Photo: Flickr user ellievanhoutte

For a while there things were going pretty well.  I had evicted a troublesome tenant, I was fully rented, and most importantly I was collecting rent from everyone more or less on time.  In December when I went by to collect rent, one of my tenants informed me that she’ll be moving before the end of the month. First, off she didn’t give me the required notice period (her lease does not expire until June 2010), and second she didn’t even pay me a full month’s rent.  She thought she only needed to pay 1/2 rent and I just keep the damage deposit.  Great.

This is a real pain because this particular unit is the hardest of all my units to rent.  It’s a decent apartment, but it is a basement unit and on the small side.  Because of that I can’t put a more mature family in there as it’s really too small for any more than two adults and a couple of young children. Also most people are put off by basement units, even though this one is quite bright, clean, and dry.  On top of this, Christmas is around the corner and it’s really hard to rent a place at this time of year; I’m busy with my holiday running around and prospective tenants aren’t that inclined to look either.

So even though my tenant technically owes me rent until the end of June, I know I’m likely not going to collect it.  My best bet is the get the place rented as soon as possible and limit my losses.  I can pursue the tenant for rent (and she may yet pay) and even take her to the tenancy board, but its unlikely worth the effort.  Right now I’m still trying to collect the 1/2 month’s rent she still owes me, but of course she’s no longer answering her phone.  Even better she now lives about 45 minute out of the city (if she gave me the right address) and to show up at her door will be really time consuming.

So for now the unit is vacant.  I’ve done a few touch ups painting doors that had peeled and generally cleaning it up and it shows very well now.  I do have someone interested in renting for February, but I’d like to recover some rent from January so I’ll continue and try to rent it before I commit to a February lease.  At least I’ve got a buffer with my new mortgage.  This vacancy will not cost me money as it has in the past, instead I’ll break even.

Photo Flickr user: inacentaurdump

This dream scenario is possible because I bought the building with 100% financing three years ago.  That meant I traded a down-payment for an exorbitantly high interest rate of 7.35% with Xceed Mortgage.  This is a self-insured mortgage, meaning that CMHC didn’t provide the insurance for this high-ratio mortgage, Xceed did.  I still had to pay an insurance of sorts in the form of a ‘fee’ that roughly equaled what I would have paid CMHC.   This high ratio mortgage, on a 3 unit rental property, that was not owner-occupied would never have met

CMHC’s tight financing rules.  I was lucky to buy this when I did, because these kind of mortgages don’t exist today.

As you know, this is a great time to acquire debt.  Interest rates are as low as they’ll ever be with the Bank of Canada Prime rate at just 0.25%.  So my mortgage broker was able to secure a mortgage from Street Capital Financial that consists of:

• 90% financing based on a market value of $255,000
• 2.40% variable interest rate(Prime + 0.15%)
• 5 year term
• 35 years amortization

After I pay off my current mortgage, that leaves me with roughly $25,000 in cash and increases the profitability of the building from about $300/month to $715/month.  It’s a win-win scenario.

Now, I know many of you are probably cringing at the thought of amortizing your mortgage over 35 years.  I’m well aware of the fact that I pay down very little principal over the next 5 years.  But that’s OK with me.  Cash flow is key here and the interest on the mortgage is a tax deductible expense.  Also, I know I can expect my mortgage rate to march pretty consistently upward over the next few years as the economy improves.  This will affect my profitability, but I’m a believer in variable rate mortgages being cheaper in the long-run (more on that another time).

So, my plan is still in effect.  I want to ‘sell up’ and get into bigger buildings, but I’m going to do it a little differently.  I’ll use the money from this new mortgage to spruce up my own house a little bit, put the rest aside, then re-finance my house and pool as much cash as I can so I can go shopping for a flip.  This way I can keep my rentals, continue to grow my equity, collect some monthly passive income, and do a flip.  We’ll see how it goes…

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.