Midwest Minute - February 12, 2012

Building Wealth through Real Estate

Almost every week I get asked about the wisdom of investing money in real estate.  The short answer is that it is definitely worth looking at; the longer answer is that it doesn’t come without effort and a business like approach.  In other words you must “plan the work, and then work the plan”.

There are two main benefits to having the right real estate in your portfolio – capital gain and cash flow.  Inflationary pressures push value up over time, thus hedging your savings against the loss of purchasing power in the future.  Positive cash flow comes when rental income exceeds expenses thus generating a surplus. 

The goal here is to incrementally accumulate surplus cash, then use it to possibly purchase more properties, or pay down debt, and ultimately become financially independent.  One of our clients started with one four-plex and now owns three.  Her objective is to get these mortgage-free as soon as she can, then retire using the net income as her pension plan.

Earnings from her current full time employment go to meet the day to day needs of her family.  No matter how tempting it would be to siphon off some cash for vacations or other discretionary purchases, she is determined to plow any and all surpluses back.  Pre-paying the mortgage gives her more equity, a greater cushion against recessionary pressures, and reduces the monthly interest commitment.

She also knows that as the value of the properties increases and likely so will the amount of rent she can charge.  With mortgage rates locked in for five year terms, annually increasing rents mean progressively larger annual cash surpluses.  She uses some of it to keep the properties in top condition.  Her theory is that good looking apartments attract a better quality of tenant.  Good tenants want to be proud of where they live, essentially helping her to look after the building.  Lesson - the best money you make is the money you don’t spend!

Funds used to maintain the property, mortgage interest, and depreciation on the building’s cost, are all deductible expenses.  Even if for some reason you don’t generate a surplus one year, the mortgage will eventually be paid off by others.

So let’s take a look at the numbers in today’s dollars and see if you could retire on this.  There are three four-plex units, currently worth $700,000 each, for a total of $2,100,000.  The initial down payment on the first structure eight years ago was 20% on $550,000 or $110,000.  The net annual income from 12 three bedroom apartments, mortgage free, is over $140,000 giving a return on investment around the 7% percent mark. 

The best part?  Unlike an RRSP, you don’t have to cash the asset in at an arbitrary age.  As long as you own the property it keeps chugging along providing you with cash.  Don’t want the hassle of tenant relations?  Hire a property management company.  All you need to do is check your monthly online bank statement from wherever in the world you happen to be staying.

Vern McClelland is an associate broker with RE/MAX of Lloydminster and a partner with The Midwest Group.  If you have questions or comments on this article or other real estate matters, he can be reached at 780.808.2700, or through the website www.wesellmidwest.ca

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