On every edition of A tale of two investments, two real estate investments will be weighed on the same scale. Let’s call it the “Return on Investment” scale. It focuses on how much profit someone’s initial investment is earning. The featured properties will always be actual properties for sale. Their location and photos will not be mentioned, since they are not relevant to the story we are trying to tell.
We hope, in time, this will give you a new outlook about real estate investments and a new perspective on how to look for investments that are passive and profitable. There will be little to no focus on appreciation because it becomes an added bonus when the main return is made up of cash flow and equity. Appreciation is a constant in both investments.
Investor X is looking to make an investment in real estate. They have a full-time job and don’t have time to manage the property. They come across seven condo units for sale in the same building with seven signed leases. This is ideal. Condo fees show internal management, so all they have to do is collect the rent.
The asking price is $1.25 million for all seven units.
They purchase with 20 per cent down on each unit, so they invested a total of $250,000.
With the seven units rented, they have an annual total income of around $100,000 a year. The costs of owning these units, not including the mortgage, is around $43,000 a year (taxes, insurance, condo fees).
At three-per-cent interest and with an 80-per-cent loan of $1.25 million, the annual mortgage is around $56,000.
$27,000 out of the 56,000 on the first year is equity/ principal.
$100,000 total income – $43,000 expenses – $56,000 mortgage = around 0 cash flow.
The investment makes no cash on cash; however it has a hidden bonus. By having the tenants repay the mortgage in full, Investor X is making $27,000 (from equity portion of the mortgage), over $250,000 invested. They are making 11-per-cent return on their investment in the first year. Equity increases each year. As the amount goes up, so does the return. By year five, the equity is around $32,000. The return will be 12.8 per cent.
Investor Y has around the same amount saved up ($270,000). They came across a building with six units, fully rented, making $60,500. The asking price is $900,000, which implies a mortgage of $35,000 annually with 30-per-cent down payment (= $270,000).
Same terms, three-per-cent interest for 25 years. Taxes, insurance, reserve fund, miscellaneous fund and snow removal fund all amass to $16,000 a year.
$60,500 – $16,000 costs – $35,000 mortgage = $9,000 cash flow per year or $750 per month.
Return on investment = $9.000/$270,000 = 3.3 per cent. Principal on the first year is $17,000. Total yield = (9 +17)/ 270 = 10 per cent on the first year. By year five, equity will be $20,000 and total yield will be 11 per cent, made up of cash and equity.
No mention of appreciation in both cases. It becomes a bonus for now. The longer you hold, the better the appreciation power, but the point of the play in these products is to ensure they don’t cost you in the short term.
Rule of thumb: An additional management fee of five per cent on the total income changes the return on investment by one to two per cent. In this case, if the R/I is 3.3 per cent without management, it becomes 2.2 per cent with management charging five per cent total income.