By Antoine Saker

Once upon a time, in a neighbourhood not so far far away, there lived two investors that chose differently. Who faired better? You be the judge.



On every edition of Tales of Two Investments, two different real estate investments will be weighed with 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. We hope, in time, this will give you a new look on real estate investments and a new perspective on how to look for investments that are passive and profitable.

There is 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:

Investors X purchased a three-unit income property in the very highly desirable Plateau, in the city of Montreal. The asking price was $1.75 million. The investor purchased with 20 per cent down, so he invested a total of $350,000.

The building was fully tenanted at the time of sale and earned $86,500 per year. The costs of owning these units, not including the mortgage, was around $20,000 a year (taxes, insurance, reserve, misc.). At three-per-cent interest and with an 80-per-cent loan of the $1.75 million, the annual mortgage was around $80,000, of which $38,500 was equity/ principal.

Cash flow = $86,500 total income – $20,000 expenses – $80,000 mortgage = around -$12,500 per year. Return on investment = -$12,500/$350,000 = -3.5 per cent.

The investment is losing cash flow every month despite being fully rented. And the down payment (money invested) is losing 3.5 per cent of its annual worth for every year of ownership. The hidden bonus is equity. By having the tenants repay the mortgage in full, Investor X is making $38,500 (from the debt repaid)/ $350,000 invested = 11-per-cent return on their investment on the first year.

Equity increases each year. However, the cash flow is negative 3.5 per cent. Without appreciation, Mr. X is making a total return of -3.5 per cent + 11 per cent = 7.5 per cent total yield. Appreciation will come; however it is very slow. It takes years for an area to appreciate, assuming no economic downfalls. No matter how many years owned, there is “dead weight” of -3.5 per cent for every year of appreciation. One step forward, two steps back.

Investment B:

Investor Y purchased a similarly sized three-unit property in Rosemont, also an up-and-coming area north of the Plateau. The asking price is $1.1 million. The investor purchased with 20-per-cent down payment = $220,000. The annual total income was $84,000 per year when the property was sold.

The costs of owning these units, not including the mortgage, is around $22,500 per year (taxes, insurance, reserve funds, misc., hydro, heating and internet). At three per cent interest and with an 80-per-cent loan of the $1.1 million, the annual mortgage is around $50,000, of which $24,000 on the first year is equity.

Cash flow = $84,000 total income – $22,500 expenses – $50,000 mortgage = around $11,500 cash flow per year. Return on investment = $11,500 / $220,000 = five per cent. Principal on the first year is $24,000. Total yield = ($12,500 +$24,000) / $220,000 = 13 per cent on the first year. Investor Y is making returns without waiting years for the property to appreciate.

Moral of the story:

1) Don’t bank on appreciation when the monthly costs of ownership are weighing you down. Appreciation will come but if appreciation is + two per cent a year and your invested money is losing three per cent a year, you will be at – one per cent return every year.

2) Location plays a major role in the value of any real estate product, but when the math is off, reassess which location would add value to your money (positive return) instead of losing value (negative return). The areas in this example were not that different. The fully tenanted incomes AND the asking price relative to those incomes played a much larger role on the cash flow than the location.

Which real estate investment would you be more confident to invest in? Let us know on Twitter @ApexRealtyInve1 and @REM_Online.

SIMILAR ARTICLES

6 COMMENTS

  1. Antoine, a good read, like any investment, it is of paramount importance to use realistic numbers. This includes a reasonable interest rate (not the lowest, nor the highest), and appropriate expenses/vacancies (yes, accounting for rainy days). Even touching on the difficult realities such as the related expenses (mortgage pre-payment penalties and real-estate commission) to sell the investment property should forecasts not come to fruition. It’s always interesting how things never quite meet the eye (larger down payment does not necessarily mean quicker equity appreciation if the property exists in a softer market etc). Looking forward to future content!

    • Hello Daniel. Thank you for your input.
      – it is of paramount importance to use realistic numbers. This includes a reasonable interest rate (not the lowest, nor the highest),
      Agreed. The model is run at 3% interest. We are certain you can get lower these days. Ratehub.ca has an average of 2/2.5% from 3 separate lenders. Even if we were to increase the interest rate in the model to 3.5%, it changes very little. Mortgage will crease slightly, Cash flow will drop slightly, Cash on cash will drop by 0.5% at most. If you get less than 2.5%, great for you! More cash flow. If you get more than 3%, it will affect the bottom line very little.
      – and appropriate expenses/vacancies (yes, accounting for rainy days).
      Agreed. The reason we focus on fully tenanted income properties is because they have leases locked into the sale. If a building is cash flow positive at the sale, a few months later a tenant randomly leaves, you are not at a total loss. Say the monthly cash flow is 800/m. Your tenant left abruptly and was paying 1200/m. You need to rent for 400/m to break even. (!!) The market and the lease you had, suggested you can EASILY get 1000/m if you dont want too much vacancy. Vacancies happen all the time. Better to have a building with a positive cash flow that can take such a hit rather than have a property barely paying the mortgage when fully rented that cannot take this hit. (Or any).
      – Even touching on the difficult realities such as the related expenses (mortgage pre-payment penalties and real-estate commission) to sell the investment property should forecasts not come to fruition. It’s always interesting how things never quite meet the eye (larger down payment does not necessarily mean quicker equity appreciation if the property exists in a softer market etc). Looking forward to future content!
      There’s a LOT in there :) we appreciate your thoughtfulness and hope we can inform you on how there is more than one way to invest in real estate. The majority seem to think “Adding Value“ is the way to go but that’s not feasible for everyone. We hope you’ll enjoy our next edition coming soon.

    • We are hoping after you read a few articles like these, you will get the hang of looking at real estate investments in a new perspective. We follow a small niche: passive investments. If you learn by the 5th article the pros and cons to passive and active investments, and that there are other ways to look at Real estate… our mission is accomplished. You don’t have to sign up to our service. We don’t even talk about our capabilities as per our agreement with REM.

      We want readers to consider another angle that ends up being more efficient for their money. ARI is the search tool (application) created for this type of thinking. We are not promoting our service here. We are promoting a new way of thinking.

Leave a Reply