Since this blog is committed to helping you increase your financial IQ so you can quickly amass great wealth, I wanted to provide you with a real case study which will give you an insight on how real estate really works. And mind you, these aren’t some fantasy numbers that I will share with you, this is the real deal (no pun intended).
Before I go on, I want to say that my favorite asset class for building and holding my wealth is real estate – bar none. Let’s get right into it. In January 2014, I had some extra cash laying around in my bank account. This happened because my online marketing company had done fairly well over the last 3 years. I met a real estate agent (a patient of my mom, who is homeopath and a doctor) who convinced me and my family that we should invest in a property in Oshawa, a small city to the East of Toronto.
I reluctantly said yes to the proposition since:
- I had some money in my bank account, which was losing around 2% of its value annually (because of inflation) and I wanted to make it work hard for me (so I didn’t have to).
- Real estate was a totally new proposition for me & I always like trying new things out, knowing there’s a chance I might land on a potential gold mine with each new “venture”.
- I had heard others make a good ROI in real estate.
So after looking at a couple of properties, I purchased a 1900 square feet detached house in Oshawa for around $405,000 with a 10% down payment of $40,500. I incurred a CMHC (mortgage insurance fee, since my down payment was less than 20% of the property value) of around $9000 when I purchased.
The idea was to live in this house for a couple of months and also to rent it out to a tenant so he would help me pay off a portion of the mortgage. My real estate agent had told me that the house would rent for around $2100 per month and I would have to pay around $150-200 per month from my own pocket in order to settle the mortgage payment, property taxes and the general maintenance.
Long story short, I realized after a couple of months that the rental market in those days paid a maximum of $1750 per month for the house so I would have to pay the rest. Another reasons for the negative cash flow was that it was my first investment & I was self-employed so the banks only wanted to issue me a fixed mortgage with a much higher interest rate (since I was high-risk to them, not being an employee, whose earning potential is always known to some extent). Another reason for the huge drawdown was that I had purchased a BMW convertible a year ago, which increased my debt to equity ratio, giving the banks another reason to go crazy with the interest rates they charged me (and they did go crazy by the way). That BMW was a real treat for me for the first couple of months, but soon turned into a nightmare, not because of its monthly payments, but because it had low utility value, was prone to breakdowns and I had to spent a ton on repairs and maintenance.
Anyway, we finally landed a tenant who was willing to pay us around only $1750 per month. This meant that I will be paying around $750 per month for the property even with the tenant in there! Yes, $750 per month is decent money and it definitely caused me some concern but I also knew that:
- The tenant is helping me pay down around $200-285 per month in principle.
- The house is appreciating in value since it was in a good neighborhood, with a police station, school & the mall 5-8 minutes away from it.
We sold the house in July 2015, exactly 18 months down the road for a handsome price of $522,500, which meant that on paper, I had a profit of $117,500.
However, things are never so simple in real estate transactions. I paid my real estate agent around 4% of the sale price of the house, amounting to $20,900. Since I was paying out of pocket the entire time the house had a tenant in it, I incurred another expense of $13,500. Also, it took a month for the property to sell which forced another $2500 out of my pocket (since the tenant had been requested to relocate).
There was also a penalty of $6000 to break the mortgage agreement (since it was a 5 year fixed mortgage with 3.5 years still left on it). We also had to renovate the house for around $10,000 in order to help us make more money on the sale (without the renovations, the property would have sold for only $485,000, around $30,000 lower). This means that I made around $64,600 in profit. Now, even with all the things which went wrong, I was able to get more than a 100% ROI on my first property since I banked around $64,600 with an investment of around $50,000 (down payment + mortgage insurance).
The best part is, this 100% ROI was achieved in only 1.5 years. However, I have invested these profits and the original down payment into many other properties, helping my portfolio grow quickly. The reason I have gone in such depth to write this case study is because I want to tell you that you can land a profit even after making mistakes. If I had not owned the BMW and had the bank given me the standard interest rates, I would have added at least $7000 more to my bottom line.
That being said, here’s what I learnt after selling my first property:
- The more debt you have in your name, the higher risk you are to banks, which means they will charge you a much higher interest rate.
- You are likely to face difficult situations in real estate investments for a number of reasons which are outside your control. The key is to learn from them & try to contain them as much as possible.
- Generally speaking, in high-demand areas, real estate values never drop (unless a major industry closes, people move out, crime increases by a huge factor etc.)
- You should always try to ensure that your property either breaks even in term of cash flow or is only slightly negative. This means that the rent you gain from the property totally offsets the mortgage payment, property insurance and taxes and any general maintenance expenses)
- Ideally, you should get your hands on properties which have a positive monthly cash-flow so instead of draining your pocket, it adds money to it.
- Having a good real estate agent is key. My real estate agent knows what he is doing & has a lot of experience in the real estate and banking sectors. I couldn’t have done this without him.
The key takeaway is this: You are never to0 late to start investing in real estate. Yes, it is a hassle at first and there will be times when things will get a little challenging. However, the benefit from the experience (and the profit you bank) is easily worth the “hassle”. I hope I have given you a lot of insight into real estate with this post. Please comment below if you have any questions.