By Antoine Saker

On every edition of A tale of two investments, two real estate investments will be weighed on the same scale. Let’s call it the “Return on Investment” scale. It focuses on how much profit someone’s initial investment is earning. The featured properties will always be actual properties for sale. Their location and photos will not be mentioned, since they are not relevant to the story we are trying to tell.



We hope, in time, this will give you a new outlook about real estate investments and a new perspective on how to look for investments that are passive and profitable. There will be little to no focus on appreciation because it becomes an added bonus when the main return is made up of cash flow and equity. Appreciation is a constant in both investments.


Investment A

Investor X is looking to make an investment in real estate. They have a full-time job and don’t have time to manage the property. They come across seven condo units for sale in the same building with seven signed leases. This is ideal. Condo fees show internal management, so all they have to do is collect the rent.

The asking price is $1.25 million for all seven units.

They purchase with 20 per cent down on each unit, so they invested a total of $250,000.

With the seven units rented, they have an annual total income of around $100,000 a year. The costs of owning these units, not including the mortgage, is around $43,000 a year (taxes, insurance, condo fees).

At three-per-cent interest and with an 80-per-cent loan of $1.25 million, the annual mortgage is around $56,000.

$27,000 out of the 56,000 on the first year is equity/ principal.

$100,000 total income – $43,000 expenses – $56,000 mortgage = around 0 cash flow.

The investment makes no cash on cash; however it has a hidden bonus. By having the tenants repay the mortgage in full, Investor X is making $27,000 (from equity portion of the mortgage), over $250,000 invested. They are making 11-per-cent return on their investment in the first year. Equity increases each year. As the amount goes up, so does the return. By year five, the equity is around $32,000. The return will be 12.8 per cent.


Investment B

Investor Y has around the same amount saved up ($270,000). They came across a building with six units, fully rented, making $60,500. The asking price is $900,000, which implies a mortgage of $35,000 annually with 30-per-cent down payment (= $270,000).

Same terms, three-per-cent interest for 25 years. Taxes, insurance, reserve fund, miscellaneous fund and snow removal fund all amass to $16,000 a year.

$60,500 – $16,000 costs – $35,000 mortgage = $9,000 cash flow per year or $750 per month.

Return on investment = $9.000/$270,000 = 3.3 per cent. Principal on the first year is $17,000. Total yield = (9 +17)/ 270 = 10 per cent on the first year.  By year five, equity will be $20,000 and total yield will be 11 per cent, made up of cash and equity.

No mention of appreciation in both cases. It becomes a bonus for now. The longer you hold, the better the appreciation power, but the point of the play in these products is to ensure they don’t cost you in the short term.

Rule of thumb: An additional management fee of five per cent on the total income changes the return on investment by one to two per cent. In this case, if the R/I is 3.3 per cent without management, it becomes 2.2 per cent with management charging five per cent total income.

Which real estate investment would you be more confident to invest in? Let us know on Twitter @ApexRealtyInve1 and @REM_Online. Please be sure to link to this story when you share your answer.

SIMILAR ARTICLES

4 COMMENTS

  1. Both property has different LTV mortgage, different amount of per unit purchase price, rent per unit varies greatly and the upkeep varies greatly. You are trying to compare Apples with Oranges. Why? Why? Why?

    • “Both property has different LTV mortgage,”
      Correct. That’s because the minimum for a downpayment in any 5+ unit has to be 30% downpayment (70% loan) UNLESS with CMHC (85% LTV) but that changes the calculus enormously. Condos are a minimum of 20% downpayment (80%loan). You can surely put 30% downpayment to make them even but it would make the mortgage 50/y (70% loan at 3% interest for 25 years). Which makes the cash flow around 6K/y HOWEVER 30% downpayment on 1.25M is now 375K. So we try to keep things fair. Minimum downpayment for Product A vs Minimum Downpayment for Product B, and you decide what is more efficient for your money. It’s the same downpayment. 250K vs 270K.
      “different amount of per unit purchase price,”
      Correct. One product has 7 units and the other 6 units. However, the focus is not the $/door value. It says nothing about how much your downpayment (money invested) is making you (cash flow). In this case you have 178K/ condo versus 150K/ unit. What is that telling you about your investment? What is that telling you about you rate of return? About your buy back period? About equity?
      “rent per unit varies greatly”
      Correct. We are focused on what those units are rented for TODAY (with a signed annual lease) and how much of that rent is able to pay for the building’s expenses AND mortgage. In this case, the data we were provided shows the 7 condos AND the 6 units were fully rented at the time of the analysis.
      “and the upkeep varies greatly.”
      Correct. Upkeep in a condo is caked in the condo fees because the expenses are shared but the owner is still responsible for personal space upkeep. Our analysis includes that upkeep in our calculus. We factor expenses such as $500/ door (CMHC standard), as well as a miscellaneous budget (1500/y) and a snow removal budget (1500/y).
      “You are trying to compare Apples with Oranges.”
      Incorrect. A real estate investment that needs 250K down (Apple1) is being compared to another real estate investment needs 270K down (Apple2). Albeit different loan to values. If you could afford both, which would you chose? One with cash and equity or one with just equity? We have no vested interest in any of them. Our message is that you look deeper into the numbers and see what that means for your the money you are investing in this real estate project or the next.

  2. I think it’s a major error not to take into account the potential appreciation. Return on investment is made of both growth and income. If you have a property A producing a higher return on your investment than property B, only in term of income, while the property A is located in a neighbourhood which will appreciate less than the property B, your end result may be totally different.

    • I think it’s a major error not to take into account the potential appreciation.
      Correct. The potential appreciation is surely there. But it is a constant of around 2%-3% per year on average. Both properties will appreciate more or less the same (2-3%/y). We are more focused on paying the monthly bills. Appreciation is great on paper, but if your investment is losing 500/m because the rents are not enough for the expenses AND mortgage (which is related to the purchase price), THEN -500 x 12/y = 6000/y. UNLESS you raise the rent. Surely you hold the property long enough, you will get your money BUT there is a 5-6K/y “leak” that will eat away at the gains from your appreciation.
      “Return on investment is made of both growth and income. If you have a property A producing a higher return on your investment than property B, only in term of income, while the property A is located in a neighbourhood which will appreciate less than the property B, your end result may be totally different.”
      Correct. However our dogma turns appreciation into a tertiary gain. Primary Gain: is the cash flow. If a property has cash flow, this means it’s able to pay for it’s mortgage in full. Secondary gain: If a mortgage is paid in full, then the tenants have paid for it, not the owner. This means the owner owes less to the bank by the end of the year. AKA principal AKA debt repaid. Appreciation will happen however it takes time. With this investment, the meat and bones are the cash flow and equity while the appreciation is gravy. It will come but you already have gains well before it does through cash flow and/or equity.

Leave a Reply