IS BUY-RENT-HOLD REALLY WORTH IT?
Of course, the above three questions are theoretical. We know in a good year, all landlords raise rents to increase our cash flow (luckily, we’re in Alberta, where there’s no rent control).
But again, back to the main question: is it worth it?
Let’s talk numbers;
- If you buy a house for $500,000
- 20% down = $100,000
- Negative cash flow for 25 years at $30,000
- Total out of pocket: $130,000 over 25 years.
How much will your house be worth in 25 years? Given the historical house price appreciation, some say 3%, others say 5%.
But are you winning with buy-rent-hold strategies?
Do you believe you’re on the winning end of this scale after 25 years, even though you’ve forked out $100 a month for 25 years?
If your answer is yes, then keep reading.
If your answer is no, then buy-rent-hold may not be your strategy in real estate. But you can still explore other strategies within the real estate umbrella.
With the above calculation in mind, a sound investment strategy is always to buy UNDERVALUED. Meaning if you have to fork out $100 a month, you will still feel good about it because you bought it below market price.
Never buy at market price. Have your realtor submit low-ball offers. Or if your realtor says no, fire him/her and find one that’s thick-skinned enough to play hardball.
How do you find undervalued properties?
First of all, be patient. Look for houses below market value or on the market for a while but couldn’t sell. Make a low-ball offer. Negotiate. Remember how good the undervalued aspect will make you feel.
How can you finance your investment?
Then find financing by either going to your regular bank or mortgage broker (we all know that traditional banks offer the best rates).
But what if you’re fully maxed out with a few houses in your portfolio, and the Big 5 (banks) aren’t willing to lend? Usually, after four houses in your portfolio, traditional banks say no. What can you do?
Your mortgage broker will have connections with different “B” lenders. With B lenders, requirements are a little higher; for example, they may request a minimum of 20%- 30% down (depending on your credit score) rates are higher, most likely prime +1% or 2%, and terms are usually shorter 1 to 2 years.
B Lenders for buy-rent-hold strategies
Now, as a regular consumer, you’re probably asking, why should I pay more for a B lender? Besides, traditional banks are cheaper!
The answer is because you’ve got a good deal on the house, and regular banks aren’t willing to finance.
That’s why negotiating for an undervalued deal is so important. You save big money on the house price and only pay a point or two extra to the B lender for a short period of one or two years. Then along with the proven rental income, you return to an A lender (regular bank) and switch the mortgage over for a lower rate. Besides, if this house will bring you 25 years of rental income, what’s the big deal of paying a little more to a B lender for a short time?
Remember, if this is an excellent undervalued deal, you’ll either make it work or let it slip away to someone else.
Using B lenders short-term for one to two years and paying a bit more to add a long-term asset to your portfolio is worth it for a long-term buy and hold strategy.
Private Lenders for buy-rent-hold strategies
Now, if you’re totally maxed out with a ton of houses and your credit is also maxed out, but you found and negotiated a super undervalued deal, and Blenders won’t talk to you, then speak to private lenders (PL).
PL’s are a different breed of lenders. They charge a much higher interest rate and fees to finance your house. Is it worth it? Let’s see how they work.
The only rule that applies for a PL is the Bank Act, which states no one can charge 60% or more per annum, so legally, a PL can charge 59.9% and still be within the law. However, realistically most of the deals fall between the 8-15% range.
A PL can be a corporation or an individual with money to lend. They can be very flexible on their terms, or they can be completely ridiculous and wreck your deal. For example, a PL can be an individual who had a bad experience living in a townhouse due to disrespectful neighbours in the adjoining duplex; therefore he may reject all townhouses in his private lending practice. You cannot argue with a PL on his/her terms. He/she has the right to say yes or no to you, for whatever reasons. So, why would you use a PL at such a high price? Because you found a super undervalued house, negotiated and closed at an even lower price and because regular banks and B lenders won’t lend you the money. If your numbers make sense based on your calculations, paying a higher rate to a PL for a short term of one year (max two, but preferably one), then this is a good option. Again, before the PL term ends, collect your proven rental income and financials and approach a B lender to switch your mortgage over. After two years with a B lender, then switch over to a regular bank for an even lower rate.
That’s why getting an undervalued house is so important. The other reason is when the economy goes south, you won’t be feeling the pain.
Now, back to the MAIN question: Why Are BUY-RENT-HOLD Strategies a Good Investment?
As investors, if you’re not limiting yourself to the big 5’s but are also willing to consider B lenders and private lenders, long-term holds can be very profitable as long as your numbers work in your buy-rent-hold strategy.
Remember: buy undervalued properties and focus on a long-term buy rent hold strategy because, after 25 years, landlords always win.
Now that you have a rental property, are you feeling a little overwhelmed with finding the right landlord forms? Nelda Schulte’s 10 Essential Editable Landlord Forms make being a landlord easy.