As a student of real estate investing since 2008, I have seen almost every way to make money in real estate. I have spent thousands of dollars and just as many hours taking courses, reading books, speaking with other investors, and trying methods I learned.
Here are a few examples of how to make money with real estate, keep in mind this list is not exhaustive:
Rent to Own(tenant first or traditional)
Sandwich Lease/ Agreement For Sale
Furnished Rentals(ie High Street)
Bird Dogging/Assignments(Sourcing deals and selling them to other investors)
Selling Real Estate(Realtors)
Foreign Real Estate(ie US)
REITs (stock market)
For each vehicle and strategy to invest in real estate, a risk/reward analysis should be made, assessing your strengths, assets, capabilities, and your willingness to invest the time needed for each.
Of all possible options to make money in real estate, I believe one is BEST and here is why…
The Buy-and-Hold real estate investment strategy trumps others because:
it is treated the most favourably by the tax man;
it offers the lowest risk;
it is repeatable and scalable;
it is proven;
and it is simple.
There is a saying: it’s not what you make, it’s what you keep that matters. When calculating returns on investment, it is the after tax net profits that count. In Canadian tax law there are three categories real estate may fall into. From most favorable to worst these are:
- Principal residence
No taxes are paid on the gain, but all expenses incurred are not tax deductible. Principal residences are great, but Canadians are only allowed one at a time(therefore not scaleable), and since the owner has to live in it, collecting rent is hard to do.
- Rental Real Estate
Capital Gain Tax is payable on 50% of the gain, if the investment was made to create income. Investors can own as many as they like, expenses are tax deductible, net rental profits are taxable as income each year.
- Transactional Real Estate
This is like buying small bags of potato chips from Costco for 50 cents and selling them in vending machines for $1.50. Profits are fully taxable as income on the entire gain. Transactional real estate includes flips, rent-to-own, and assignments.
When it comes to taxes, intention is everything, so for every real estate purchase my intention for the property is to create income.
That is why I have not engaged in flips, or in buying land to develop, or other methods of making money. My goal is INCOME!
If someone offers me a ridiculous sum of money for my real estate after a big spike in property values, I might sell. However, since my intention was to create income rather than sell at a profit, only half the profit is taxable.
My preferred method is to pay the least amount of tax whenever possible, and the Buy-and-Hold method of real estate investing provides for this nicely.
Flips, real estate development, and brokering(ie Realtors) are not investing in real estate per se. These activities are running an active business, and this transactional real estate can appear profitable because of big numbers possible when you do things right. The potential for a big paycheck at the end of a project is tempting for many would-be investors.
However, these profits are Earning Before Interest, Taxes, Depreciation and Amortization(EBITDA is an accounting term you can read more about here). AFTER these expenses, many investors find meager profits in exchange for many hours managing the “investment”. Mistakes can be very costly; renovations go over budget, sales slow down causing holding costs to rise, etc. I have seen investors who would have made more money taking a second job for minimum wage, and at the same time putting their capital at unnecessary risk.
For example, I looked at a doing a flip in the Brocklehurst area at the beginning of 2013. It looked great because the sale price was projected to be $150,000 more than the purchase price. After almost $1000 in due diligence and many hours of research, I ultimately recognized I was out of my comfort zone.
I sold my due diligence reports and recaptured some of my costs, and a year later caught up with the investor. I was informed that after one year and putting over $250,000 at risk, the profit BEFORE taxes was less than $20,000.
Hardly impressive. And this was an experienced investor who had completed many such projects, and developed many properties in Kamloops. The main reason was that the city would not approve a zoning change which could have extracted $100,000 more from the deal, a perfect example of an unforeseen circumstance that can wipe out projected profits.
I think he is lucky he did not lose any money!
Instead of the flip, in 2013 I purchased two rental properties to add to my Buy-and-Hold portfolio, these properties generate $4250/ month in rents. The properties were purchased a little under market value, with about $20,000 equity to start things off.
