March 22, 2007

Making Money in Real Estate is as Easy as 1-2-3

by Dave Peniuk & Julie Broad     

Many of Canadian Business Top 100 Wealthiest Canadians made their money through investing or developing real estate. It seems like it was easy for them, so wouldn’t it be easy for anyone? Five years ago, with only a small amount of savings and RRSP’s and a loose plan, we set out to see if we could join the ranks of the rich.

13 properties into our real estate investing adventure, we have learned a lot the hard way. But despite $45,000 in surprise repairs, a property turning into a crack house, and having a property manager rob rent money from us we are in the real estate market for life. Each year we have averaged returns on our investment of 63% despite some pretty big mistakes.

Of course, increasing property values over the past five years gave us shelter from the storms we created with our mistakes, but even in properties we own that didn’t appreciate much over the past five years, we still made money. That is because in real estate, there are several ways to build wealth.

You can make money through any or all of these ways:

• Property appreciation
• Cash flow
• Other people's money paying your mortgage.

Let's look at a basic example of just how powerful each of these can be. Pretend you find a desirable property for $100,000, and you buy it for 25% down ($25,000).

1) Appreciation: Property goes up in value by 5% in year 1. It's now worth $105,000. Return after one year is 5000/25000 = 20% on your $25,000 investment in the first year!

2) Cash flow: Rent each month is $1000. Your mortgage, insurance, taxes and miscellaneous expenses are $900/month. Income minus expenses = $100/month. 12 months x $100 = $1200/year income.

Add that to the appreciation and you have made 6200/25000 = 25% in the first year through appreciation and cash flow.

3) Other people's money paying down your mortgage: Assuming you have a mortgage at a 5% fixed rate, at the end of the first year you will owe $73,440 on your $75,000 mortgage. You have now built an additional $1560 equity into the property ($75,000 - $73,440 = $1560).

Your return including appreciation, cash flow and reduced principal give you a first year return of 7760/25000 = 31%.

Of course, finding a property that gives you consistent monthly cashflow is difficult, especially in the heated markets we have seen recently. But, over the long term, you don’t need to have all three of the above to make money from your investments. That is the beautiful thing about real estate, there is more than one way to make money from it.

A big thanks to Lance Brown for inviting us to submit the above article in the BC Real Estate Convention's 2007 showguide.