Small investors Guide to Making Money in Canadian Real Estate

Small investors Guide to Making Money in Canadian Real Estate
Gary Weiss - 1992

Consult with a tax or legal advisor in doing transactions. Real Estate laws change continually.

Real Estate (a home) is the biggest single investment Canadian families own.

Attractiveness of RE as an investment: cash flow (defined as the money you get after expenses from a rental property), tax advantage

Required to invest is: need to be smart, need to have time, need to have connections, need to have propensity for risk-taking.

As a landlord, you can deduct the following: property tax, insurance costs, heat/light/water, salaries to supers, etc., accounting services, legal fees (not ones connected to property purchase), commissions to rental and collection agents, landscaping costs, payments to tenants to cancel their leases, interest on money borrowed to improve the property, certain auto expenses (collecting rents/managing property), current general maintenance and repair (but not the value of your own labor and not property improvements that enhance ORIGINAL property value – these are called “capital expenses”). And they have to be deducted in same year you pay for them.

Painting, fixing leaky faucets, patching walls, sanding floors, and doing a thorough cleaning can increase resale value by thousands of dollars (or the rents you can get for it).

The idea therefore is spend the least possible money on a “fixer” and don’t include anything that upgrades over original value, as this is just taxable under “capital expenses”.

Real estate losses are tax deductible. So even if a property goes on the fritz, losses from it are deductible against overall income.

Leverage is what makes Real Estate truly the best investment around. The less of your own money you put in the more leverage you have. Note: this would include mortgage payments, insurance, etc., while waiting for a flipper to sell.

The RE market is IMBUED with the false idea you ‘have to have money, credit’, etc. There is truth to it, but you can roll without it if you have a JV partner with funds. In this case you would need to have some experience with RE. If you a property for nothing down, you make almost infinite ROI (after comparing to any interest costs of borrowing, mortgages, etc).

Some investors couldn’t manage a doghouse. Others can create profit where none existed before and convert meager returns into rich rivers of cash. RE investment markets are inefficient. The well-informed investor who moves decisively and knowledgeably always stands to profit first from new opportunities.

Something of interest as a small investor: if you can’t drive to an investment property in an hour, don’t get into it.
All the properties you need to buy to become wealthy are in a 10-15 mile radius from where you live!

ROI = cash back yearly on your initial investment (after debts and expenses, but not after taxes). Taxes of every sort are the largest single expense of most Canadians. Therefore pay special attention to the tax information in this book!

To buy: consider the tax effects of buying, holding or selling. On property taxation for example, tax is based on INTENT when property purchased. If intention is to rapidly re-sell, all your profits will be taxed as regular income at the regular rate instead of capital gains. You need to hold onto it for a year or more or pay full tax.

If intention is to hold the property and rent it out (and then if you sell for unexpected reasons and can prove it) it could be taxed as ‘capital gains’, with a 50% tax advantage. In other words, if you make $20,000 in capital gains, you are only taxed as if you made $10,000. So needless to say, being a real estate investor has tax advantages!

Real Estate investment advantages come from tax savings (as seen above) plus deferred capital gains as long as you hold a property with increasing value), tax free interest payments on investment property - deductible), equity buildup (realized fully only on resale or refinancing) and appreciation of the property over time. Major benefits also come from leveraging intelligently.

For a Real Estate investor, a mortgage is not a burden but, like a carpenter with his hammers and saws, it is an exact tool with a specific purpose and used in an exact way.

As an individual wanting to create real estate riches, the fastest way is by carefully using borrowed money in the form of mortgage loans. A mortgage provides leverage and enables you to control large assets with relatively little of your own money – perhaps even none. Used carelessly, mortgages can lead to disaster.

Note: there are a lot of ways you can save interest in paying off a mortgage. One immediate tip is to pay it weekly or bi-weekly instead of monthly. A 25-year amortization paid weekly can actually be paid off in 16 years instead of 25 if you also make some extra payments.

How do lenders evaluate whether to give a loan? You can have excellent credit and still be turned down if you don’t fit into a lender’s arbitrary guidelines. This does not mean you give up. Another lender more familiar with investment properties could well give you the loan and more. Know your lender and plan ahead. Don’t go in cold and expect to get a mortgage. Also, go to the manager if needed – he or she may be more understanding and flexible than a clerk.

Additional factors lenders take into consideration are down payment (5% to 25% for conventional home mortgages - 35% for income properties). ‘High-ratio’ loans are considered those in excess of 75%.

The lender may check the source of your down payment. Did you borrow it? Is your income stable and from a paycheck or is it from commissions and bonuses (which are viewed as less reliable)? Capital gains or extraordinary income may not be taken into consideration at all in your income.

