Moving from Equity to Income

[andyr]

I`m new to this, so hopefully I`m doing this all correctly!

I just finished reading the Real Estate Investing in Canada and really enjoyed it. However, I was left with a few questions that I was hoping to get some insight on.

My personal Belize is not to own 100 properties (although that might be nice). To begin with I realize you are working on building equity in your investment properties and any passive income is just a bonus. Where I get lost is understanding how you move from building equity to generating passive income.

The book didn`t really go into detail about when to sell the properties or what to do with the properties when you do sell them. I can see that you`d be able to buy more and more properties with the sale of properties that increased in value. At some point do you sell and move a portion of the funds into something else? Buy a property out right so you get the rent as 100% passive income? Or...

Any advice will be appreciated. Might improve my chances of getting my wife on board too.

Thanks in advance.

 

[kboughen]

QUOTE (andyr @ Sep 25 2009, 12:51 AM) At some point do you sell and move a portion of the funds into something else? Buy a property out right so you get the rent as 100% passive income? Or...
Selling part of your portfolio and paying down the mortgages on the remaining properties to increase cash flow is a common strategy. Depending on the properties you own, your leverage and your personal goals, you may not need to sell any. For example if you hold (10) properties with a 75% LTV and they generate a monthly cash flow of $500 each, you may be happy with the $60,000 per year in passive income.


There are many REIN Members using more sophisticated ways to generate income from Real Estate Investing, I am sure they will add to this thread.

 

[invst4profit]

Keep in mind that paying down a mortgage although it increases cash flow it does not increase positive cash flow.
The result of putting cash into an investment property is a wash in that respect.

Cash can never turn a bad investment into a good investment. If that were the case every investment property on the market would be a great deal.

If you do not have positive cash flow on a property there are basically only a few ways to obtain it. Increasing rents, combined with reducing expenses are the most common.

Also never bank on appreciation stick with investing in positive cash flow properties. SFH very rarely have positive cash flow. Home owners generally are prepared to pay higher prices for SFH making them a poor investment as rentals. If you chose to speculate on appreciation and supplement the rental income monthly that is another option.

 

[EdRenkema]

QUOTE (invst4profit @ Sep 25 2009, 07:44 AM) Also never bank on appreciation stick with investing in positive cash flow properties. SFH very rarely have positive cash flow. Home owners generally are prepared to pay higher prices for SFH making them a poor investment as rentals. If you chose to speculate on appreciation and supplement the rental income monthly that is another option.


Maybe in your experience SFHs rarely have positive cflow Greg but not in mine. They are not easy to find but they are out there and tenants tend to be of higher quality depending on the location and investing strategy.

To the point of this thread Kevin and Greg are both correct, focus on areas with strong appreciation based on economic fundamentals but don`t bank on it as things can turn down temporarily, always invest for positive cash flow and learn how to analyze it correctly - this is especially important as you initially build your portfolio.

 

[invst4profit]

I did say they rarely cash flow.

There are some gems to be found but from my perspective too high risk as one vacancy is 100% loss of income. Expenses also generally are higher in comparison to income. A new roof on a triplex may cost half again as much but the rental income is two or three times higher than a SFH.
SFH simply are not investment efficient.

They also tend to be targeted by professional tenants with large extended families. Again too high risk for my blood.
For me personally they have never fit my business plan.

 

[GaryMcGowan]

QUOTE (EdRenkema @ Sep 25 2009, 10:22 AM) always invest for positive cash flow and learn how to analyze it correctly - this is especially important as you initially build your portfolio.

Well said Ed,
The strong positive cashflow in our portfolio is our biggest asset when applying for new mortgages. I would say the appreciation is the added bonus. Invest in strong fundamental areas that will provide appreciation because of job growth, infrastructure growth,,, if you have read Don`s book you know what to look for using the Property Goldmine Score card.

 

[Thomas Beyer]

QUOTE (andyr @ Sep 24 2009, 10:51 PM) ..Where I get lost is understanding how you move from building equity to generating passive income.

.. when to sell ..

Equity = trapped cash.

Unlock cash by selling or re-financing.

Generate more cash-flow by increasing rents, or lower expenses, such as lower interest rates or smaller mortgage.

Sell whenever you think it makes sense for you .. as on average prices are always higher a year later (not always, of course) but on average prices rise with inflation.

