Switching Gears: Selling Up to Generate More Cash-Flow
Attribution: Flickr user jurvetson
Ever since I purchased my first rental property I’ve been mentally conflicted about the best way to grow my rental portfolio while making money (cash-flow positive) and creating equity. In my experience positive cash-flow investments seem to be mutually exclusive of potential for great equity gains, especially in the short term. The investment opportunities I’ve come across that are revenue positive without the requirement of a large down-payment tend to be in ‘rough’ neighborhoods where the purchase price is low enough to generate great returns on your rent. Conversely, up and coming neighborhoods tend to yield much higher purchase prices and rents need to be in line to compensate. When I run the numbers, they just don’t seem to make the grade.
The trouble with the hood (as I like to call it) is that the investment is great on paper, but in reality it’s much more work. You already know from previous posts that rent is hard to collect from low-income tenants and in some cases impossible. I estimate that I’m out approximately $2,500 in uncollected rent, which significantly changes the ROI on your investment. Moreover, tenants who don’t pay your rent on time are infinitely more work to manage than those who don’t. Its another paradox in that you spend lots of time chasing little money. Finally, in order to mitigate these issues, you have to be very selective in choosing your tenants. This again leads to more time spent screening applicants and sometimes lengthy vacancies between leases.
From an equity perspective I have earned about 12% over the past 3 years on my two tri-plexes. Certainly better than a savings account or most mutual funds (especially this year), but not huge get-rich-quick type money. This is especially true when you factor in real-estate fees, closing costs, and capital gains taxes when it comes time to sell. That 12% return is only on paper.
On the flip side, I rent 1/2 of my own house out in a desirable neighborhood in Halifax. Renting this unit is very easy and I always get good quality applicants. I can charge a premium rent and still be picky about who I choose. After nearly four years of renting this property I have yet to have a bounced check or payment issue. Even better, there’s never been any damage and I hardly ever get a phone call or a knock on the door with an issue. It’s a dream.
From a cash-flow perspective this unit really just subsidizes my living costs. Renting the entire house out on its own breaks even at current heating prices. So it’s got a net cash-flow of zero and I still have to come up with money for maintenance & repairs as they arise. However, equity gains have been phenomenal. In just 4 years I have reaped nearly 50% in equity gains, not including the improvements I’ve made to the property. This amounts to approximately $100,000 in paper value.
Clearly I’m making far more money from the investment in the house I live in than I am from my rentals. But I have the cash-flow dilemma. To buy a pure investment property I’d either have to eat the loss on the monthly cash-flow and repairs or I’d have to invest significantly more in the down-payment to make the operating costs revenue positive. Since I don’t have lots of extra money to throw at a down payment I’d be stuck with funding a money-losing investment each month in the hopes that I make a big payout on the equity gains.
The only way I see to get around this is buy bigger buildings with 10 units or more units in good quality neighborhoods. This way I can reap the equity gains with a cash-flow positive building. As a bonus, I can hire a superintendent and I can offload daily tenant issues. Of course, in order to buy a 10 unit building I need to have significantly more cash than I have now for two reasons. First, the purchase price is going to be much higher so my down payment will be as well. Second, when purchasing over 5 units I’m now into a commercial mortgage which requires a minimum of 15% down payment.
So I need to raise some cash. I figure about $200,000 will get me into a good 10-15 unit building in or near Halifax. I’ll be selling both of my triplexes, then I’ll refinance my own house and use this money to go shopping for a new project – a flip. I’m planning on flipping a few houses until I raise enough money for the big buy. I’ll keep you posted about the sale of the properties, and my adventures in my first flip.
Hi Steve,
I really enjoyed reading your posts! I made the mistake this year of renting a four-bedroom on Oxford Street out to four girls from Dartmouth who were living on their own for the first time AND footing their own bill. What a disaster. One girl’s cheques bounced every single month. (I figure she paid at least $700 this year in bank NSF fees and my NSF fees!) Another girl’s cheques bounced about half the time. Extremely time consuming, stressful and frustrating. They are now gone – and I got all my money, which was lucky. Normally I rent to Dal students from Ontario whose parents are footing the bill. I definitely prefer the latter.
As a side note, I thought commercial mortgages required a 25% mortgage…
Glad to hear you’re still working away on The Plan.
Emily
Interesting. I thought that having your rental in a good neighborhood would ensure you avoided a lot of rent-collecting problems, but I guess you get a whole different set of issues wherever you are. I can’t believe you were able to collect all the back rent, and get them to cover your NSF fees. I’d never be able to do that with my tenants.
Regarding the commercial mortgage, I thought it was 25% as well. I was speaking to a commercial mortgage broker and he told me it was more based on the business case of the building you are buying and your history as an investor. I guess its not as clear cut as black & white.