As promised, We are taking you through the entire process of what we believe is one of the most lucrative investments in real estate. If you have been following our previous blogs, you will already understand why doing a Legal Duplex Conversion is far superior to just a Single Family Residential investment and also much safer than buying a property with an in law suite and renting it out as 2 units. Start reading why here
Before we get started on renovations or any of the fun stuff, it all starts with the numbers, so brace yourself. As any sophisticated investor will tell you, real estate investments are not purchased on emotions, but on numbers. It doesn’t matter how pretty that house is or how good of a deal it looks like, if you don’t do the math and due diligence, you are just speculating and setting yourself up for failure.
The following figures are based on our recent purchase of the project we are taking you through step by step. As a sophisticated investor, you will always plan your exit strategy together with your initial cash flow calculation. In this case, We have decided to exit the property after 5 years by selling.
Next, We add together, the Cash Flow, Market Appreciation, Principal Pay Down and Forced Appreciation, in order to calculate the ROI or Return on Investment.
Cash flow : $63, 111.71
Mortgage (principal) Pay Down: $31, 711.67
Market Appreciation : $114, 656.84
Forced Appreciation : $40, 000
It is important that you understand at least the basic cash flow calculations, and to be clear..
Rent minus Mortgage does not equal cash flow.
In order to get accurate cash flow, you have to account for Mortgage, Taxes, Insurance, Maintenance (you could get very technical about this depending on how accurate you want your business plan to be, but for the purpose of keeping this short, we will use a flat number of 5%), Potential Vacancy and Property Management. Keep in mind that most new investors do not account for that, thinking that they would self manage.
For this project we are getting a Conventional Mortgage plus an Improvement Loan, so our total capital invested will only be the downpayment and closing costs.
(approx $ 73, 000)
Stephanie and I certainly do not account for it given that we are both very capable Realtors with an understanding of the landlord tenancy act and full market knowledge about our projects, but we do recommend that you take management into consideration or at least make sure that you properly educate yourself on the process as there is far more to it than placing ads on Kijiji and collecting Rents.
Please note that there are many ways to finance a project and because we like to focus more on the real estate market and the project itself, we leave the financing up to our team of very knowledgeable and highly qualified mortgage professionals.
As a side note, it is crucial to work with a mortgage broker that understands investments and creative financing. We always recommend that our clients work with our brokers, as we have 100% confidence in them and that they can get the deal done.
To calculate Net Cash Flow, we want to take the gross rents collected and subtract the Mortgage Payment, Taxes, Insurance, Potential Vacancy, Maintenance Cost and if you are not self managing, you want to subtract Property Management cost as well.
Figure 1 Your total Mortgage, Taxes and Insurance (for now, we have increased rates to keep with inflation)
Hamilton vacancy rates are 2-3%
Figure 2 Net Rents after Potential Vacancy and Maintenance deducted.
* This column represents gross rents, taking into account a 2% increase per year, as per current government allowance. Actual increases could vary, depending on the government. Although Hamilton vacancy rates are closer to 2-3%, we account for 8%, considering 1 month of rent loss per year, although you should diligently try to avoid that. Maintenance depends a lot on the age of your property and the updates recently completed, but for this current project, we are using 5%.
Figure 3 Monthly Cash Flow x 12
The Beautiful thing about Real Estate Investing is that your total return on investment, comes
from more than just Monthly Cash Flow.
We benefit from multiple levels of Capital growth in the forms of:
Therefore, to calculate the Total return on invested capital over a 5 year period, we add together:
Cashflow, Mortgage Pay Down (principle), Market appreciation and Forced Appreciation
First, we have to calculate the market appreciation for the project for the total of 5 years. As previously noted, we will use a conservative number of 5%.
Upon Project completion, we will have boosted the value of the purchased property from $340, 000 to $415, 000. We will be calculating compounding interest on that number as follows:
Figure 4 Market appreciation at 5%
Both Stephanie and I will have a different % on ROI, as I have decided to invest cash and she is drawing from a line of credit.
Your greatest ally when it comes to investing is your access to capital or capability to borrow it. Never look at what somethings costs, rather look at what your return will be.
I would borrow a million dollars @ 10% interest in a heartbeat, as i know that i can re invest that @ 20-30% easily!
The LESS Hard Capital you have invested, the HIGHER your Return on Investment will be
Now compare that to an investment in today’s volatile stock market where your returns are less than double digits, and you will see why we love what we do. I’m not saying, don’t invest in stocks or bonds as it is always a good idea to diversify, but the returns speaks for itself!