Sell perhaps into a boom or temporary peak i..e after prices have risen very fast for a few years, such as 2003-2007 .. 2007 would have been a good year to sell .. but guess what: 2017 prices will be higher still ..

 

[JoefromTO]

Here`s the way I see it. At some point in your life, you`d like to stop working...the typical 9-5. If you had X amount of passive income /year with investment properties, it would allow you to the opportunity to do that. Let`s use an example, lets say you make $60k per year gross. That pays for everything you currently have and provides for your current lifestyle.

If you had invesments that provided $60k gross, you could (eventually) quit your job and maintain your current lifestyle, however, it would probably be an improved lifestyle..timewise. You would not be working 9-5, instead working on your RE investment(s).

So here`s a picture to show how that can happen(this is just meant as an example). You invest in 2009 and purchase 1 property that provides $60k gross. Remember, there are alot of other factors that dictate what you actually get to keep...ie expenses! But to continue with the example. You use no money down (not wise buts lets say you do that). The property would probably have a negative cashflow, unless your lucky enough to find an Ace that was under priced and under rent. So the cashflow for the 1st 5 years is zero..give or take.

After 5 years, some of the principal was paid down. Now lets assume the interest rates have not changed and you negotiate the same rate. By the way, this can go the "wrong" way and interest rates climb, making it worse on cashflow...So the rate is the same but on a slighly smaller principal. Now the cashflow should have improved somewhat. After another 5 years, more of the principal has been paid down...decreasing you main expense, increasing your cashflow. After 25 years, you have completely paid down your debt, you now have $60k gross income.

Here`s the thing, after 25 years, chances are the rents have climbed, so the $60k might be $80k or more. Also, the property has more than likely increased in value as well.

Keep in mind, there is a cost associated with owning the property. Things like roofs, boilers/furnace, windows, doors, etc...just like your primary residence.

At the end of the day, what your trying to do is buy something that will grow and provide a safe return on your investment.

To address the question of how equity becomes cashflow...when you invest, you will probably do like most other people and use other peoples money to buy the property. Some will be yours or a joint venture which would be the % you put down on the purchase (which is the equity you initially put in), the rest comes from a lending institution like a bank. As you pay down the debt, you build equity. If the value of the property increases, thats another way to build equity, but one you should`nt bank on...consider it a bonus. As you pay down the debt, your equity increases.

But as Thomas said, equity is like locked in cash. A primary residence is a great example of that. If you were debt free on your home, you`d probably feel rich! I`d rather pull equity out of the home and buy another property or 2 or 3 or more with it, having them generating income, paying down debt on multiple properties. So, if my goal was to have 4 properties paid for in 20 years, that would be 1 way to do it.

So it depends on what you want to achieve.

 

[MikeMcCrae]

There are so many ways to make money in the real estate business. My plan was to buy a bunch then in many years sell a few. Then I would put the cash from the sales into mortgages and with the interest on the mortgages and the income from the properties I could live the lifestyle I want.

 

[andyr]

Thanks for the quick responses. I was expecting to get an e-mail when someone responded, but I never did.

kboughen, I like the idea of paying down the mortgages. I don`t see how you`d get $500/month cash flow without paying down the properties seeing as you`re using most of the rent to pay the mortgage. Don Campbell got pretty excited for $100/month in cash flow.

invst4profit, did you read the book? It sounds like you don`t agree with the principles in the book. I admit, I`m not seeing any properties that met Don`s requirements yet, but I`m looking for those "skipping stones" he mentioned. I`m in no rush to buy unless I find the right property. The ACRE system takes the vacancy into account too. Mind you I`m just getting started and am trusting I`m getting good information from this book.

I have some vague ideas about how to get to where I want to go, but still feels a little hazy. I don`t really want to wait 25 years to start making money. Especially since Don recommended taking longer mortgages, so I don`t want to wait for those to be paid off.

I was also hoping for something more specific about getting out of the market. He gives you the indicators for Spring, but none for Fall. He mentioned not getting greedy and waiting for the top of the market. Is this just feeling based?

I loved the book and the step by step directions. Just disappointed with the follow-through. Feels like a second book is needed.

Either way, I`m convinced this will get me to my goals, I`m just not sure how. So I`m going to move forward and figure out the rest later. If any of these questions get answered in a live seminar, I might just have to attend a few of these.

Thanks again everyone. Look forward to reading all your comments.

 

[invst4profit]

I have read the book and agree with most advice but like most people add to book knowledge with my own real life experience.

