Bring the Cash Flow

The lever. Potentially one of mankind’s greatest inventions, no? Ken over at ARRDPD brings up a good point about making investments with little or none of your own money. (His post was in response to this one). This is of course contrary to the traditional savings scheme taught to us by our parents via their parents.

First, to address Ken’s comment, I think most PF blogs are touting the traditional ways of raising capital for retirement. Those being: you work at a job, you save your money, you invest it wisely (and usually conservatively) and then you wait. and wait. and then retire.

This is why investing in real estate is so much more interesting because you have many more options available to you. You can leverage your own money to make larger investments. You can set up a corporation like Ken has, which lends money to investors and secures it against a property. You can start an investment group where you and your partners pool their money, then leverage it through the banks and invest in larger-scale developments. Either way, you are using other people’s money to make yourself more money!

In my scheme, I’m hoping to find investors who will accept a rate of return of say 10% on their money. I’ll then pool it all, and invest in as much real estate as possible (while ensuring my return is much higher than 10% because I’ll need a safety margin to guarantee interest payments/dividends). All the money will be kept inside the company, and reinvested… thus making all of investments more and more secure over time.

NLG

Obviously there are different philosophies to generating rental income. Today, 2million blog posted an analysis of the yearly income for his rental property. His ROI is around 7%, not exactly stellar. One reason for this is that his property is not highly leveraged. Many financial advisers recommend amortizing rental properties as far into the future as possible. The reason being that any money spent on interest for rental properties is tax deductible.

The key difference between 2mil’s results and my own are that I rent to students, so I can cram 5 people into a house that would normally only have 2-3 bedrooms. Thus, my monthly rents for the house are in the $2000 range and my expenses only increase slightly due to increased utility costs. This is a major advantage to my area’s demographics (mentioned earlier).

Overall, my ROI is in the 30% range including the $$’s that flow back into the home’s equity.

I’ve recently been investigating the difference it makes to re-amortize my rental mortgages out to 25-years (they are currently slightly accelerated due to a calculation error at the bank). My payments would reduce by $60/month. If I divert this cash to my home mortgage, I’ll pay it off 2-years earlier and save $20,000 in interest (a 40% ROI when you think about it). The big advantage here is, as mentioned above, rental mortgage interest is deductible, where personal interest is not.

Thanks for sharing your results 2mil.

From ARRDPD:

_“basically, my LLC is borrowing money at say 5% from people. That’s all the people know and care about. They know that their money is going to be secured by a 1st mortgage in real estate.

The LLC takes the money, let’s just say it comes out to $100,000, and lends it to someone at 10% as a 1st mortgage.

Every month the LLC gets paid around $800 and it pays the people $400, therefore making $400._“

A man after my own heart! Great work Ken. Using the money of risk-averse investors to make yourself money. The only thing I’m leary about in this particular scheme is the amount of risk involved. I suppose a simple title search will tell you that there are no other mortgages on the property. But, these are high-risk clients, I imagine since they are paying 10% interest, so the chances are higher that they could default. If they do, the principal is guaranteed, but there will be significant lawyer fees associated with the sale of the home and issuing foreclosure documents. These are unrecoverable.

In my scheme, I’m thinking about using investment money to buy investment properties. Thus, I would leverage their money by putting 25% down, and generate cash flow with a ROI of around 30% on that money. Then, I would pay them about 7-10% giving me some padding in case of unforseen expenses, vacancy rates, or market fluctuations. The investors would become Class B shareholders in the company. I would keep all the generated capital in the corporation for investment in further properties.

The hard part is convincing the investors, and finding the right properties.

Stay tuned….

Tags: Real+Estate, Investing

Well how now brown cow… I have much to learn.

ARRDPD has another interesting post that is worth writing about. This one is in regard to capitalization of a rental property. Basically, the gross income generated divided by the value of the property (similar to stock market capitalization). This is a measure I hadn’t considered yet, mostly because I was searching for properties that gave a good ROI for me. This is a similar measure, however, because my investment is a percentage of the house cost, and my income is the gross income minus expenses. However, I believe that both numbers are useful in analyzing properties as they will tell you different things (especially considering that interest expense varies month to month, thus changing ROI comparisons to prior acquisitions).

Anywho, let’s look at property #2 once more. The cap is 16%, ROI ~30%. My other property also generates a cap of 16%. The similarity is due to them both being 5-bedroom houses, rented by the room within 1km of each-other. ROI for each property does differ, however.

Cap varies significantly in my city. As you approach certain areas near the university, prices for comparable houses jump by $60k or more. One could raise rents slightly (say by 20%), but the cap would still drop to 11.7%.

However, one could also argue that these houses are still better investments than mine. Why, you ask? Because the area is somewhat nicer, the property values are higher, and because the houses are very close to the university, interested tenants are easier to find. Furthermore, if there is a downturn in the economy and enrollment drops, or more apartment buildings are built in the area around the university causing vacancy rates to raise… properties like these would ideally be easier to rent than similar properties located further away.

I am comfortable with my purchases right now. I plan to improve my properties as much as possible, making them more attractive, and because my cap and ROI are higher, I have room to lower rents and still maintain positive income/cash flow.

Anyway, enough rambling for one evening, I think.

1. The Town:

My city has a population of about 400,000 people, and is highly suburban.  Our land area is about 400 km^2 by my own estimate, but this is probably a low-ball. 

Further to the permanent population, we are a universtiy town playing host to one of the largest universities in Canada.  The universtiy brings over 30,000 students to the area, and these students need somewhere to live.

2.  Rental Market:

With 30,000 students, there are many opportunities for student rental properties.  The going rate for one bedroom in a 5-bedroom house is approximately $350-$450/month.  Two-bedroom apartments range from $800-1500 depending on proximity to the university.

I currently have 13 bedrooms for rent at an average of $400/bedroom per month.  I include all utilities in this cost, and provide cable TV and highspeed internet as a perk.  My vacancy rate, is unfortunately about 20% due to the difficulty in securing tennants over the summer months when they are not in school. 

continue reading…

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Welcome to my first post.  I suppose I should introduce myself…  I am N. Gifford, a 26-year-old Mechanical Engineer living somewhere in Canadian suburbia.  I am currently working in the defense industry, largely due to socio-economic factors as the primary employer of engineers in my city makes defense products.  I assure you my interests lie elsewhere, and that is where this blog comes in.

 I intend the blog to be an exploration of life, mostly the financial side of life.  My current struggle is to budget my household expenses, and learn how to generate more income from savings and my rental properties.  I hope this site will be a good resource for financial information, especially relating to real estate dealings because I currently cannot find any real estate blogs.

 Naturally, I am a geek, so I will probably post some interesting links found during my daily web surfing…  and hopefully I can find out how to host this site myself… that should be interesting.

Next, I will post a bit about my financial situation, and my rental properties.  I will also include some links of the websites I watch.
NG