A good idea is to pay off all loans and credit cards before applying for a mortgage if possible.

On income properties, some institutions will not even consider such mortgages and some only if you prove it is already rented out (which is better for you as it gives you immediate cash flow and the ability to take tax deductions when you repair and upgrade the property).

Some do not care if you even have a job if you have good equity as security for their loan. This means that you are buying a property that has a good resale value and they will be happy to take it off your hands if you default on their loan.

With exception of first time buyers, the normal maximum loan-to-value mortgage is 90%. 15% down payment is usual minimum for investment properties but many institutions require 25% or even 35%.

There are many different lender mindsets, opinions and policies so never assume they are all the same. You can go to one and they will consider it better if you had come to them before you had the planning approved for your project. You go to the next one and they will not lend you a cent unless your project is already 50% done. Just find someone who will work with what you have and where you are at on the construction process.

Vendor Take Back mortgages are owner/seller (vendor) financed properties. At times a seller will offer financing as part of making the closing easier and faster for you. If you are selling a property, offering such a mortgage makes your property more saleable (easier and faster dale), as the financing is easier for the buyer.

The way you decrease your interest payments on paying a mortgage and pay it down fast if you are determined to do this is:

Give a bigger down payment at the start if possible. This gives less total money to be borrowed thus creating smaller interest payments. Remember, a mortgage loan is money you are borrowing from a lender. There is a ‘cost of borrowing’ and the more you borrow the more interest you pay weekly, bi-weekly or monthly.

Decrease the interest rate. Shop around for a lower interest rate on your mortgage before activating it. And make sure this interest is compounded monthly and not daily (ask and read the fine print!). An apparent 6% interest rate compounded daily instead of monthly has an effective interest rate of about 7%. This is a little complicated but just check it out.

Pay your mortgage weekly or bi-weekly (every two weeks) instead of monthly. This alone can reduce a 25-year amortization schedule by YEARS because you are constantly paying extra bits of the principal off a week, 2 weeks or 3 weeks earlier. It has the same effect as making additional mortgage payments. Don’t worry about the hassle of making more frequent payments. Just have the payments automatically deducted from your bank account so you never have to think about it.

Pay extra principal whenever possible. Every time you pay some more of the principal off, you reduce the existing total amount owed to the lender and thus decrease the amount of interest to be paid every week or month thereafter. Your aim is to reduce your mortgage to zero as soon as you can. Every dollar you pay towards principal becomes another dollar of your home that you own and adds to your net worth.

Shorten down the amortization period of your mortgage from 25 years to 20 (or even down to 15 or 10 years if you do not have all that much left on your mortgage and can afford the payments). This way the principal is getting paid off much faster and the total principal owing is significantly less month to month. This is best done upon renewal of your mortgage.

Many banks and lenders hope you don’t know the things you are reading about here. Their business is making maximum profits from servicing you. After all, it’s just business and everyone else does it! So don’t wonder why you were never told these things!

If you get it right on mortgages, you can do many other things wrong financially and still get wealthy.

On mortgages, check what the application fee is and check for any discharge fees in the fine print.

The most creative financing is sometimes only a matter of asking. Ways to reduce cash for a down payment with creative financing:

Converting other assets you have. You can assign to the seller periodic payments made to you. You can give the seller of the house you are buying a 1st, 2nd or 3rd mortgage on your own home or one of your properties. Give the seller a promissory note for all or part of the down payment (deferring it for a number of months). This must usually be accompanied by a significant amount of cash. Barter other valuable assets or services.

Use other people’s money instead of your own. Many first-time homebuyers borrow money from relatives for a down payment. You can ask the seller to arrange new (assumable) financing on the property (and you then take it over at closing). The new mortgage has let him pull his equity and thus gives him the cash he needs.

Investors often restrict themselves to properties where mortgages can be assumed, few questions asked, or where VTB financing is available.

Once you have experience and resources, the money from institutional lenders comes easier, even when the down payment is borrowed.

In a buyer’s market, it is easier to use these techniques than in a seller’s market.

Mortgage brokers are useful due to his/her lines to standard institutions as well as private lenders wanting to sell mortgages. They are useful for difficult mortgages or second mortgages. They also act as intermediaries for VTB (sells and buys). If you want to buy a VTB mortgage or a mortgage note of some other kind, check with a broker. Add a mortgage broker to your network.

An equity lender is more concerned with the equity in the property than with the borrower’s ability to make the payments.

Brokers can also help you when you are a bit over GDS ratio, by making suggestions as to how you can get within ratio. Where an institution has a good record of referrals from a particular broker, it may ease its requirements on a deal. Real Estate agents generally know who the honest or reliable brokers are. Watch for rip offs. Read all the fine print carefully and have your lawyer check out the mortgage contract.

