Absolute Newbie Looking to Jump Into Rental Properties

[Tyler Cruz]

Hello everyone!

This is my first post here as I am brand new to both BiggerPockets and property investments.

I have some money lying around in my bank account that's doing absolutely nothing (was made from my business), and so I was looking to build some (relatively) passive income and turn that liquid cash into property assets.

I am prepared to invest up to $150,000 CAD ($140K USD) into rental properties.

I would like my investments to be as passive and hands-off as possible, and so I would definitely be hiring a property management company.

I have endless questions, but I guess my first would be whether it'd be better to buy off properties in whole first, or to take on mortgages. Please excuse my complete naivety in this matter - everyone has to start out somewhere!

In the smallish city where I live, apartments on the cheapest end of the spectrum are listed at around 69K (all prices from hereon out are in CAD) and renting out for around $650/month. Moving up to $125K list price and they're renting out for around $825. At $150K list, they're around $875. It seems the lower end of the market has a better cost:rent ratio.

Taking the $69K - $650 rent as an example (there are a bunch of these units for sale; they're in a complex with a lot of units for sale), let's say I bought 4 of those (although I wouldn't want to put all my eggs in one basket buying all in the same building, but this is just for samples sake).

Using a 15-year amortization period with a 3% rate (I'm in BC, Canada), and a purchase price of 65K and down payment of 30K (46%) on each place, that would work out to a $241 monthly mortgage on each. That's $650/month rent on each. Say 10% for property management, and another 15% on top of that for vacancies, repairs, etc. which I believe to be conservative (but am just pulling out of my ***), and that leaves me with $487.50. I do not know the strata cost of that building yet, but let's just say $100 (they're pretty cheap). So that's $387.50.

Subtract the mortgage and that's $146.5 positive cashflow per unit. Times 4 units that's $586 net profit before taxes a month and it's building equity each month. This is not taking into consideration the closing costs of the purchases.

That's a $120K investment. Or, for roughly the same price I could buy two of those units completely and profit $775 a month (that's factoring in the expenses too) and hold full equity...

Hmm... assuming I did the math right, it seems I may have answered my own question right there? The major downside to mortgaging to me seems the fact that you don't know what interest rates will do.

My business is in an industry that is extremely volatile and unpredictable. I can go from making virtually nothing one month to making $50K profit the next. As a result, I am looking to parlay the income I do make from it and put it into more passive means of generating wealth.

Therefore, my plan at the moment is to take the money I'm making from my business and throw most of it into income-generating property. So in some ways, I may have a somewhat faster path in rental property growth as I won't be relying solely on a slow growth formula of the renters paying off my mortgages.

I need to get my feet wet first though and take the plunge. That is the hardest part, I'm sure...

Comments, suggestions, and advice is greatly appreciated!

[Roy N.]

Originally posted by @Tyler Cruz:

Welcome Tyler.  We cannot have all that money laying around, let's put it to work, but let's do is smartly.  When it comes to starting out, the biggest piece of "wisdom form {mis}experience" I can share with you is patience.  Being impatient will lead to you making poor decisions and deals.  Be thorough in your analysis and guided by the numbers (emotions need to run secondary to hard facts).   When the time comes to make offers, remember your are purchasing a business, not a piece of property and repeat the mantra: "there will always be another property".

If this is the case, then perhaps a better fit for your objectives is lending.  You can set yourself up to lend first or second mortgages to third-parties - either from cash-on-hand or from a registered plan (ie. self-directed RRSP).   There is a bit of learning here, but no more, perhaps even less, than being a landlord.  Most of the learning will be around due diligence and setting the correct terms of the loans ... as with tenants, lending is all about screening your borrowers. 

You can easily earn 6-14% return on your money though writing first and/or second mortgages to other investors.

Another almost hands-off approach is to partner with an experienced investor - naturally with a proven track-record of success - in your area - either in direct partnership or purchasing into a syndication.   In this type of arrangement you could have the option of being the "hands-off" money partner - you supply the downpayment and renovation costs either in the form of a mortgage (as above) or as an equity partner in the venture.

Bigger Pockets is a great place for endless questions.  There are enough of us out here that you will get a variety of experience and opinion in response.

That sound cheap for the east coast of Vancouver Island.  It also sounds like you are talking about condominiums/fractional ownership.   If you decide being an active landlord - as opposed to being a lender/silent partner - is the direction you wish to go, then I would suggest you look at entire buildings in addition to (or rather than) condominiums.  Owning condominiums as rentals can work well, but there will be extra costs and constraints (HOAs) with which you will have to deal (read: more politics).

The most common amortization on a residential mortgage in Canada is 25yrs.  Some of the conventional lenders will still extend a 30yr mortgage on residential rental properties (1-4 units).   If you really want a shorter pay-back period, my suggestion is to model your property (business) using the commitment of a 25yr amortization, but to make sure any mortgage you secure allows for a substantial annual pre-payment  (15 - 20%) or payment increase (again 15-20%).  This way your obligation is the lower payment of the 25yr mortgage, but you are fee to pay more as/if you can.   The effective outcome is the same, but with more flexibility retained by you.

Also, when it comes time to look at placing a mortgage, I strongly encourage you to look at a variable rate, fixed term product.  You will save 0.5+% interest over the conventional 5-yr fixed rate/fixed term mortgage which really adds up, especially in the earlier years.

Do not under estimate your operating costs - it is alway best to conservatively over estimate them and be pleasantly surprised when you come in under your numbers than the other way around. In addition to utilities, taxes, insurance & {possibly HOA fees}, you also have administration (accounting, advertising, legal). You should also set aside 10% of your net income as a capital reserve to fund all of the renewal/replacement of the property itself (roof, HVAC, floors, kitchen, bath) which will occur every 5-20 years and replacement of appliances (fridge, stove, washer/dryer, etc).

I think your CBFT numbers are a little rosy, but let's say they are half of that (387.50/mnth), that is $4650/yr ... a 3.8% return.  Not wonderful.   But let's say you decide to hold a mortgage.  You can now purchase 8-10 properties rather than 2.  Your monthly CFBT will be less as you will have debt service, but your overall cash flow will be greater since you have 4-5 times the revenue sources.  Your vacancy risk will also be lower as it is spread across more units.  Finally, your tenants will be building equity for you. 

While that is true, the interest rates seldom get too far ahead of rent (the early 1980s being an exception).   North America is more likely to continue suffering from stagnation than another round of {hyper}inflation.  That said, if you partitioned your available funds, using one part to acquire properties (with conventional mortgages at 2.5 - 3.5%) and the other part to private first and second mortgages (at 8-12%), then you have established an arbitrage which hedges you against the rise in interest rates.

I run my own businesses as well and, though my revenue streams are not quite that volatile, I too am dependant on the business cycles of my clients.   Moving some retained earnings into residential real estate to smooth the income stream and, in may case, reduce personal travel, was what motivated me to start investing in real estate as well.

Just because you do not have to rely on your tenants paying of your mortgages does not mean you should not avail yourself of the opportunity.   If you are seriously concerned about mortgage rates increasing significantly, there are ways to protect yourself (lending as indicated above; retaining a substantial cash reserve to pay-off properties if interest rates jump, etc)

I hope some of this helps.