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Generating Wealth Through Real Estate: The 3 Fool Proof Sources of Return

 
 

Written by on February 1st, 2018

Generating Wealth Through Real Estate:

The 3 Fool Proof Sources of Return

 

Nanaimo is in the midst of one of the strongest real estate booms it has ever experienced. Recent property assessments are giving home owners the false sense of financial security that only comes when the market is showing signs of nearing a peak. Buyers are throwing caution to the wind and submitting subject free offers in multiple offer situations on negative cash flow properties under the false premise that you can’t lose in real estate and we are possibly just entering into the third year of the famous “7-year cycle”.

Here’s a dose of reality

You CAN lose in real estate and we are NOT in the early stages of a seven year cycle.

While we believe that real estate is the #1 investment category to use to generate wealth, it is important to note that in order to be successful, you must have a plan, process, and screening methods to ensure you are making an investment that is going to positively impact your financial situation. Although there are many ways to make money in real estate and many accompanying risks, much of the risk associated with a real estate investment can be substantially reduced by focusing on the 3 fool proof sources of return. Taken together, these 3 sources are a powerful combination that can create substantial wealth over the long term for the prudent investor.

Let’s take a closer look at these 3 sources:

  1. Mortgage Pay-Down: Simply put, your tenants are paying your mortgage, so after 25 years (or whatever your amortization term is), you will own the property outright. By investing in markets with attractive vacancy rates over time driven by a strong local economy and continuously rising population, you are best positioning yourself to keep your rental property occupied. Over time property values generally rise, so the home is likely to be worth far more than it is today, serving as an inflation hedge. The other interesting point to note is that the CRA will actually allow you to deduct the interest you pay on the mortgage of an investment property as an expense against any income generated on the property, reducing your tax burden.
  1. Appreciation: Over time, real estate values go up. Yes, real estate is cyclical so values do fall from time-to-time, but they recover, and then go higher. Think I’m being overly optimistic? Well, if you can find a time in the last 75 years where values were not higher than they were 10 years previous in this market, I’d love to hear about it, because it hasn’t happened. Although we do not have a crystal ball, we can be reasonably certain that the best indication of what is to come, is to look at what has happened time and time again, through the various real estate cycles of the past century. According to the Canadian Real Estate Association, in 1984 the average price for a home (all home types) in Canada was $76,351. Fast forward 8 years to 1992 and the number had increased to $149,864.  After a relatively subdued run in the 1990s, the average price hit $164,373, before continuing its aggressive upward ascent in the 2000s to $304,663 in 2008. After recovering from the prolonged post-2008 slump, in 2016 the average price hit $442, 264. If you’d had bought that house in 1984 on a 25-year amortization, by 2009 your tenants would have paid off your mortgage on an asset now worth nearly half a million dollars (and rising) which is kicking out cash flows of thousands of dollars a year.
  2. Positive Cash Flow: True positive cash flow occurs when you have a return left over after all expenses have been paid and allowances have been made. Mortgage payment, insurance, property tax, utilities (if you cover) and allowance for property management, vacancy, and repairs and maintenance must be included here to qualify as a true positive cash flow property.

My #1 rule for a profitable real estate investment

Only invest in true cash flow properties. There are too many out there to forego this important point. After all, with out positive cash flow, the only thing you are guaranteeing when you purchase the property is that you will have an outgoing expense to cover. If you are currently looking for a cash flowing single-family residential investment property in Nanaimo, I know, I know…they don’t exist. So don’t invest in a single-family residential property in Nanaimo. Look at another market, another asset class (multi-family, commercial, etc), sit on your hands, I don’t care, just don’t pay thousands of dollars to guarantee yourself that you will lose money each month!!! PLEASE!

If your property is cash flowing from day 1, you can ensure that you will benefit from appreciation when you sell because your property will be more than paying for itself which will give you flexibility to better time the market to maximize your return. Over time, as long as you have a tenant you will benefit from your mortgage being paid down over time with each payment contributing more towards paying down the principal. And finally, inflation generally results in increasing rents over time. As long as mortgage rates don’t move upwards substantially, rising rents should only serve to increase your cash flow and overall return over time.

Moral of the story

Only invest in a property if it ticks all 3 boxes (or all signs point to the fact it will). Sacrificing cash flow and betting on appreciation is a flawed strategy, as is investing in boom and bust economies with strong cash flow currently, but potential vacancy issues and value decreases down the road (think Alberta oil boomtowns)… Generating wealth through real estate should be viewed as a long-term proposition. By focusing on these 3 points alone, you will be off to a great start.

If you are considering an investment in real estate or need some assistance in developing a plan of action, put our full-service advisory team to work for you. Contact us anytime for your complimentary consultation at 250-751-0804 or info@jahelkagroup.com.