The question we get asked sometimes is why do we invest in real estate – why not stocks, bonds, or RRSPs? The answer can be broken down into two sections: Risk and Reward. In fact, when purchasing any investment, the balance between risk and reward is something that always needs to be considered based on your own personal goals.
Risk: We often hear that real estate investing has a lot of risk. This blanket statement is no different than someone saying that all RRSPs have risk, or all stocks.
“GTA home sales plunge 67% in April as COVID-19 pandemic freezes real estate market” – May 2020
“Toronto Detached Real Estate Prices Still Down Over 10% After Two Years” – June 2019
Headlines like this can be intimidating and will scare most people away however we must remind ourselves that there are multiple different strategies in real estate, and they all come with a varying spectrum of risk. We utilize the long term buy and hold strategy. This is one of the safest investments you can make. The strategy concentrates on securing monthly cash flow payments. This steady stream of income rarely fluctuates and depends solely on the supply and demand of rental housing in the local area. In fact, if real estate prices were to “tank” – we would be extremely excited as this would create a perfect purchase opportunity. This is simply because the appreciation of real estate is not what our strategy is about. If it does increase over time – that is great but not the main reason why we purchased the asset.
In the GTA, there is currently a housing shortage and we will continue to see that over the next 25 years as we go from 7.28M to 10.2M residents. This level of growth naturally pushes people out to nearby cities as they look for affordability. Hamilton is expected to grow from 590k people to 769k during the same time frame. The limit in supply protects you against vacancy risk. There are other strategies you can implement as well in case vacancy becomes an issue in the future.
This is another reason why we like real estate. You are re able to change the direction or strategy of the investment at any given time. We can use any of the following: flip property, short term rental, rent-to-own, student rental or even private financing. The ability to pivot and have full controller-ship of the investment strategy enables us to protect ourselves from risk.
Real estate is tangible in nature, you can touch it and feel it – it is a hard asset. The material that the property is built from has an inherent replacement value. This raw material and labour required to build the house will increase over time due to inflation. Think about a staple product like bread from 10 years vs now its probably 2x or 3x in price. Think about our minimum wage over time. Ten years ago, it was $10.25/hr and now its $14.25 in Ontario. We will not get into why inflation happens in this Blog but its important to know that it is real, and it is something that our investments should account for when we talk about our returns on investment. Below is a demonstration of how much you must pay for the exact same item today ($212) that costs $100 in 1990.
Real Estate protects us from inflation in two ways. First, since the prices for goods/services increases every year; this will naturally increase the value of our property – over the long term. Second, in Ontario, you can increase rent every year by the rate of inflation. This protects your cash flow returns.
Reward: There are 4 key components to reward using the long term – buy and hold strategy: appreciation, mortgage pay down, monthly cash flow, and leverage.
Appreciation: Over the long term, real estate will appreciate over time. Unless there is some major catastrophe that wipes out the entire city – you can bet that the brick, mortar, and the labour required to build the property will get more expensive as time goes on. The supply and demand in your local market plays a big role here as well. We treat appreciation as a type of bonus payment to our overall strategy. Since appreciation is inherently speculative in nature, you want to avoid basing your entire strategy on this component.
Mortgage Pay Down: Every month your tenants will pay their rent. A portion of it will be used to pay for the mortgage principal and interest. There are 3 ways you can use this principal pay down within your investment.
1) Sell the property and upgrade to an asset that can work harder for your money
2) Refinance to purchase another property – again so your asset can work harder for your money
3) Sell and enjoy the funds that have acquired over the period
How we use these funds will depend on your long-term strategy. There is nothing wrong with simply paying off the entire mortgage of the investment and using it for retirement. It is a good goal to have. However, if you want to grow your investment portfolio exponentially – refinancing or upgrading your portfolio helps you achieve financial freedom much faster.
Cash Flow: After all the expenses are paid off at the end of the month you should have an additional amount of money left in your pocket. This is the main component that we are after as buy and hold real estate investors. We want to multiply our cash flow to the point where we are comfortable and financially secure. Think of it as a dividend payment from a stock. This continuous payment stream is extremely attractive and a good foundation to build your wealth on. For evaluation purposes we typically use the 1% rule to determine the feasibility of the project. To calculate this, you just need to take the monthly gross rent and divide it by the purchase price.
Example:
1% > Gross Rent / Purchase Price or 1% = $5,000 / $500,0000
This will provide you with a healthy monthly cash flow stream as well as cover all your expenses for the property.
Read more about our blog on “How to Calculate Cash Flow” - https://www.steeltowntitovs.com/post/how-to-calculate-cash-flow
Leverage:
This is what attracts investors to real estate in the first place. We purchase asset at a fraction (20%) of the cost but we reap full benefits. I will give you an example of the first property that we have ever purchased. This was our personal residence and we only put down 5% or $20k however the example will have 20% down as this will most likely be the scenario for most.
You can see that the 19% return is based on cash flow only – this return is hedged against inflation (as discussed earlier). At the same time, the principal pay down is now at $81k. We excluded appreciation from the chart on purpose. Although appreciation has made the property considerably more then the original purchase price – as noted earlier its simply a bonus – not the primary objective.
If you’re 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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