Recalibrate your returns

Income property investing ticks a lot of boxes for people: a measure of control, relief from stock ticker anxiety and the prospect of seeing investment capital generate passive income. But it’s also fun and accessible – every property is a bit different, and the next one is just a click away. What’s not to like?

An idea so full of win sells like hotcakes. Real estate investment clubs, seminars, CREW – they all sell your interest in real estate back to you in the form of education. Getting informed is essential when you’re talking about a big-ticket purchase, and very few investors are worse off after having sought out an education prior to spending money, but a lot of that education falls short. These teachers upsell all the good things about real estate and then add an overly simple caveat at the end: “Hey, make sure you cash flow. Because if you cash flow, nothing can go wrong. Get as much of it as you can, and you’re set!”

We need to recalibrate our approach.

Rapid changes versus established customs
Real estate used to be a deep-pockets play: big down payments and high interest rates; cash flow was easy to find because there were more barriers to entry; people stayed as tenants because they couldn’t afford to become homeowners. But the game has changed. The proliferation of cheap money and low down payments has brought real estate investing into the mainstream, and many investors are evaluating deals with a personal consumption component as a factor in their decision.

The net effect has led to prices increasing faster than rents in most Canadian markets. And it sometimes goes off the rails like we’ve seen in Toronto and Vancouver, where people get caught up in price appreciation and couldn’t care less about rental yields. Like everything else these days, the world of real estate investing is changing rapidly, and it is increasingly at odds with old-school established customs.

What made a good real estate deal in 1817 still largely makes a good one in 2017: Buy in cities other people want to move to. Buy in communities with convenient, moneysaving transportation options. Buy on streets where others are spending money to improve your location for you. The catch is that it is getting more and more difficult to find all of this in a property that cash flows for the minimum down payment required by most lending institutions, which frustrates investors and holds them back from moving toward their goals.

Recalibrate your expectations and approach
So what’s a real estate investor to do? We can recalibrate both our expectations of property performance and our approach to real estate investing in general. Remember that cash flow is just one formula; it is not the only determining factor of success. And yet I constantly encounter investors trying to turn every property into the exact same thing: an OK deal that generates a little cash flow. They buy in dumpy areas that are going nowhere because the rent-to-price ratio is favourable.

Some properties will never cash flow with traditional down payments, but they are still superior real estate deals because they are nearly assured a value increase due to the fundamentals at work in the local market. These properties can be purchased for equity gains as opposed to income, and after an investor has achieved his gains, he’ll sell and consolidate his capital in properties designed to enhance net income.

Total return is the name of the game here. We buy these properties when we don’t need income, using them instead to maximize overall return on our capital, using a staying fund to cover the planned overages. Certain properties are built the right way – to take tenants in and out for years – and are the type we buy, pay off with the gains from our equity plays and keep forever for true cash flow.

It’s very much the same type of strategy used by professional investment fund managers who are looking after billions of dollars of other people’s money. They don’t require every company they invest in to do it all for them. Instead, they take a portfolio-based approach to wealth generation (and subsequently wealth preservation), and modern real estate investors would be wise to contemplate a similar path.

The endgame is much the same as it is now for many – to own a bunch of income properties free and clear, and live off the cash flow. But the best path to financial independence might be different than you have been led to believe – one that frees investors from requiring every purchase to be a forever property and instead uses them as stepping stones toward a portfolio built for lasting cash flow.

Brett Turnner is the broker and co-owner of Redline Real Estate Group, a Calgary-based real estate brokerage with in-house mortgage and property management companies. He has been representing real estate investors for 12 years.

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