Paying down a mortgage does not generate positive cash flow and does not make you wealthy.
To own a home outright means you have put real cash into paying down a mortgage. If you have the cash and tie it up in a mortgage it does not increase the value of your investment. The longer it sits there the more opportunities you miss to make more money.
If on the other hand you ignore the mortgage debt on a investment property and put your cash elsewhere it can grow in value.
Cash must earn it`s keep on it`s own not simply by reducing the interest on a loan. Unless of course the interest is greater than any other return you can achieve. If that is the best you can do with cash then you have not learned from Don`s book.

Paying down a mortgage is a "money safe" move not a "money smart" move.
As they say.........The higher the risk the greater the reward. There is virtually no risk in paying off a mortgage.

 

[luckyluciano]

QUOTE (invst4profit @ Sep 26 2009, 09:24 AM) I have read the book and agree with most advice but like most people add to book knowledge with my own real life experience.

Paying down a mortgage does not generate positive cash flow and does not make you wealthy.
To own a home outright means you have put real cash into paying down a mortgage. If you have the cash and tie it up in a mortgage it does not increase the value of your investment. The longer it sits there the more opportunities you miss to make more money.
If on the other hand you ignore the mortgage debt on a investment property and put your cash elsewhere it can grow in value.
Cash must earn it`s keep on it`s own not simply by reducing the interest on a loan. Unless of course the interest is greater than any other return you can achieve. If that is the best you can do with cash then you have not learned from Don`s book.

Paying down a mortgage is a "money safe" move not a "money smart" move.
As they say.........The higher the risk the greater the reward. There is virtually no risk in paying off a mortgage.

I`m not sure your line of reasoning. I am sure you understand the ROI analysis on properties (down payment vs cash flow including mtg pay down) Even properties that do not have positive cash flow are providing a return on Investment. These properties are paying themselves off with only the tenants money. Yes, you can continue to leverage yourself to the Hilt for the rest of your life till the day you die and continue to only purchase properties that have positive cash flow.You are right that SFH typically do not have left over cash flow but they are a lot more headache free. I don`t fear renting to these tenants and I agree these tenants are of the highest quality. I have rented several properties per year for clients, I use common sense on top of the usual checks. I have NEVER had a professional tenant in 24 years. I NEVER have had a delinquent tenant. The worse tenant I have had are the ones that eventually move on, as there is a cost to this also. I have rented and owned both types of properties....SFH and multi-family. There is no comparison in the quality of the tenant. Tenants are business partners to me and I prefer to be associated with high quality people. Besides some of us live in the GTA and prefer to invest here. Positive cash flow properties of any quality are rare here. My plan is same as Joe from T.O. accumulate and pay off. All the wealthy people in my life have done it this way and trust me I have many extremely wealthy mentors. I don`t know any that are continuously accumulating debt and and not equity. Weather your property is amortized over 35 years, lowering the the equity portion and increasing the cash flow portion, you still must pay taxes on that money. You mentioned in another thread you preferred to pull equity and income out to reinvest in mutual funds or mortgages which is essentially investing in other peoples business. Most good real estate investments have a cap rate of 6-8 % nowadays and this will soon increase as when interest rates rise so do cap rates. I see no better investment than 5-10 million dollars of bricks and mortar, payed off, with mainly the tenants money, with a cap rate of say 7 %.

 

[kboughen]

QUOTE (andyr @ Sep 25 2009, 09:57 PM) kboughen, I like the idea of paying down the mortgages. I don`t see how you`d get $500/month cash flow without paying down the properties seeing as you`re using most of the rent to pay the mortgage.
I avoid properties where most of your rent is going to pay the mortgage with a 75% LTV; my first filter is adequate cash flow. Once you get to 75% LTV it`s not that difficult to achieve much more than $100 in monthly cash flow. I have included a sample below with today`s 5 year fixed rate and a 35 year amortization (current cash flow is much better with current variable mortgage of 1.45% and 40 year amortization). There are several successful investors on this Forum that use different calculations and would never touch these deals, but they fit nicely into my investment goals.


