Why invest at all??
Most folks plan to work until they are 55, purchase RRSP’s, and eventually draw on them for retirement. If they are lucky perhaps they even have a corporate pension to help them out. Some jobs will have a cost of living adjustment every year to match inflation but many do not. The harsh reality is that every year everything costs more, even though your wage is often stagnant, and this will continue long after you retire. Your only option is to purchase assets that appreciate faster than inflation can erode what you worked so hard for. Even better is to invest in assets that are leveraged to get an even higher lift, as inflation also lifts the price of your assets. A few simplified examples below showing how inflation works for and against you:
- $100,000 in a sock drawer for 10 years. Inflation has eroded the value that you now only have $50,000 to spend. (-50% ROI).
- $100,000 invested in RRSP’s. In 10 years a reasonable return is generated, however inflation has taken a big chunk of it. You have $120,000 to spend. (20% ROI).
- $100,000 invested in a home with a 50% mortgage. Your cash is tied in an asset that is worth $50,000 more. You have $150,000 to spend (50% ROI).
- $100,000 invested in two duplexes with 80% mortgages. The appreciation is $200,000, and you now have $200,000 to spend (100% ROI).
Hence…. Purchase the largest assets you can with the lowest amount of cash you can reasonable afford. A $500,000 house will appreciate more than a $100,000 house will. Lets say inflation over 5 years is 10%. $90,000 is left doing nothing from the 100K. If a $1,000,000 property is purchased, the same 10% lift yields $100,000 to double your money.
Soo, buy as many assets as you can and hold them as long as you can!!!!!
Why apartment buildings?
Apartment buildings, like many other types of real estate investments, have significant advantages as well as a few disadvantages. If purchased right, appropriately managed, and with the right amount of time can consistently outperform many other types of real estate with minimal risk. Below are a few examples of the types of property we have been involved with, their pro’s and cons and why we feel Apartment Buildings are the preferred asset class. The numbers used in the examples are for simplicity only.
Single Family Home purchased (as a rental)
Purchased for $100,000 with $25,000 (25% down)
$75,000 mortgage for 5 years, break even cash flow
In 5 years, what is the house worth? Very good question. Most likely, this will depend on comparables.
Assuming you borrowed the $75,000 at 4% interest and had no cash flow in 5 years. How much money did you make in 5 years? Mortgage is paid down to $65,000.
Well, assuming you sold for $100,000, flat market, you still made 40% in 5 years! Not Bad!!
Now say the property sold for $105,000, (5% gain), you now made 60%!
- Advantages – Liquidity, easier to sell with more buyers available, easy to find decent deals, less acquisition costs. Vacancy, your either full or empty!
- Disadvantages – more expensive to manage per unit, difficulty qualifying for more than a few mortgages, sales price depends on comparable only. one vacancy = 100%!
Side by side Duplex
Purchased for $150,000 with $37,500 (25% down)
$112,500 mortgage for 5 years, minimal cash flow.
In 5 years, what is the duplex worth? Likely a combination of income and/or comparables.
Assuming you borrowed the $112,500 at 4% interest and had some cash flow in 5 years. How much money did you make in 5 years? Mortgage is paid down to $98,000.
Well, assuming you sold for $150,000, flat market again, but made $7500 cash flow. You now made 59% in 5 years! Not Bad!!
Now say the property sold for $157,500, (5% gain), you now made 79%!
- Advantages – Lower cost per unit (economy of scale), usually some cash flow, one vacancy = 50% and not 100%! Sales price is dictated by comparables and/or income.
- Disadvantages – Less buyers than single family, still costly to manage per unit, difficulty qualifying for more than a few mortgages. Very few on the market.
Apartment Building (15 suites)
Purchased for $1,500,000 with $375,000 (25%)
$1,125,000 mortgage for 5 years, good cash flow.
In 5 years, what is the building worth? Simple, it is worth what it earns. It’s that simple. a simple formula called CAP rate = net income/purchase price.
This project was bough at a 6.0% CAP rate. What was the net income at purchase?
Purchase price * CAP rate = $1,500,000 * .06 = $90,000 net income, income minus expenses but before mortgage. The CAP rate is your rate of return if you paid all cash.
Assume the net income rises to $110,000 in 5 years. How much did you make?
A nice profit of $478,000 or 127%!! (Sold for $1,833,000 at 6% CAP rate)
Simply put for every dollar you can raise rents the building value goes up by $200! therefore a $50 increase to one suite increases the building value by $10,000! I have heard this called “the big lift”, the “rosebud”, or the “multiplier effect” but I simply call it AWESOME! And this is the primary benefit Apartment Buildings have over other types of real estate!!
- Advantages – Even lower cost per unit (economy of scale), good cash flow, one vacancy = 5% Sales price is dictated by income, or potential for future income only. Qualifying for unlimited mortgages since they are based on property income and not your personal income.
- Disadvantages – Very high upfront costs, large cash reserve required, very large down payment, decent properties tough to find.
Why Alberta and Saskatchewan?
For almost two decades since I purchased my first home in Saskatoon, Saskatchewan, I have purchased all of my real estate in Saskatchewan and Alberta. There are several reasons for this:
- In Migration. Alberta and Saskatchewan consistently have the highest numbers for in migration, even during the commodity down years from 2015 to 2017. Alberta grew by 11.6%, and Saskatchewan by 6.3% between 2011 and 2016. http://www.cbc.ca/news/politics/grenier-2016-census-population-1.3970314
- Landlord tenant laws. Saskatchewan in particular, has very favorable laws regarding rent increases, evictions, and has no rent control unlike BC and Ontario.
- Opportunity. Both provinces see large numbers of people migrating for work and to start businesses. They may not be retirement locations as is driving BC, but people will continue to migrate to where the jobs are to be found. As of June 2017 the commodity sector (oil, potash, uranium) are all near record low prices. Substantial upside is almost certain.
- I know these areas very well. After spending 10 years in Edmonton, and about half of that in Saskatoon, I know the micro and macro areas that will drive the highest returns on investment. I also have teams of realtors, lawyers, inspectors, and property managers already set up in these strategic locations.
In my own words, after living in Edmonton I can say there really is no other place like it. From an investment perspective, it is simply the best place in Canada to invest!! I was employed for several years in Alberta driving a service truck all over northern Alberta, and the sheer size of the projects and money invested is staggering. All of my real estate investments have been in Alberta and Saskatchewan, where there are no rent control laws. The first apartment building in Saskatchewan I purchased I raised the rents 40% in one year! That is a very large lift in value.
Edmonton is a large center of about 1,000,000 people but property is substantially less than similar projects in Calgary, with rents being only slightly lower. Many out of town investors have flocked to Edmonton in recent years however I had the advantage of scouting out every neighborhood and know each one in detail, the risks involved, and areas to watch out for. It has consistently been in the top 10 best places to invest according to the Real Estate Investment Network (REIN) and is currently number 1. Rents are high, vacancies are low, and prices are significantly less than they are in Calgary.
Gateway to the North
With a trillion dollars worth of projects in Northern Alberta, in the Fort McMurray geography of north east Alberta, Cold Lake to the south east, and the central Peace country there is an unprecedented oil boom happening in Alberta. I had the pleasure to work in the industry for 7 years and traveled to many of the regions of the province to see the projects with my own eyes and they are truly amazing. Alberta in migration was over 21,000 in the first quarter of 2014 alone squeezing the demand for housing even tighter. Although we have been going through challenging years and likely will moving into 2017, we see tremendous long term potential as we realize there is limited time to pick up quality assets on ‘sale’ and we plant to be aggressive purchasers in 2017-2018.