Case Studies Case Study #1: "Being Creative to Make Everyone Happy!" Case Study #2: "Investment Decisions Not Always Obvious." Case Study #3: "Investment Property Equals Very Affordable Home!" Case Study #4: "Good Investments Often Made, Not Found!" Case Study #5: "Best Not to Panic When Dealing With Problems." Case Study #6: "Real Estate is an Expanding Investment." Case Study #7: "Big Deals Don't Always Require Big Money!" Case Study #8: "Don't Overlook The Ugly Ducklings!" Case Study #9: "Hot Market Mortgage Rates Drop, Prices Rise:" Case Study #10: How the Banks look at Investment Properties Case Study #11: "Rising Executive" Case Study #12: "High-Income Professional" Case Study #13: "Middle-Aged, High-Income Professional" Case Study #14: "Middle-Income, Empty Nesters with Recent Inheritance"
Case Study #1: "Being Creative to Make Everyone Happy!"
The Property: A large (3400 sq.ft.), 4 level, 4-plex containing 2-1 bedroom and 1 - 2bedroom licensed apartments plus 1 unauthorized 2 bedroom basement suite on a 30’ x 88’ corner lot. The building is structurally sound, but required repair work in a number of areas including roof, plumbing and wiring. The Revenue: At closing, the gross rent was $3,005/mo., or $36,060/yr, with upside potential as some of the rents were below market. Taxes and expenses were approx. $7,000/yr, providing a Net Income of $29,000/yr or $2,422/mo. The Sale: The property was listed for $428,000. The sale agreement was for $450,000 with the seller “giving back” a repairs rebate of $25,000 upon closing. This made the actual sale price $425,000. The seller also agreed to “take back” a 2nd mortgage of $30,000 @ 7% for a 2 yr. term with “interest only” payments of $175/mo or $2,100/yr. The Financing: As well as the 2nd mortgage from the seller, the buyer arranged a 1st mtg of $337,500 @ 4.7% for a 1 yr term with payments of $1,905.68/mo or $22,868/yr. This amount was based on 75% of the “contract” sale price before the seller’s $25,000 rebate. The buyer agreed that 75% of this $25,000, or $18,750, be held back and disbursed to the buyer once he had completed the planned repairs on the building. The initial down payment, therefore, was the sale price ($450,000)less the rebate ($25,000) less the 1st mtg ($337,000) less the 2nd mtg ($30,000) plus the “holdback” ($18,750) or $76,250. Closing costs of approx. $7,500 brought the initial investment to $83,750. The Investment Analysis: In this case, the potentially conflicting requirements of the 3 participants (buyer, seller and lender) were met by creative collaboration to get the deal done. The Buyer: acquired a large, high income rental property in a prime area with good financing and a relatively low down payment. The net income of $29,000/yr less the 1st & 2nd mortgage costs ($22,868 + $2,100 = $24,968/yr) provides a positive cash flow of over $5,000 in year 1! The 1st mtg. structure gives him $18,750 to immediately do repairs to get the building into 1st class condition (and allow rent increase). The 2nd mtg. “takeback” allowed him to do all this with a down payment of less than 18%, avoiding high ratio financing premiums while increasing his positive leverage and overall % return! The Lender: required some convincing and got additional safeguards to approve a well secured loan backed by a strong appraisal and good income in a preferred location. By “financing” the repairs for the property (via the $18,750 initially held back), they contributed to an increase in the property’s value and its income potential. This both secured and reduced the risk of their loan. The Seller: was able to sell a property that no longer met his needs at 99% of his asking price while avoiding issues of repairs and maintenance. The 2nd mtg he “took back” allowed him to defer a bit of capital gain tax from the sale, as well as giving him a decent return of 7% (well above GIC or term deposit rates) on his $30,000 investment in the 2nd mtg.
Case Study #2: "Investment Decisions Not Always Obvious." Not all investment decisions are obvious ones, and the requirements and circumstances of an investor can change a seemingly questionable investment into a profitable opportunity. This example shows how a buyer takes into account his total portfolio of properties and finds a “fit” for a new purchase. The Property: A large 3 level triplex (legal duplex with unauthorized basement suite). The building is approx. 2900 sq.ft., with 1-2 bedroom suite and 2-1bedroom apartments on a 50’ x 120’ lot. The condition is excellent and the large yard is well kept. The property generated rent of $32,400/yr. or $2,700/mo. from good tenants. Taxes and expenses are approx. $8,400/yr. or $700/mo. The Sale: The property sold for $615,000 to an investor who used the income and equity for his other holdings to “100% finance” the sale, including $11,000 for property purchase tax and closing costs. A mortgage of $626,000 was arranged at 4.9% on a 1 year term and 25 year amortization, with total monthly payments of $3,605. The Investment Analysis: For most investors, this would be a difficult purchase to justify. After expenses, the property generates a net income of $2,000/mo., which carries financing of only $347,000 - even at the low interest of 4.9% - requiring a down payment of almost $$280,000 or 45% for it to support itself without the investor subsidizing it from his own pocket. For the buyer, however, the property fit his requirements nicely. Firstly, he considered the property a bit of a jewel - great location, large lot, classic character building in excellent condition, good long term tenants, and rental “upside”. Secondly, he calculated the financial picture as follows: With a net income of $2,000/mo. and mtg. payments of $3,605/mo., the property showed a negative cash flow of $1,600/mo. The buyer’s other rentals generate enough income to support this purchase and place him in a 50% tax bracket so that his net negative cash flow after tax is actually $800/mo. or $9,600/yr. He anticipates that this property will appreciate by at least 3.25%/yr. so that after three years the value will have increased by at least $60,000. He also anticipates being able to refinance the property at that time and “take out” at least 70% of the increased value or $60,000 x 70% = $42,000. After he “pays back” the after tax income shortfall of $9,600/yr. x 3 years. or $28,800. he is able to put the rest (42,000-28,800) = $13,200 in his pocket - tax free! In fact, the rents for the property are below market and the buyer has been able to increase total rent by $150/mo before completing the sale. This extra income reduces his after tax negative cash flow to $725/mo or $26,100 for the 3 years, so that by refinancing after year 3 he will receive ($42,000-$26,100) = $15,900!