This was a much better use of my time, as I was able to do this while working my full time job, running my small business, and traveling to Italy for a week!
If Buy-and-Hold investing in conducted properly, using the formulas that have been tested for thousands of years(see below), Return On Investment(ROI) is consistently better after all expenses are accounted for.
Buy-and-Hold Real Estate Offers Lowest Risk/ Highest Reward Possible
In Canada’s free market economy, there is a risk-return tradeoff. Lenders and Investors alike expect that the higher the risk they take on, the higher the potential reward. The lower the risk, the lower the potential reward.
We see this in action when borrowing money to invest with Risk Based Pricing.
Loans for stocks/securities, developing property, business start ups, and other such investments have higher interest rates. Such loans are also offered at lower Loan To Value(LTV) than Buy-and-Hold real estate.
In contrast, Buy-and-Hold real estate loans(mortgages) remain the lowest cost and highest LTV investment available. Here is this concept in greater detail:
1. Residential real estate has the lowest cost of financing.
Residential Mortgages are among the lowest interest rates available. 3% or less is common these days for a mortgage, for assets that are worth hundreds of thousands of dollars.
Your first credit card limit was for $500 or maybe $1000, and yet you had to pay close to 20% if you carried a balance. That is almost 7X the interest rate on a much smaller amount of money!
Why the disparity?
Because conventional real estate investing is a very low risk business. Business startups, credit cards, vehicle loans, and other ventures are a higher credit risk. Therefore the market prices this risk into the loans available for these ventures, and the interest rates are higher.
What about stocks? Surely a mechanism designed to create wealth for shareholders would have lenders tripping over themselves to finance?
Go to your securities brokerage and see what interest rate is on a margin account. It will be much more than 2.99%, the 5yr fixed mortgage rate at time of writing.
2. Of all investment options, residential real estate is the lowest risk.
We know this because the highest loan to value(LTV) ratio available for investment loans is within real estate. You can borrow 80% or more of the value of your real estate investment. ie. With a 20% down payment, you may purchase a $200,000 for only $40,000.
Compare to Margin accounts: 50% LTV if you borrow $500,000(higher than the cost of a decent Real Estate investment) or a maximum of 30% LTV if you borrow $1 million or more.
Proven Investment System
Successful Buy-and-Hold investors I have met who are “self made” and did not inherit a large sum of money all did it the same way.
Buy 1, rent, hold for a couple years. Buy 1 more, rent, hold for a couple years. Buy 2 more, rent, hold on for a couple years. Buy 4 more, hold for a couple years. Never sell.
15-25 years later, they have one or two million dollars in their portfolio, or perhaps much more.
1. Kelson Group owns many of the multifamily buildings downtown Kamloops. It is one of the largest private owners of apartment buildings in Western Canada, and is currently operated by the sons of the founder.
2. The majority of the student housing near the university was purchased over time by the same man, who unfortunately recently passed away, but he left his children and grandchildren a large portfolio, providing a legacy for them few could even dream of.
3. A friend of mine has been investing in Kamloops for many years in houses, and more recently multifamily buildings. His first multi unit building was purchased 15 years ago, and he was just informed by his accountant that his after tax profits if sold would be over $700,000.
Repeatable and Scalable
As these investors grew, they took on management staff, accountants, and other professionals(a good realtor who can find great deals is worth her weight in gold!) and the business grew, with the properties paying for everything along the way, and the investor kept working a day jobs.
A mentor of mine says that your investments should be BORING. Then you can use the money you make to fund your FUN!!! When you find excitement outside of your investments, you will never lose money.
With Buy-and-Hold investing in a stable economy such as Kamloops, the worst case scenario is that tenants will pay off your mortgage, leaving you to live off the cashflow, or perhaps sell and go on a multi year trip around the world.
There is much more that could be said about investing in real estate, please share your experiences with me, and join the conversation !
Until next time,