# how to evaluate buying RE for investment?



## joncnca (Jul 12, 2009)

what're some good resources for investing in real estate? books, blogs, websites, etc.? 

i've read some articles on milliondollarjourney, landlordrescue, other online articles. i want more fundamentals, i like math, like seeing numbers.

i know everyone says the indicators say RE (in toronto and surrounding areas) may be overvalued..i'd like to know, how are people coming to these conclusions.

i'm focusing on 2 scenarios with residential property, condos or otherwise. one is buying pre-construction, hoping for some capital appreciation (i KNOW people are saying property prices are forcast to go down...regardless, i'm hoping to see some of the math). the other is buying a property for rental, which really should look at capitalization rate and should not rely on capital appreciation.

i've attached a HUGELY SIMPLIFIED excel spreadsheet with a possible scenario. purchasing a preconstruction lakefront condo, HST included, with discount on price, i hope it's otherwise self explanatory. assignment is done before occupancy date so as to avoid some taxes and legal fees. other scenario assumes keeping the place until occupancy, after which, the capitalization rate calculations would apply.

of course, there are assumptions in the calculations, like growth rate..does this seem like a tool i can build on and use in the future? remember, it's really simplified right now, but i appreciate suggestions.

and as i mentioned, more resources on this topic would be very useful. 

if RE is so overpriced now, are you saying that NO ONE is buying real estate for investment purposes now?

thanks!

NOTE: i fully love the way capitalization rate has been explained in the past, particularly by Berubeland and others, about how you shouldn't rely on capital appreciation, etc., and i have a eye on that, so don't worry, i'm not losing sight of it =)


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## Dmoney (Apr 28, 2011)

http://canadianmoneyforum.com/showthread.php?t=8502


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## financialnoob (Feb 26, 2011)

Why is the investment term only 3 years? If it's truly a short-term investment, don't forget to factor in the 3-6% realtor fees for selling which will make a dent in your ROI.


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## the-royal-mail (Dec 11, 2009)

How about the taxes, condo fees and closing costs?


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## joncnca (Jul 12, 2009)

i was playing around with how the scenario might play out with assignment of the property before occupancy closing. pre-construction typically takes about 3 years to reach occupancy. with assignment, my understanding is that you would pay _some _ legal fees (and i guess realtor fees), but avoid closing costs like land transfer tax, property tax prepayment, as the assignee would be responsible for those costs. that's also why the last deposit charge of 5% is not included, as this would be part of the occupancy closing costs, also responsibility of the assignee. assignment has no charge.

you can change the expected growth from 5% to something else and see how the net amount changes...pretty dramatic, i think i plugged in -10% (from that TD projection) and i think there's a net loss of about $100,000...haha.

there's a second sheet in the excel file. plays out scenario in which the property is kept through occupancy closing. this includes the extra 5% downpayment, and i changed the legal fees to $15000 to account for additional legal fees, realtor fees, and land transfer tax. but occupancy closing is where the spreadsheet stops. the next step would be to determine cap rate and such, which would account for condo fees, and operation of the property as a rental irrespective of capital appreciation.


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## Potato (Apr 3, 2009)

For real estate investing in general the math isn't that hard: it's just like the buy vs. rent math I've gone through (from a few different angles) before, except instead of looking to see if it's break-even you want to be more conservative so it's actually an investment: you also have to assume that there will be some vacancy, and make the maintenance budget more generous since it'll be your mystery tenants and not your conscientious self living there.

Nothing I've seen in Toronto suggests that there's any money to be made in RE investing (certainly not easy money), but if you want to satisfy yourself by looking around and running the numbers by all means, go ahead. Even if you fudge some numbers and end up buying something to rent out, losing a a little bit a month isn't likely to kill you.

But pre-construction is playing with a whole different kind of fire. The problem with pre-construction is that it works _great _until it doesn't.

You have all the regular risks of investing in real estate (that the market in general goes down, interest rates go up) plus some unique factors to buying sight-unseen that exacerbate everything. In particular, you run the risk of the project not matching expectations (in terms of square footage, finishes, quality of build) or the project being delayed (pretty much guaranteed). 

