There are many avenues for investment: stock markets, precious metals, even tulips! One investment that has seen remarkable results over the years is revenue properties and real estate.
As Mark Twain once said: “Buy land - they’re not making any more of it.”
But are they making more of it? We see more condos being built every day, and the cost of building is skyrocketing. The majority of pre-sale condo developments in Victoria, Vancouver, and Kelowna are surpassing prices of $1,000 per square foot. These buildings are sleek and very appealing, and many have impressive amenities. When it comes to a stunning place to call home, these can be quite attractive.
But what if you’re looking purely for a revenue or investment property?
The glamour of a shiny and new amenity-rich condo does not always translate to increased revenue. The typical renter is generally more concerned with living space and location, rather than lake views and infinity pools. There are many established developments (read: older) which can realize stronger ROI (Return on Investment) than glitzy new builds. There is significant price appreciation potential in these established communities, as the ever increasing construction costs on new builds inevitably bolster the relative values of older developments.
Importantly, as the resale market has softened over the last few months, the rental market has remained incredibly strong. Good news if you’re a landlord… or a soon-to-be landlord.
Rental income will usually cover the costs of the mortgage, strata fees, and property tax. With a bit of luck, there will be some light cash-flow as well. But the real magic of an investment property is in the monthly principal paydown. You invest the down payment up front, and from that point on the majority of the monthly costs are covered by the tenant.
Will this make you rich overnight? No. But long term, it is powerful.
Let’s do some math...
Take this Lower Mission condo located about a five minute walk to the beach: 3735 Casorso Road. It’s offered at $554,900, which is only $484/sqft. According to the latest rental analysis from Associated Property Management, this condo should attract rent of at least $2,700/month (excluding utilities, which are the responsibility of the tenant). With a conventional 20% down payment, the monthly mortgage payment will be about $2,195. Add in strata fees and property taxes, and your total monthly expenses are $2,745. Between you and me, I bet you could find a good tenant who will pay $2,750.
So let’s call it a wash. No cash flow, but no out of pocket expenses either. Not very exciting on the face of it, but wait - there’s more!
When you look at the breakdown of the mortgage payment, you’ll find that in your first year of payments, the principal of the loan is reduced by about $7,300. In Year 2, it is reduced by $7,600. This amount will accelerate every year. As the loan value reduces, so does the interest paid, which increases the amount that goes against the principal.
5 Year Summary
Let’s say you need to sell the condo in Year 5. To be conservative, we’ll assume the market has been relatively slow, growing at just 2% per year. Your condo is now worth about $612,000. In that same time, your tenants have paid down $40,000 in principal on your loan. Even with sales commissions included, you have profited over $74,000 on your $111,000 initial investment.
Long story short, you put in $111,000 at the outset, haven’t paid out a penny more, and walked away with $185,000. That’s an 11% annual return when the market itself has only increased 2% annually. That is the power of principal paydown, completely paid by the tenant.
10 Year Summary
If you can hold on for 10 years, that rate of return will increase, as the amount of principal paid down increases each year. Given the same set of assumptions, in 10 years you will have profited $186,500 - nearly $90,000 of which comes from the tenants paying down your mortgage. You put in the same $111,000 up front, and walk away with darn near $300,000.
So, there you have it. Cash flow isn’t the only thing to consider when investing in a revenue property. The power of principal pay down plays a massive role in the picture!
Let me know if you have any questions - I would love to help you find the perfect investment property when you’re ready!
Personal Real Estate Corporation
Royal LePage Kelowna