Running the Numbers

by Mr. Cheap

It always drives me nuts when people recommend a specific investment, give a bunch of reasons to buy it then finish with “of course, do your own due diligence before buying”. As I’ve written before, it always feels like such a cop-out. Often books which specifically claim to help you learn how to buy stocks or real estate will give the same out. Or they’ll encourage you to talk to an advisor before making any purchase (not a bad idea, but didn’t you buy THEIR book for information, then they just tell you to go talk to someone else).

I’d be a little more accepting if they gave a detailed overview of HOW to do your own due diligence, but I’ve seldom come across any writers even willing to give that. By way of example, I thought it might be worth running the numbers on a property currently for sale here in Toronto (this is an exercise I’d usually go through to decide if it was worth going to see a property and digging further into the details about it).

I like to watch real estate listings in one area of North York and another area called Crescent Town (which is near the Victoria Park subway station). I’ve been able to get a feel for prices in these two areas, as well as rents. If I found out another area that supposedly offered good deals, I’d look into it, but would be a lot more skeptical of my calculations (and would spend more time verifying things before making an offer or following through with a purchase).

Crescent Town is great in that its a complex with a bunch of buildings, so there’s a TON of comparables for any details you might want. The cheapest unit available is listed here (link will be dead eventually, I’ll write relevant details here – the asking price is $92,900). As a 1 bedroom unit, a $900 rental price is probably reasonable (that’s what other units in the complex rent for), as long as its in decent shape (which they claim it “Shows Well”).

Income ($900 / month):

  • $900 / month (rent)

Expenses ($476.02 / month):

  • $370 / month (condo fees)
  • $66.02 / month (0.8528434% property tax)
  • $40 / month (insurance – this is what I pay on my condo)

This is looking pretty good! $424 / month cash flow positive! Sweet! Perhaps we’ve been reading the Canadian Capitalist too much, and we know he insists on REAL expenses, not just the pretend hypothetical kind where we ignore stuff we don’t want to face (he’s such a stickler for reality!). So lets add on 5% of the monthly rent as a vacancy rate, and 1.5% / year of the purchase price as a maintenance rate (this might be a LITTLE high for a condo, since the corporation handles all outside maintenance, and SOME inside maintenance).

  • $75 / month (vacancies)
  • $116.13 / month (maintenance)

The maintenance DOES look high, but we’re including in this things that are expensive and only rarely needed (such as replacing the carpeting or getting the unit painted – amortizing them over the length of time we own the unit). $233 / month profit is still pretty nice.

Lets think about transaction costs and financing now. Legal costs will probably be about $2K, Toronto’s new transfer tax will be $1,393.50 (1.5%), if we put 5% down (lets ignore CMHC fees) that’d run us an additional $4,645. So cash down we’re looking at about $8K (we’re assuming NO renovations are needed).

On an INTEREST ONLY mortgage at 5.5%, we’d be looking at paying $404.50 / month in interest (simply the purchase price, minus the down-payment, multiplied by 5.5% and divided by 12).

This puts us at $170 in the hole each month. We’re paying $8K for the honour of losing this money each month. And this is the cheapest unit in the complex. In order to BREAK EVEN every month, we’d need to up the down payment to 20% and for them to accept a purchase price of around $81.5K. To make $50 / month (as recommended by Violent Acres), we’d need a purchase price of $72.6K.

Surprisingly, telling sellers they need to give us a killer deal in order for us to have a cash flow positive property rarely produces good results. As a very low priced unit in the complex, I don’t think the agent or the sellers would take you very seriously if you went in and offered them a low ball offer. However, there’s nothing to lose, so there’d be no real reason not to (and maybe you’d get lucky and they’d need to sell for some reason). Some real estate investors claim the hardest part of getting into it is being willing to burn down the shoe leather looking at places and putting in low offers (trying to find the 1 in a 100 seller who will accept). This unit has been on MLS for a while, so I’m sure they’d entertain offers below asking.

Obviously you can make the numbers work for ALMOST any property by just increasing the down payment (as we did when we upped our down-payment to 20%). You have to be honest with yourself, however, that money has value. If you’re using it for the down-payment, you’re missing the chance to use it for something else (the opportunity cost). Assuming a 10% opportunity cost for the down-payment and transaction fees might be reasonable to include in your calculations (we won’t here, as it’d put us in the hole again).

Condos are notoriously bad money makers for people getting into real estate investing, and the numbers are usually bad. By being able to control the costs that are made up by your condo fees, in properties that you own on your own, you’re usually able to cut costs to turn a profit. The big advantage is that condos are cheaper than single family homes or apartment buildings and let you “try on” the landlord hat without being overwhelmed.

