Even though most property holders are looking for cash-flow, Adam & Matt are not convinced this should always be the deciding factor. Join us this week while we consider a cash-flow neutral case study and discuss the TOP 8 things to consider when looking for future appreciation!
What do we mean by cash flow positive, negative and neutral?
Cash flow positive is covering your costs, e.g. mortgage payment (after putting down 20% on the property), and the monthly maintenance fee, insurance, and property taxes plus having excess cash. Cash flow negative is having a deficit, so the property becomes a liability. In this case it gets subsidized. You need to believe in the investment and have a strategy to do this. Cash flow neutral is covering the costs and breaking even – finding this in Vancouver means you’re doing very well.
Cash flow neutral case study:
Adam bought in Chinatown about a year and a half ago at the Keefer Block. This is on Main & Keefer, and is built by Solterra.
- 2-bed, 2-bath, 878 sq. ft.
- Built in 2015, has a 2-5-10 warranty.
- Has little overhead, no need to worry about fixtures or appliances.
- Renting out in this area is easy; renters like new.
This came down to budget; an area they liked and had been monitoring, and thought was under-valued. The gap to downtown was too wide for turnkey rental opportunities, and rents were the same as downtown. The specific unit was under-valued. Adam and Matt brought clients through; nobody offered. It showed horribly.
The property was listed at $599,888 and Adam paid $590,000.
- Maintenance is $440 per month which is expensive, but it includes hot water and heat which is good for tenants.
- Down payment (20%): $118,000
- Property transfer: $9,800,
- Closing costs: $800
Adam’s total cost was $128,600. He mortgaged $472,000, with a 2.79% (5-year fixed) interest rate. After insurance, taxes, mortgage, and strata fee, this is $2,797 monthly in carrying costs. He didn’t factor in potential for vacancy and has it rented out for $2,800 per month, which is conservative as he wanted a good tenant. This is as neutral as you can get to the dollar.
The property increased in value from 18 months ago. However, if it had not increased in value, Adam feels it was still a good investment because:
- The mortgage was $472,000 and he planned to hold the property for a minimum of 5 years. At the end of this time, he will have paid $70,206 in principal – people forget that you have someone paying your mortgage. With today’s interest rates, at least 50% of your payment is going to principal.
- Per annum this is $14,041. So, he can carry this $590,000 asset with only $128,000 of his own money – this is 11% return on the $128,000 per year. This is called leveraging.
Adam projected for just a 3% increase annually, which makes the property worth about $608,000. This is a $17,700 difference or 13.5% return on the $128,000 investment. Even if the market performs modestly, there’s a return of about 24.5% based on the 3% increase and paying down the mortgage.
What actually happened
For the buy-in amount, this area outperformed most markets. A unit just above Adam’s sold in May 2017 for $825,000; Adam could probably get the same. This is an increase of $235,000 plus the equity he built, and works out to over 200% return on the money invested. If he had been just looking at cash flow, he would have walked away from this!
Cash flow, therefore, is not always the measure to use.
There was a gap in the market – how can you be so close to downtown and the SkyTrain and be getting amazing rents, for a price so much lower than downtown, Yaletown, or Coal Harbour? It made sense to get into this area. Following the city plans, it didn’t feel like a gamble. Even if it goes down 20% in value, it’s still a good investment. You never hear about rents decreasing dramatically, but the mortgage will go down, and Adam probably won’t have issues with building for 20 years.
The market doesn’t have to go up 40%; it can go up marginally or stay balanced for this to be a good investment.
8 ways to locate a good, appreciating buy in Vancouver:
- Get to know your city. You can’t locate gaps or the next big areas, or take advantage of areas the city is redeveloping if you’re not aware of them. For example, the City could be planning light density by re-zoning single-family home areas to duplex or multi-family homes. Or, look at official community plans – you’ll know what the changes in the future will be and can benefit, e.g. Grandview-Woodland and Northeast False Creek plans.
- Youthful growth. This is when a young contingent moves into a certain neighborhood, town, or city. The areas are vibrant, youthful, and accessible, and appeal to those with dual incomes, who are willing to spend money and want to be there. Consider the “Starbucks effect” – Starbucks has resources to understand what’s happening in a community. They put money behind this before opening a store. Developers know this too. They do this research, so why not leverage that? There is also the hipster effect – for instance, Main Street in Vancouver 10-15 years ago is an example of this. It had cheaper rents, and great restaurants and shops opened up. Investors followed, and rents went up.
- Look for illogical gaps in pricing. If a building is so expensive and it’s not premium or there is no good reason for it, when say the building across the street is less, figure out why. This doesn’t make sense. Most people can justify paying more to be close to where they want to be. There is lots of potential in under-developed areas.
- Rent prices. Be in tune with the market, talk to property managers and people at open houses. Real estate agents, mortgage brokers – those who monitor the market on an ongoing basis. Compare to downtown prices. Use conservative numbers.
- Transportation lines/hubs and walkability. Adam’s Chinatown investment is close to the SkyTrain. People bought around the Evergreen Line in Port Moody, and New Westminster developed around the SkyTrain. Commercial Drive and Mt. Pleasant will likely see more development as their transportation hubs grow.
- Many young families invest where they think the best schools are. North Vancouver has done very well with this.
- Look for anticipated population growth. If you look at Vancouver generally, there will be many people coming in the next 10-20 years. At the same time, many people are leaving because of affordability.
- Believe the hype. When it comes to many investments, people say, “By the time you know about it, it’s too late to make any money. Insiders have taken the profit.” In real estate, this isn’t the case. It’s not too late for some areas; these things take a lot of time. For instance, clients thought they were too late for the Evergreen line in 2015/2016, but people have still done so well following transportation routes. Real estate doesn’t move that quickly.