When a house is not a home, it can be a money-maker
Whether it's a 'flipper' or for steady rental income, property is an attractive way to diversify, GABRIELLE BAUER writes
By GABRIELLE BAUER
Special to The Globe and Mail
Thursday, October 28, 2004 - Page T2
Investment in real estate is starting to look good again, even to people who couldn't fix a leaky faucet if their life depended on it.
With property prices continuing their nationwide ascent and confidence in stocks still wobbly in the wake of the political and economic crises of the past five years, many Canadians are looking to real estate as a way to diversify their investment portfolios.
Unlike mutual funds, which require as little time and effort as a signature below a dotted line, investing in real estate does take some legwork.
On the other hand, if you're in it for the long haul, there's no such thing as a bad time to invest, says Ozzie Jurock, a real estate analyst, lecturer and author based in Vancouver. "Don't worry about the market," he says. "The biggest mistakes are made in a hot market and the best deals often happen in lousy markets."
Mr. Jurock divides real estate speculators into three categories -- shark, flipper and genuine investor -- and says it's important to know which category best describes you, as "each one requires a different investment strategy."
The shark looks for -- and capitalizes on -- extreme distress sales. "If you can't see yourself buying a house where a girl just drowned, you're not a shark," he says.
Flippers purchase undervalued houses or homes in need of extensive repair, and resell them within a year or two.
Debra Gould used this strategy to advantage when she bought a home in Montreal in May, 2002, and resold it three months later at a $30,000 profit. The president of Six Elements Inc., a Toronto firm specializing in home staging or "fluffing," Ms. Gould used her decorating talents to polish the home's appearance before selling it.
To her clients interested in the flipping scene, Ms. Gould advises: "Buying a structurally sound but ugly house in a great location, and preferably one that needs lots of minor repairs and cosmetic changes like removing old carpets, wallpaper and lighting. These changes can make a huge difference to the perceived value of a property, often at minimal cost."
While it's true that flippers can make large gains, they can also land belly up if real estate prices take a dive after they purchase.
Genuine investors, on the other hand, take no such risk, Mr. Jurock says. The smart way to invest, in his view, is to buy property that gives you a positive cash flow right from the outset. That way, your investment doesn't depend on the whims of the market.
But how to ensure that positive cash flow?
For starters, look for an income-price ratio of 0.75 per cent or more, Mr. Jurock advises. That means a $100,000 property should generate at least $750 of monthly rental income. Some investors also use capitalization rates to gauge the soundness of a property. To calculate a property's cap rate, divide the projected operating income (after expenses and excluding the mortgage payment) by the purchase price, and multiply by 100. A cap rate in the double digits, such as 11 per cent, bodes well for your investment.
Mr. Jurock cautions against over relying on such figures, however, emphasizing that each property "tells its own story."
Key questions to ask yourself:
What is the tenant history?
Are the tenants paying market rates?
What capital improvements are needed?
How old is the building?
Then do the math: itemize all expenses -- mortgage, taxes, insurance, and maintenance/repair costs -- calculate the expected rental income, and subtract expenses from income. You're looking for a plus sign in front of the answer.
If you can't see yourself tinkering with those leaky faucets, you'll need to add property management fees (typically 7 to 9 per cent of rental income) to your expense sheet.
Still, Darren Weeks, president of the Edmonton-based wealth management company Fast Track to Cash Flow, says it's possible to find properties that yield a positive cash flow even after accounting for such fees.
"But you may have to get out of Canada's large cities to get such a property," he notes.
Mr. Jurock, in fact, recently bought some townhouses in Prince George, B.C., making a 10 per cent down payment on each $43,000 property.
With each unit bringing in $230 a month after all expenses, he says he feels "secure about the investment, even if it doesn't yield any capital gains down the line."
Feel ready to take on a small apartment building? Mr. Weeks says you'll need to think like a business person, with checks, balances and contingency plans in place. In his experience, "95 per cent of apartment buyers underestimate expenses and vacant-suite costs, so cash flow becomes a problem."
If you're taking your first bite out of the real estate investment pie, Mr. Weeks suggests you start with a more modest transaction, such as a single-family home.
"To know whether you're getting a good deal, you'll need to become an expert in the area where you're buying," he advises. "Find out what rent the market can actually bear, not what it 'could' bear under ideal circumstances."
You should also know that you'll be slapped with a 2.5 per cent GST bill if you buy a brand-new home. Until three years ago, only owner-occupants could get a rebate on this expense, says Toronto real estate lawyer Alan Silverstein.
In June, 2001, "the government changed the rules," he says. "If you hold the unit and can demonstrate you expect to rent it for a year, you can get the GST rebate after the year is over." This has "levelled the playing field for investors."
The tax perks of real estate investment don't stop there. "You can write off your expenses," Mr. Weeks says, "and you can claim depreciation on the property, even if it appreciates in value while you're holding it." Of course, you'll eventually face a tax bill of about 25 per cent of any capital gains you make when you do sell the property.
If the prospect of buying and selling homes makes you nervous but you'd still like a piece of the action, you may find your investment niche in real estate investment trusts, or REITs.
Using pooled capital from investors, REITs invest in various forms of real estate, usually income-producing assets that generate regular cash distributions. Here too, the tax breaks are considerable.
"All told, you can shelter about 40 to 60 per cent of the distribution," says Seymour Temkin, a senior business adviser and REIT specialist at the Goodmans LLP law firm in Toronto.
With the exception of REITs specializing in the hospitality sector, which tanked after 9/11, Mr. Temkin says REITs have yielded an average return of about 18 per cent over the past three years.
So why isn't everybody flocking?
"Many people believe interest rates will soar and REITs will run into trouble," he says.
For his part, Mr. Temkin foresees a more modest rise in interest rates - about 1.5 per cent -- and a healthy future for REITS. "They're an excellent choice for the long-term player."
Having decided to play the real estate investment game, you may be wondering where on earth to make your first move.
Vancouver-based real estate guru Ozzie Jurock suggests you start by "looking for a high-employment area with a low vacancy rate."
Does this mean bright lights, big city? Not necessarily, Mr. Jurock says. "In some provinces, such as Ontario, you're better off looking in the suburbs or smaller towns." But above all, "avoid investing in an area with a high vacancy rate."
According to Douglas Gray, a real estate consultant and retired lawyer in Vancouver, the Canada Mortgage and Housing Corp. keeps statistics on expected rental rates in every part of Canada. "It's fantastically useful information, and it's available for free," he says.
Mr. Gray, whose second edition of Making Money in Real Estate is scheduled for publication in early 2005, also suggests that would-be real estate investors think like demographers, and ask questions such as: What is the baby boomers' next move? What areas will be attractive to downsizing seniors?
Other things to look for:
"An attractive enclave in a less valued part of a city -- the 'well-kept-secret' -- has a good chance of appreciating over the years," Mr. Gray says.
In terms of property prices, "an area that hasn't shown a big growth spurt yet. An area that seems to be on the cusp."