It is a well known fact that investing in real estate can yield some of the highest returns on investment (ROI) when compared to alternative investment vehicles. That being said, for the first-time investor, selecting the right property and strategy can be a daunting task at best.
Your friends, family, and even financial advisors will have their own personal opinion on what’s the smartest real estate investment you can make, but in actuality, it is your individual investment criteria which will ultimately decide what sub-category of real estate will best reflect your investment goals. Profitability aside, one has to consider the following when determining which real estate investment makes the most sense for them (this list is not exhaustive):
- holding period
- risk tolerance
- capital reserves
- time allocation
- renovation skill set
Many of these items may seem self-explanatory, but how do they translate into the decision making process? This is where connecting with an experienced investment realtor can pay huge dividends, putting the pieces of the puzzle together for you. Over the next several weeks I will review each of the above six criteria in greater depth.
So, without further ado, let’s begin with the first topic, and likewise, one of the first questions you should be asking yourself: What is my realistic holding period for this investment property?
For those of you who are new to investing, the holding period is exactly how it sounds – how long do you intend to hold onto your investment property for? This may seem like a rather trivial question, as one may argue “if it’s making a good return, who cares how long I plan to hang onto it for?” There is some truth to that statement, but only for an investment strategy focused purely on maximizing annual cash flow. Therefore, if you are overlooking the importance of your intended holding period, you are also overlooking many alternative investment strategies.
For example, if a short-term (< 5yrs) holding period is your intention, you will indeed be mainly focused on positive annual cash flows given that there is little time to realize much of an upside upon resale. In this case, you don’t have to be quite as concerned about location, as long as the property has enough demand to secure a Tenant. There are always exceptions to the rule though. For instance, one may decide to purchase a student rental that yields a slightly lower annual return than more desirable student rentals on the market at the same price point, even when their investment horizon is, say, only 3 years. The reason being: the property is actually located in Waterloo on a street that has been approved for the upcoming Light Rail Transit (LRT) development later that calendar year. Thus, even though the property is currently in a less desirable location than others with respect to the U of W, once the LRT construction is completed in a couple year’s time, the property will not only now have direct access to the U of W (i.e. better rentability/higher rent = less turnover/more profit), but the property value will be positively affected by these perceptions. So, the real profit in this investment strategy is in the short-term property appreciation realized upon completion of the LRT system. These type of investment strategies can be the most lucrative endeavours, as they have a large monetary impact in a rather short period of time. Although, they are also some of the most rare too, and without the connection to a realtor that stays current with Municipal Planning and Initiatives, these opportunities are near impossible to capitalize upon. Another short-term investment strategy available to real estate investors is:
- flipping – purchasing one of the worst (most out of date) properties in a desirable area for well below market value, fixing it up cost effectively (usually with your own sweat equity) to attract Buyers that would have otherwise overlooked the property (b/c not move-in ready) and sell it for a profit well above your renovation cost (make sure to be fully aware of all the costs associated with renovation/property disposition before entering the flipping game)
Now, if you have a more average holding period in mind (5-10yrs), positive cash flows are still fairly important, but future property appreciation should become of equal importance. With a longer holding period, your options will expand, as time is on your side when investing in real estate, generally speaking. Many condominium investments don’t make sense on a short-term holding period because by the time you subtract your mortgage payment, property taxes, HOA fees, etc. from market rents in that building, you are often left with a break-even scenario where rental income exactly covers your expenses as a Landlord. With a longer investment horizon in the 5-10 year range, these condo units become a viable investment strategy for the risk averse, first-time investor who requires an affordable, low maintenance property and has the ability to hold onto it long enough to reap the benefits of appreciation upon resale.
Lastly, a long-term holding period (10+yrs) will surely afford you the most opportunities in the real estate investing arena. With 10, 20, 40 years on your side, all conventional and unconventional investment strategies are fair game. At this point, positive cash flows tend to step slightly into the background and the future upside of the property is it’s main asset. Without delving too deep into the intricacies of portfolio management, some seasoned investors may actually value a property with slight negative cash flows, but a large long-term upside. This is because on an annual basis, this negative cash flow will help offset large capital gains realized on their other properties that are doing exceptionally well within their portfolio. This in turn reduces their tax obligations to a point that outweighs their minor negative cash flow on that one property, all while protecting a healthy profit when it comes time to sell in a couple of decades. Other investment strategies that pair well with a long-term holding period would include, but are not limited to:
- purchasing rural/farm land just outside of City limits with the intention of selling to a residential developer for a much larger figure when those boundaries are extended to include your property. On Downey Road in South Guelph is a potential area for growth to slowly push towards Puslinch and Cambridge. We have already seen some farm sales in that area which are simply being held, but no longer harvested.
- purchasing a property that is not at it’s highest-and-best-use, obtaining proper re-zoning or minor variances to allow the new use, develop the property, secure Tenants, generate excellent cash flow, and eventually sell it for big bucks as a fully-leased investment property. A great example within Guelph was the former Pergola driving range which was purchased to be demolished and developed into a large retail plaza with an excellent Tenant mix (i.e. bank, movie theatres, restaurants, fast food, shopping) and strong anchor Tenants (i.e. Cineplex, The Keg, Harvey’s, Bank of Montreal, Jysk). This was a major home run for the developers and the owners of the driving range did very well themselves too considering they were basically selling vacant land.
- purchasing a parcel of land for speculative development, the “build it and they will come” theory. You need deep pockets for this type of investment, timelines get pushed back, unforeseen expenses arise, and Tenants take awhile to secure. That being said, getting in at the ground floor can have a huge upside, especially if you have access to cheap money, low construction costs, and erect a building that targets an under-serviced segment of the market. These types of ventures tend to be a commercial real estate project and it is imperative to utilize a realtor with commercial experience in these situations, as they are much more complex in nature than your average student rental. Large Multi-tenant industrial buildings in the South end of Guelph, like 195 Hanlon Creek Boulevard, are a testament to this this approach, as there was a definite lack of supply of industrial space in the Southgate/Hanlon Business Park, aside from the Cooper Construction buildings which weren’t divisible into as small of configurations. With unit sizes now available under 10,000sf, many well established businesses were able to make the leap to the South end (I personally represented the plumbing supply company Noble in their move from the Northeast into the Southwest end of Guelph thanks to the development of 195 Hanlon Creek Blvd.)
- simply purchasing a fully-leased property that is in good condition and in a great location. This will be an excellent balance of short and long-term profitability. Try to find a building that is capping in the +-7% range and have your realtor review all Tenancy agreements. This could involve anything from a $600,000 6-bedroom student rental on Gordon Street near the University of Guelph to a $10,000,000 retail plaza with 20 Tenants of varying sizes, businesses, and lease agreements.
*** Not sure what capping 7% means?…That’s okay! Stay tuned for my next article following “The BIG Decision” mini-series, where I break down cap rates in more detail.