But the big grand-daddy risk is the pairing of liquidity and financing risk: real estate isn't very liquid to begin with, but pre-construction? Forget about it. Sure, in a good market you can sell an assignment. But a good market isn't when you're worried about liquidity. So what happens if the market does correct? Not even necessarily a big crash, but enough that you can't sell your assignment before closing, and that, upon closing, the value isn't enough to get a mortgage with what you've put in. You need to cough up more cash as a down-payment before you can get financing and close, or walk away from your down-payment and spend the next few months in court. With a ready-built investment property you put your 20% down, and even if there's a 10% correction you won't get a "margin call" and have to suddenly find more cash (in theory I suppose that's possible, and it may be required for refinancing/changing lenders, but for just renewing a mortgage it shouldn't happen). But with pre-con you don't get your financing (so your downpayment/appraisal isn't counted) until the building is finished years down the road.

In return for taking on these risks vs. just buying something that's already built and can be inspected on the spot, pre-construction is traditionally sold at a discount to existing inventory. If all goes well, you make a fair bit of money for helping the developer finance their project. If some of the ordinary risks crop up (the final unit not meeting the expectations of the sales model) you're still at around break-even thanks to buying at a discount to begin with. If the market as a whole goes up, your gains are amplified by both the up-front pre-construction discount and the general market move, so with a very small amount of money deposited, you can make a very good return. 

So buying a pre-construction place is kind of like buying a call option: you get lots of leverage to the upside with little required up-front. Where it's not like a call option is that you can't just let it expire worthless if the market (or particular project) goes against you. If a year in you find the market tanking, you don't have the option of panic selling, you're riding the rollercoaster all the way down for the full term (3 years in your example).

These pre-con call options have been making speculators a lot of money in Toronto for several years running, and now "it is known" that the place to make money hand-over-fist is pre-construction, just like all those people before did. Except the key ingredients to making money with pre-con are a rising market, and a discount to ready-built inventory. So before you lock yourself in to a pre-con agreement, you need to seriously consider whether there is a good expectation for the market to continue to go up between now and when the unit will be ready, and also whether there is a discount to current inventory, and how much that is. If you prefer videos, here's a video by David Fleming explaining that in 2011 there is no pre-con discount, and that's a bad thing.


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## kcowan (Jul 1, 2010)

Precon flipping is a great idea until it no longer works. Developers stuck with unsold inventory will discount units to unload them. They will cut corners to stay afloat. All this works against the speculator.


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## joncnca (Jul 12, 2009)

hmm. those are interesting points, and that a neat video.

i'm wary of the downtown pre-construction market right now inherently. you hear a lot of different people with different opinions. i know that when i got out of there, it was a lot of hard work because there were so many people selling in the building, another bad sign. in fact, there was someone DIRECTLY beneath me selling, with exactly the same layout....which was pretty irritating. glad i got outta there, but there's still some allure because it's the toronto lakefront.

let's say there was a good resale rental property uptown...actually, i'm not even sure what 'good' would entail, because i don't see how anyone can make money off rentals without having paid off over 75% of the market price....sigh..

anyway, i think the desire to look into lakefront properties is because of the proximity to downtown districts, and the limited amount of space down there. the big 'what if' is if there isn't much space left and prices get driven up even higher (even if irrationally)

how would this change if one were to compare pre-construction downtown to resale uptown, where prices could be lower for comparable unit?


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## Berubeland (Sep 6, 2009)

Great Video Potato. 

Let me tell you a story I read on the REIN forum about a year ago. 

"I'm an investor and I bought a preconstruction condo but the unit is now worth 80K less, I've got a real estate lawyer and I'm trying to break the contract." 

Answers ranged from those contracts are airtight and it's unethical to break it because it you had profited from it the developer would not be allowed to break the contract and sell it for more to someone else. 

Turned out the lawyer couldn't break it and he had to pony up the 80K to close the apartment because of financing. Furthermore if I remember correctly he had other assets and the developer could have sued him for not fulfilling his obligation because he had other assets and gotten paid for the 80K difference between what he bought it for and what it would sell for plus legal fees of course.

This is not in the US it was in Calgary a few years ago. 

On my last trip downtown last week from Bathurst & Lakeshore I counted 11 sky cranes new buildings going up and the rental market is soft, soft, soft. Plus up to 70% of new buildings are being snapped up by speculators who are planning to rent them out. 

When a building does close 10-12 or more units similar to yours are on the market for rent. It's a race to the bottom with the rents. Whoever blinks first loses for everyone. After carrying the place for a year before you can rent it to someone, owners are not patient, they're desperate. 