If anyone goes to view this condo (Guinness416 lives in the neighbourhood I believe), please post a comment with how it looks, and if anyone makes an offer, please let us know how it goes!

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{ 9 comments… read them below or add one }

1 Canadian Capitalist

Thanks for the mention, Mr. C. I don’t think I’ll ever directly invest in a rental property but I do check out ‘deals’ for fun and just check the cap rate using the income and expense details provided. In this case, it is 4.6% net plus the other expenses you’ve noted. Hardly better than investing in a bond, IMO.

2 Samantha

I love the idea of going around and putting in low ball offers. When we went to buy our house that was our plan but then our real estate agent – a friend – kinda let us know that he wasn’t willing to go around town putting in low ball offers because putting in a bunch of “not serious” offers would cost him his credibility.

It may be hard finding an agent willing to do all that work for likely very little profit.

3 guinness416

Interesting! How do you see DOM on mls? Not only am I not a million miles away, I’m married to a Bangladeshi guy who has been trying to persuade me to buy something in Crescent Town since we moved here :)
(It’s pretty much the first stop for the rapidly growing Bengali population in TO). I’m not sure if I should show him your post or not! If you hook up with the bengali mafia you’ll find that there are usually a number of FSBO units floating around there all the time too.

Also, wikipedia says that Kiefer Sutherland grew up in Crescent Town.

4 MM

From the listing: “EXTRAS **** Fridge, Stove, Elfs, Window Coverings** ”

Elfs come with real estate in Toronto now?

5 Mr. Cheap

CC: I agree, this isn’t the best deal in the world. I definitely agree with what you’ve written before that many real estate investors deceive themselves about the real return from their property.

Samantha: Yeah, agents might resist. I don’t think its about hurting their credibility, its just more work for them. Ultimately you can approach the selling agents directly and low ball them if you wanted to try low balling but couldn’t find a buyers agent who would work with you.

Guiness416: Yeah, MLS conviniently omit DOM. The agents get them on their version of the system (so if you have a buyers agent, they can tell you the DOM).

MM: Yes, they used to come with Gnomes, but we’re heading into a recession you know… (ELF stands for Electrical Light Fixtures)

6 AJC @ 7million7years

My Rule of Thumb: invest in your own home, then the ‘cap rate’ is meaningless and eventually you will build up enough equity (see my 20% Rule for more on this) to do some ‘real investing’.

Even if the cap rate is no higher than a bond, long-term capital appreciation should do the trick … esp. if you can lock in at today’s low interest rates for as looong as possible.

7 Four Pillars

Why are condos bad for landlords? Because of the condo fees?

Interesting case study.

Mike

8 Mr. Cheap

I think its two-fold why they’re bad. There’s the “tragedy of the commons” issue, where people don’t conserve common resources (like heat, water and electricity), because they know the cost will be shared across all units in the building. Everyone doing this leads to higher costs for everyone.

The second element is that obviously a condo should be quite a bit cheaper than a house, since MUCH of the infrastructure is shared. People compare the purchase with a house, and want to get a better deal, but tend to bid up the price higher than what it should be. The higher price leads to it being a worse investment.

Many apartment building owners get fantasies of turning their building into condos. If they did, they see that the value of the building would jump significantly. Apparently there are a LARGE number of legal and politcal hurdles to make this happen, which is why owners don’t do this.

If there was less friction in the process, this would be a GREAT investment strategy. Buy a building, turn it into a condo corporation, sell enough units to make back what the building’s purchase price was, then rent out or sell the remaining units (which you got for free*).

* Minus the cost/effort of the purchase and conversion of course.

9 Michael

Condos were never intended for landlords. That’s what apartment buildings are for. If you want to be a landlord, buy an apartment building, don’t go turn somebody else’s home into a slum, because that’s what investors do to condos. That’s why banks either charge more or won’t lend at all to buy a condo in a development that’s less than 80% owner-occupied. There should be laws against these speculators.

Furthermore, NEVER buy a condo that was converted from rental property. The walls are paper thin. You get a lot of noise from neighbors. And the shared heating system is an invitation to waste and sky high heating bills.

(PS: I live in a townhouse condo that was built as condos. I bought it pre-construction. We have separate heating systems, and we’re over 90% owner-occupied. I put down 20% when I bought it, refinanced it 4 times, each time getting a lower interest rate and buying DOWN the principal. I paid off the mortgage in 16 years. When my employer was bought by a foreign competitor and shut down, I was sure glad I didn’t have mortgage payments, and without an income, there was no tax advantage to having one anyway.)

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