Getting Started With Investment Real Estate – Part 8

by Mr. Cheap

To start at the beginning – please see part 1 of this series.

As detailed in the previous posts of this series, I bought a condo in late 2006, fixed it up (new floors, new electrical sockets and a heavy paint job) and found tenants. All the gurus and real estate TV shows use funny math to show how “you can’t lose at real estate”, so here I’d like to lay out, as close to the penny as possible, what my investment has looked like over the last 6 months.

In retrospect I wish I’d kept a journal of how much time I spent, as that’s obviously a consideration. I’d give a rough estimate that I’ve put 40-80 hours of work into finding the condo, supervising the contractors, showing it to tenants and doing repairs. This is a VERY rough guess. The hours weren’t in discrete blocks (1.5 hours here, 3 hours there), so don’t consider it work “equivalent to a work week or two”.

I purchased the condo for $126,000. I made a down-payment of $34,160.57 which includes a 25% down-payment, and closing costs, which were $2,308.19 (legal fees mostly). $34,160.57 is more then 25% down plus the legal fees, which I’m not 100% where the extra $352.38 went (maybe mortgage fees, I’m not 100% sure right now – I know I got a small check back from the lawyer, the SOB made me pre-pay his fees, but it was certainly less than $352.38). Renovations (including labour, materials, condo fees during rehab and mortgage interest) were $10,551.41. As percentages, closing costs were 1.66% of the total purchase, and rehab costs were 7.6%. Ignoring the cost of selling (5% agent commission plus legal fees), my break even sale price would have been $138,859.60. Given that comparable units have been ASKING for $155-165K over the last few months (the rule of thumb supposedly is that condos in Toronto sell for 96% of asking), I’m quite pleased with the cost of purchasing/fixing this unit.

In case you’re wondering how I got such a deal, the place looked REALLY bad when I first saw it. There wasn’t any floor (bare concrete), the walls were an electric blue colour, and had gashes in them. The seller took the perspective “why put more money into something I’m trying to sell”. While I understand that perspective, the condo had sat on the market for over 6 months (and he’d moved, so he was losing $500 / month in condo fees), and everyone who looked at it just viewed it as buying a problem they’d have to fix. He had to drop the price far more then repairs would have cost in order to sell it to me, and he shelled out quite a bit of money over the time period when it wasn’t selling. I’m not a “flipper” at all (I’ll probably post more about this in the future, but I basically think its a suckers game where people convince themselves they’re making more then they actually are), but if you can accurately estimate the cost of repairs (not as easy as it sounds unfortunately), there are certainly deals to be had on run-down properties.

I saw another condo recently that was in even WORSE shape, and I put in a low offer, hoping to pick up another “fixer-upper”. The seller kept insisting on wanting market value for the unit (even though it would have cost $15K to get it into “market value” condition), so I obviously walked away from that deal. So the other factor to keep in mind is that not all run down properties are a good deal. You’re a sucker if you pay market price for a property that needs extensive work. You’re a sucker if you pay market rate – cost of repairs for a property that needs work (you’re accepting the risk of repairs being more expensive then expected and doing the supervision of the repair work without compensation).

I tried to rent it at higher amounts, but in the end rented it for $1300 / month. My condo fees, insurance, mortgage INTEREST and property taxes come out to $1,042.87 / month, so I have a positive cash flow of $257.13.

When I calculated JUST the down-payment and reno costs, I came up with a cost of $43,811.68 over the first 6 months. Using the $257.13 monthly profit (which already accounts for the mortgage interest, condo fees and other ongoing expenses), this gives me a ROI of 3.51%, which would work out as an annualized ROI of 7.03%. This assumes I was making the $257.13 since purchase, which I obviously wasn’t, and also assumes there will never be any unexpected costs in the future (which is equally absurd).

This may not seem so great, but firstly this was a learning project for me (so part of the costs/benefit is my “tuition”). Secondly, this ROI is JUST based on the monthly cash flow, if I bought at a bargain price (which I believe that I did), I should also get a satisfactory return on the sale price. Thirdly, if real estate appreciates, this will increase the difference between my purchase price and the sale price. Fourthly, there will be positive tax implications (I can depreciate the property in order to defer taxation). Fifthly, inflation should increase rent, which will increase the monthly cash flow (and decrease the cost of my mortgage). And finally, as my mortgage gets paid down, less of each payment goes to interest (which also increases the monthly cash flow).

In case you read the previous paragraph and are planning to run out and buy all the real estate you can find, the risks in this investment include: future vacancies, difficult tenants (damaging the unit or making demands which will cost lots of time/money), legal liability for any problems resulting from the property, a real estate market crash, and high interest rates when my mortgage comes up for renewal (in 4.5 years).

With my current cost of living estimate, I believe that I could cover my living expenses with 4 more similar properties. If it was possible to get a better deal, or to get a similar deal with less cash invested, I might be able to do it with less. Therefore I am potentially $175,246.72 (4 x $43,811.68) away from retirement.

This concludes the “Getting started with investment real estate series” – feel free to check out the real estate archives for more article on real estate.

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