With a preconstruction condo there are a few risks I would consider too much for me to take on. 

1 - Time risk : Once the developer has your money, they have to sell most of the units before they can get financing. How long this will take nobody knows. I had a couple who bought a preconstruction condo come to rent a condo I was renting at Keele & 401, they had been waiting for 5 years for them to break ground. Their new site was a stone's throw to the condo I was renting and they wanted to keep an eye on the site... another investor I know bought in one of the Sherway Towers, #3 I think, well tower 4 and 5 are well underway and three still is not built. That's about 3 years or so

2 - Interest rate risk : Who knows where mortgage rates will be in 3-4 years 

3 - Life changes risk : In 3-4 years almost anything can happen to you, lose your job, your marriage and so on. Meanwhile some developer has your money firmly in his pocket. 

4 - Rental market risk - If your plan is to rent it out, who knows what the prices will be in a few more years. The prices may go down on condos, the market is pretty soft and it takes a month or more to rent. A few years ago it took a week tops. 

5 - Resale market risk - who knows what will happen and with plenty of downwards trending markets in the States to look at... well....

Now if these risks were being priced into the price well, it would make sense but it as the blog says they aren't well it really isn't a good deal. If capital appreciation is the play, the same play can be made in a resale building, without the other risks involved in buying preconstruction. 

By the way I have no problem with speculators as long as that's what they call themselves and as long as they have the coin to stand the gaff. One of my favorite clients is speculating and knows it and has the money too. What I have a problem with is the sharks that go around calling these investments and selling them to people who are desperate to make a fast buck with their grocery money. That is too often the case.


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## joncnca (Jul 12, 2009)

Berubeland said:


> Great Video Potato.
> 
> Let me tell you a story I read on the REIN forum about a year ago.
> 
> ...


always appreciate your thought-out responses =)


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## the-royal-mail (Dec 11, 2009)

jonca, it wasn't necessary to quote that entire page of text only to add one line of new content. Can you or the mods please edit that quote out of there?


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## Berubeland (Sep 6, 2009)

TRM has anyone ever mentioned that you may have a control issue 

Plus I wrote it so it's so fantastic that it deserves to be duplicated.


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## donald (Apr 18, 2011)

Berubeland-You know your stuff.On a side note,i love your writing style,its like a mix of knowledge and comedy,not to sure of the rules around here but your blog entries are entertaining on your blog...i always laugh,should be a reality show on hgtv or something...life of a landlord...id watch a show like that anyday,If i was a exec over there....there is a idea!hey if realtors have shows like big city broker,why not one with landloarding?Seriously.You could make a killing.


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## joncnca (Jul 12, 2009)

the-royal-mail said:


> jonca, it wasn't necessary to quote that entire page of text only to add one line of new content. Can you or the mods please edit that quote out of there?


tada! =)


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## Berubeland (Sep 6, 2009)

thanks Donald

I have often thought that a building would be a perfect setting for a sitcom. Like I used to have this 97 year old lady bring me food everyday. See her daughter would come and bring her food because she wasn't eating well but she would bring too much. She was always trying to pawn off these weird containers of strange food. Now in my culture it's extremely rude to turn down food (French Canadian) I would dutifully take these containers and then wait for her to leave. Then I would dump them out. The containers had to be returned of course. So she would come back down to get her containers. We maintained this elaborate charade for a year, had I said no in the beginning it would have been fine but I did not and I didn't want to admit what had been going on. 

I am also known as a very straight shooter and the other office staff took great pleasure in my elaborate thank you's and descriptions of the wonderful recipes. 

So the old lady and I got pretty close and she used to inform me of all her numerous ailments every day, her hips, the problems walking and so on. One day she comes down to the office, pulls down her pants and shows me her bedsore. OMG I was like uhmm no way ! pull up your pants, don't show me your butt! Our office was also on security camera so the staff over in the next room could see the lady pulling down her pants and showing me her sore. 

Then one day when the owner was in, we had two strippers come in. The owner took one look at them and said to both of us rental agents no way you're renting to them, this is a family building! So we sent our accountant to do the apartment showing. He was quite grateful. 

So yeah there are many funny funny moments.


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## joncnca (Jul 12, 2009)

haha


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