THINK BIG: WHEN TO UPGRADE?


Our goal over the last 2 years has been to purchase a purpose built 8–16-unit apartment buildings. In our opinion purpose-built apartment buildings are easier to manage and tend to scale better. There are economies of scale when you get into these types of commercial units. For example, there is 1 driveway, 1 lawn, 1 furnace, and 1 roof. If you were comparing a 12-plex to 6-duplexes – well guess what? Now you have 6 driveways, 6 lawns, 6 furnaces, and 6 roofs to worry about. In addition, when you get into purpose-built apartment buildings, most of the units are a replica of each other. This makes it easy for you to update, renovate and maintain the property. The other benefit in purchasing a commercial property is how evaluation is created. Its all based on cap rates and not comparable sales as it is in the residential space.


We have viewed a couple smaller multi-unit buildings in the past, but a “better” smaller deal tended to always come across. But the real question is, were they better or were we blind-sided by only looking at the surface? We wanted to share our point of view with you – hope you enjoy!


Is money the problem? We have gone through the path of BRRRR strategy for most of our properties. If you do not know what BRRRR is – we highly recommend that you check our 3 blogs about our real-life examples:

These are your typical single-family homes that we have converted to a duplex. After renovating, renting, and refinancing – we would try to pull out most of our money. The problem is we would only have $150k-$300k to play around with. With the going rate of ~$200k/door in Hamilton, ON – this surely was not going to buy us the 8-12plex that we want. We would need almost double that amount for the purchase of the 8-plex + some extra cash for renovations. This is mostly due to the cap rates’ compression that we have seen within our market over the last 5 years. This has made it even harder to make the #s work. Now, money should never be a problem, we must think about this situation differently. We must be solutions driven, there will always be obstacles, but we must think outside the “box” – no pun intended.


There are options of course:

  1. We can raise capital and give up equity of the asset?

  2. We can borrow private money if our plan is to turn over the units…

  3. We can see if the seller is willing to do a VTB?

There is lots to cover in terms of financing. What if we wanted to finance it on our own? Have you thought about selling your current assets to upgrade? At first glance, it might turn a lot of people off due to the capital gains that you would have to pay in Canada. It would feel like we are losing money, but are we?


Here is an Example:

We bought a property 7 years ago for $400k, we just got it appraised for $825k. If we pulled out today, that would give us $425k [before tax]. We have joked around that we will sell once it hits $1M – I think we are far from that time; however, once it does, you can be assured that this property will hit the market. The reason for this is easy – we look at a couple things:


  1. What are the current cash flows?

  2. What upside do we have?

  3. What is the potential appreciation?

The last question that we ask ourselves is, would we buy this investment today at current price and current rents? A lot of the times the answer is no. That is a sure sign that you have maximized the returns and maybe a trade-up is worth considering [given the right B/E analysis of course].

Going back to the example, let us say we go ahead and sell the property at $825k. That means we will have to pay approximately $106k in taxes, however the bigger picture is its “capped out”. There is no growth. So how do you grow? Its important to look at the overall net impact of the transaction. Although in isolation, the $106k in taxes might seem devastating and the wrong move, but its essential to look the gains and losses and compare to current state. This way we have an apples-to-apples comparison and look at the entire picture. So, if we were to go ahead and sell the property after taxes, closing, and realtor fees we would have approx. $275k to invest. This is just enough to purchase a 6-plex. At current cap rates, it wont cash flow on day 1 however there is a substantial upside. You can see in the example, that at current cash flows there is quite a difference however if we look at the upside there is 10k difference between the two. Not to mention that for every dollar that we increase our rents, we are essentially increasing our appreciation of the building as well by 20x (based on 5% cap).


The other thing worth discussing, is refinancing. Some will say, well why not refinance the property instead? The problem with the refinance, is it a) reduces your cash flows and b) you will always have ~20% stuck in your deal. So, in the $825k property, we have $165k not doing anything for us. So really what it boils down to is, the return on your equity. So, what is the point of all this? The problem is that when we look at something in isolation, it puts on blinds on our analysis and we end up deciding, that is not necessarily the best for our future. Sometimes we need to look at the entire picture and “Think Big”. Remember, its those that make bold moves that break out from the crowd.


If you are interested in finding out more information on how you can invest with us on our next deal – reach out to us directly at 289-242-6294 or steeltowntitovs@gmail.com


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LEGAL DISCLAIMER

The information provided in this blog is for entertainment purposes only and is not intended to be a source of advice with respect to the material presented. The information contained in this blog do not represent legal or financial advice and should never be used without first consulting with a financial professional to determine what is in your best interest to meet your individual needs.


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