Are you a Real Estate Investor or a Real Estate Speculator?
The Nanaimo real estate market has been on a steady, and in some neighbourhoods, a rapid upward ascent for at least 2 years now. With home prices soaring, vacancy rates have dropped below 2% and many landlords are reporting never having received so many applicants for their rental units. Consequently, landlords have been able to increase rents to levels never before experienced in the city. With rents and home prices soaring, what better time to become a real estate investor…After all, how can you lose? Everybody is making money in real estate these days…Have you seen the most recent property assessments? Just buy a few properties, wait a few years and you’ll be retired, sipping Pina Coladas on a tropical beach, all financially supported by your real estate riches…
OK…and…back to reality.
Let’s take a quick look at what has happened over the past few years in Nanaimo… Following the great recession in 2008, Nanaimo’s real estate market experienced a prolonged slowdown. Demand was subdued, prices were flat or down (depending on the type of property and neighbourhood) and vacancy rates on rentals soared from 1.1% at the height of the last cycle’s boom to 8.3% as recently as the spring of 2013. When the market started to show some signs of life in late 2014, the most desirable neighbourhoods (North Nanaimo, Hammond Bay, Departure Bay, etc.) began to move and prices escalated. Fast forward to late 2016 and most buyers had been priced out of the most desirable neighbourhoods and are having to look closer and closer to the city limits, if not beyond, to find a suitable property. The rental market has followed a similar pattern, rents have soared in the most desirable areas driven by demand, and vacancy rates have fallen. Then, like a wave emanating from the epicentre of an earthquake, those unsuccessful in finding or unable to afford a home in the most desirable areas are looking closer and closer to the city limits where, just like housing prices at this stage in the market cycle, rents are on the rise.
So fast forward to early 2017, the elusive “mainland buyer” priced out of their local market jumps on the computer and discovers…wow, you can buy a 5 bed/2 bath home on a quarter acre in Nanaimo for around $400k, vacancy rates are sub 2%, and the market is actually up close to 20% year-over-year… Investigating further, it is discovered that Nanaimo’s market has really only been on the rise for a couple years and conventional wisdom suggests the real estate market cycle usually lasts about 7 years. Wow… this market looks like it has a lot more room to run…if the market continues at this pace, that $400,000 home would be up $80k in a year on appreciation alone…With 20% down, that’s essentially a 100% return in 1 year, not even taking into consideration mortgage pay down or cash flow… At this point, said buyer is probably thinking “how can I go wrong?”
Let’s pause….If this is the way you are looking at the market, you are a SPECULATOR. You are gambling 100% on your future expectations. You haven’t considered cash flow potential, where interest rates are likely headed (impacting your future mortgage payments), the potential major renovations a house in this price range may require to even keep it rentable, how vacancy rates can quickly spike in the area when the economy inevitably takes a downturn, the type of tenants the area attracts and the amount of turnover you will likely see, etc. These are just a few vital considerations a speculator would have no regard for. Speculators often try to time the market, using momentum to make fast gains. If they time it right, Woohoo!!! If not, well you probably know how that goes…
On the other hand, an INVESTOR would follow a disciplined process of analyzing any local market before strongly considering an investment. This may involve looking at population growth, housing supply, cyclical trends in regards to rents and vacancy rates, key economic drivers, affordability relative to average incomes, etc. The investor would likely drill down and examine specific neighbourhoods and the amenities that would make them attractive to potential renters such as proximity to jobs, schools, parks, transportation routes, shopping, recreational facilities, etc. But, first and foremost, what differentiates an investor is that they would be primarily concerned with the numbers. Not what could occur in a best case, almost dream-like scenario (as outlined above), but what could reasonably be expected to occur, based on the macro and micro analysis discussed above, and based on what is happening currently with regards to the financials. Most importantly, does the property cash flow? Not does it cover the mortgage payment…Does it cover all costs associated with the property (mortgage + property tax, insurance, any utilities included, etc.), have you built in a vacancy allowance, is there a buffer for property management and repairs and maintenance? Whether you self-manage or not currently, your situation can often change in the future so we always recommend to our investor clients that they account for property management in their analysis.
Looking at our $400,000 home, purchased with a 20% down payment at 2.69% over a 25-year amortization and you have a monthly mortgage payment of $1464. Factor in property taxes of approx. $200 per month, home insurance of $150, city user rates (garbage,sewer, water) of $75, and you have expenses already at $1889. With projected rents in the $1800-$1900 range, you are already possibly in a negative cash flow situation. Factor in property management ($190 – 10% of rents), allowance for repairs/maintenance ($95 – 5% of rents) and a vacancy allowance ($63 – 3% or rents), and you are now potentially in a negative cash flow position by $437 per month. Upon further investigation, the investor would likely discover this home was probably worth about $250,000 2-3 years ago, the neighbourhood attracts a transient rental pool, vacancy rates typically soar in the area as soon as the economy enters a slow down…the list goes on.
In this scenario, clearly the investor walks, with the speculator likely to jump in anticipating quick profit. While there is no conclusive right or wrong approach to take, after all, the market could rise another 20% in the coming year resulting in a great flip opportunity the investor would have missed, there are measures you can take to mitigate your risk when investing in real estate. Our view is that real estate investing is a long-term wealth building strategy, not a get rich quick scheme. As such, it is every bit as important to protect your downside, as it is to look for opportunities to realize extraordinary gains. Your real estate investments should be viewed in a similar manner to your traditional paper assets (stocks, bonds, mutual funds, etc.) assembled by first having a qualified professional assist with creating a financial plan intended to achieve your financial goals using tools that fit your risk profile and investment objectives.
Make no mistake, if you are investing in real estate, to maximize your results you need a plan. Buying smart, realizing consistent returns over the long-term, and intelligently leveraging equity to expand your portfolio should guarantee you achieve your long-term financial goals through real estate.
If you are considering an investment in real estate or need some assistance in developing a plan of action, put our team to work for you. Contact us anytime for your complimentary consultation at 250-751-0804 or firstname.lastname@example.org.