Purchase Price: $ 140,000

Mortgage at 75% LTV: $ 105,000

Mortgage payment, 3.89%/35yr: $ 456

Condo Fee: $ 179

Property Taxes: $ 169

Insurance: $13


Fixed Monthly costs: $ 817


Rent: $ 1,320


Gross Income: $ 503


15% Rent for repairs, maintenance, management: $ 198


Budgeted cash flow: $ 305

 

[luckyluciano]

That. Is some incredible rent you are collecting for a $140k property. Do you have the basement rented or is it a student rental? Is that current market value or did you buy it 10 years ago.

QUOTE (kboughen @ Sep 26 2009, 11:24 AM) I avoid properties where most of your rent is going to pay the mortgage with a 75% LTV; my first filter is adequate cash flow. Once you get to 75% LTV it`s not that difficult to achieve much more than $100 in monthly cash flow. I have included a sample below with today`s 5 year fixed rate and a 35 year amortization (current cash flow is much better with current variable mortgage of 1.45% and 40 year amortization). There are several successful investors on this Forum that use different calculations and would never touch these deals, but they fit nicely into my investment goals. Purchase Price: $ 140,000 Mortgage at 75% LTV: $ 105,000 Mortgage payment, 3.89%/35yr: $ 456 Condo Fee: $ 179 Property Taxes: $ 169 Insurance: $13 Fixed Monthly costs: $ 817 Rent: $ 1,320 Gross Income: $ 503 15% Rent for repairs, maintenance, management: $ 198 Budgeted cash flow: $ 305

 

[luckyluciano]

That. Is some incredible rent you are collecting for a $140k property. Do you have the basement rented or is it a student rental? Is that current market value or did you buy it 10 years ago.

QUOTE (kboughen @ Sep 26 2009, 11:24 AM) I avoid properties where most of your rent is going to pay the mortgage with a 75% LTV; my first filter is adequate cash flow. Once you get to 75% LTV it`s not that difficult to achieve much more than $100 in monthly cash flow. I have included a sample below with today`s 5 year fixed rate and a 35 year amortization (current cash flow is much better with current variable mortgage of 1.45% and 40 year amortization). There are several successful investors on this Forum that use different calculations and would never touch these deals, but they fit nicely into my investment goals. Purchase Price: $ 140,000 Mortgage at 75% LTV: $ 105,000 Mortgage payment, 3.89%/35yr: $ 456 Condo Fee: $ 179 Property Taxes: $ 169 Insurance: $13 Fixed Monthly costs: $ 817 Rent: $ 1,320 Gross Income: $ 503 15% Rent for repairs, maintenance, management: $ 198 Budgeted cash flow: $ 305

 

[kboughen]

QUOTE (luckyluciano @ Sep 26 2009, 04:56 PM) That. Is some incredible rent you are collecting for a $140k property. Do you have the basement rented or is it a student rental? Is that current market value or did you buy it 10 years ago.
No, just market rent for boring single family homes in a boring top 10 Ontario town following the boring REIN system over the last 18 months. Prices are up 5 - 6% this year, but they still work for me. I don`t want to appear to pushing any particular town, but if you search my posts there are definite clues.

 

[invst4profit]

Actually $1320 is in the ball park for a $140,000 investment property. When buying your rent should be 1% or higher of your purchase price. This example is close and should be achievable.
Hard to find these days but still possible. I have never made an offer on a property, regardless of the asking price, that did not meet the 1% rule or better.
In some areas, such as certain parts of T.O., this is impossible but that just means you do not buy there.
If the numbers do not work then you wait or shop elsewhere.

 

[housingrental]

Hi Lucky:
That rent is obtainable for student housing. For non student housing its doable in smaller areas in Ontario. Add 20K+ to purchase price and doable with good selection of low end townhouses in many (non gta) areas

 

[luckyluciano]

QUOTE (housingrental @ Sep 26 2009, 07:32 PM) Hi Lucky:
That rent is obtainable for student housing. For non student housing its doable in smaller areas in Ontario. Add 20K+ to purchase price and doable with good selection of low end townhouses in many (non gta) areas

Ok, so give me an example of where I can get rent of $1.300 on a $160K SFH purchased at market value where there is not a catch? (ie: needs repairs, LTO, illegal apartments.)

 

[luckyluciano]

QUOTE (housingrental @ Sep 26 2009, 07:32 PM) Hi Lucky:
That rent is obtainable for student housing. For non student housing its doable in smaller areas in Ontario. Add 20K+ to purchase price and doable with good selection of low end townhouses in many (non gta) areas


Does that property meet the by-laws allowing for student rentals as some cities & towns are beginning to crack down on this?