Lawyersare an essential element in real estate transactions and in safeguarding your assets. Watch for rip offs though and ask about all fees up-front. You want a REAL ESTATE LAWYER.

The average house purchase requires about 8-12 hours of lawyer time and 6-7 hours of para-legal time. Sales are 3-4 hours for the lawyer and 2-4 hours for the para-legal. Use a trustable lawyer and make him part of your network.

Longer investments have better chance of tax breaks upon resale (i.e. in a couple of years as opposed to a few months). What works in one area may not work in another.

Relate “inferior/superior” location with potential profitability more than swankiness of neighborhood. Also location is relative to use and zoning. A poor residential area could be a good commercial/industrial area.

Don’t hang onto losses. If a property is causing you too much trouble, drop it if advisable and tax the tax break on the loss, learn from the mistake and find a better opportunity.

Don’t wait for the perfect property. You may see nothing but flaws and risks and never buy. “Death and taxes are your only guarantees”.

Missing opportunities can’t be avoided. Most lives are a series of missed opportunities. Find a reasonably good opportunity and act!

Don’t be impatient. On properties you are holding, selling too soon could miss you out on a big profit opportunity.

Don’t get emotionally involved in a property to the exclusion of good sense regarding its handling or investment.

Avoid the “herd” instinct. When buyers are lining up to buy is the time to sell. When buyers are scarce is the time to buy. Take an opportunity when it comes. For example, if I deal in multi-tenant properties and suddenly a Single Family Dwelling turns up at a steal - take it. Take the great opportunities when they are there. Also, opportunities come to those that are prepared, and those who are prepared exploit the opportunities when they come.

Market comparables are okay, but not the only method to use. Can get ripped or miss opportunities in a changing market. Also, market comparables are IN THE PAST. Market comparatives don’t necessarily have any relation to future direction of prices.

Decision to buy should be based on traditional appraisal techniques, a careful evaluation of future possibilities and shrewd and careful bargaining tactics and strategies.

An occupied building with a good (especially long-term) tenant who pays the rent is much more valuable than an empty building.

When you buy an investment property, the expenses are inevitably higher and the revenues inevitably lower that what it appears. Always leave room for error and get as high a “stated income” as possible, as low as possible mortgage payment, do a good inspection so as to spot potential trouble areas and be prepared for “unexpected expenses”.

The most successful investors are future oriented. While they don’t ignore the lessons of the past, their major interest is in what change is coming and where. An investor may take a property with less of an immediate return if the property is in a good location that will appreciate its value in a few years.

3 areas to consider:

Physical indications of future increase of property value: improved or changing transportation, new highways, rapid transit, parks, nearby real estate development, a heavy machinery factory being converted to a high-tech center,

Economic indications: the overall economic health of a country or community. Example he gives is in 1986, Calgary and Edmonton were in economic doldrums and the wealthiest Canadian families were secretly acquiring major companies and real estate at bargain prices. In Toronto in a bad recession, Asian families were profiting from Toronto-based real estate giants breaking up.

Untapped potential in the property itself: when buying a property, estimate potential of: improvements to the property (based on what improvements most raise value – see later chapter), raising rents, re-zoning, severance and redevelopment, better management to increase cash flow, and how that cash flow can be increased or improved, maintained and capitalized upon (see my doubling system and additional stream setups on any property).

One successful investor makes money regardless of market, always buying below market, at market with large VTB, or all cash offer well below the asking price. His attitude is “take it or leave it” or a pleasant, “I’d love to give your asking price, but it’s just not warranted. How would I explain to my partners?

Paying close attention to the ever-changing market cannot be over-emphasized.

Renovations that pay

There are certain reno’s that are good investments and others that are not. As covered earlier, a good lawn can add 3% to a home and fix ups can add 5% more.

Things that are valuable to do for the sake of upgrading salability and market value are: adding a rec. room (depending on time/funds to upgrade it), improved and modernized bathrooms (overboard not needed), renovating the kitchen (cabinets, counter space), opening up the space if possible (not to extremes) and making it lighter/brighter, central A/C (especially in or near summer), fencing back yard, extra washroom(s), opening up unused attic space or basement, adding an extra bedroom may be worthwhile if not needing extensive renovation costs, and parking/garage (parking can add thousands to resale value).

Things that are not valuable for the same are: adding carpet, installing a sauna or pool, window A/C, sun porches, fencing front yard, storage sheds and fireplace (improves value but not salability). Note that older homes may have a covered-over fireplace, which could be uncovered and upgraded and add $10K to the value of the home.

Concentrate reno’s money on interior rather than exterior. A neat, clean appearance is usually sufficient and does not attract tax assessors and burglars.