Case Study #3: "Investment Property Equals Very Affordable Home!" The Property: A small, 3 level triplex (legal duplex with unauthorized extra apt). The building is approx. 2100 sq.ft., with 3 1 bedroom apartments on a 40’ x 66’ lot. The condition is good, as the owners had done renovations during their 4 years of ownership. The property generates rent of $1,750/month, with tenants paying heat and light. Taxes and expenses are roughly $350/mo. The Sale: The property sold for $260,000 to an owner occupier planning to live in the smallest unit, and collect rent of $1,250 from the other 2 apartments. Down payment was $65,000 (25%) and a 1st mortgage of $195,000 was arranged a 6.25% on a 5 year term, 25 year amortization. Monthly payments are $1,276 plus $90 net taxes. The selling Realtor observed that “Someone with a paper route could afford to own this house!.” The Investment Analysis: For an investor, the initial “numbers” look like this: Down payment of $68,500, including property purchase tax and closing costs: 1st year net income of $16,800 less $15,320 debt service = $1,480 before tax. Assuming that net income will increase at an average rate of 3% year, the net income after 5 years will be $18,910, or $3,590 after debt service, and the mortgage balance would be $175,800. At a capital appreciation of 3% per year (very conservative), it would be worth $301,500 after 5 years. At that point, the investor could refinance or sell. If the property is kept, the monthly net income of $1,575 could support a new 1st mortgage for the balance of $175,800 to a rate of 11% - providing some interest rate “risk insurance” for the owner. If Interest rates stayed the same (6.25%), the income would permit the investor to “take out” his original investment of $68,500. If the property is sold at $301,500, the net proceeds (after commission and mortgage balance) is $113,370. The internal rate of return to the investor for the 5 years (before tax) is 13.5%.
Case Study #4: "Good Investments Often Made, Not Found!" The Buildings: Two “Duplex Buildings”, with a total of 4 three level (including full basement) townhouse units. Each of the units is totally self contained with its own hydro and gas meters, hot water tank, furnace and laundry hook-up. The units are just over 1600 sq.ft., for a total building area of 6500 sq. ft. The buildings are very plain and about 60 years old, but are in reasonable condition with no pressing maintenance issues. The basements are mostly unfinished and have further development potential. The Land: is a 66’x115’, (Multifamily) zoned, corner lot. The zoning allows for redevelopment of the property to a multifamily building of 8 to 14 units, and up to 10,800 sq.ft. of floor area. The neighboring properties had recently sold (for $135 PSF) and a large condo development has been built. Replacement Cost: Land prices for similar types of property in the area had ranged from about $110 PSF to $135 PSF. Building costs under current City code would be about $100 PSF. Total replacement cost would be about $220 PSF or ($220 x 6,500 sq.ft.) = $1,430,000. The Revenue: 2 of the units were rented at an “undermarket” rate of $1,100/month, while the other 2 units had been brought to “market rents" of $1,400 and $1,500 for a total monthly income of $5,100, or $61,200/yr. The units are fully self contained, there is no common area maintenance and the tenants pay all utility costs. So expenses are quite low - after taxes, gardening, garbage removal and maintenance, yearly expenses are about $12,500/yr. The Sale: The property was listed for $875,000 and sold for $780,000. Offers were received from developers planning to build a new multifamily project, at a higher price than the eventual sale price. These offers were marred by the requirement for lengthy “tie-up” periods, and other conditions unattractive to the seller. The successful buyer is an investor who plans to hold the property. The Financing: The buyer received a mortgage for 75% of the sale price ($585,000), at 6.5% interest with a payment of $3918/month or $47,000/yr. The Setup: Gross Yearly Income: $61,200 Less Expenses & Reserves: (12,500) Cash Flow From Operations (CFO): $48,700 Less Financing Costs (FC): (47,000) Cash Flow After Financing (CFAF): $ 1,700 - Return on Assets (ROA): $48,700/$780,000 = 6.25% - Financing Cost (FC): $47,000/$585,000 = 8.03% - Return on Equity (ROE): $1,700/195,000 = 0.87% The “Upside”: The buyer purchased an “easy care” property in good condition at a price close to “land value”. The property was “under rented” and the units contained “unimproved” space in the basements, allowing the buyer to add value immediately. By renovating the basement areas and adding a bathroom and bedroom at an estimated cost of $10,000/unit, he should be able to increase rents to a total of $1,700/unit. If he finances the improvements at the same rate as his purchase, his “New Setup” looks like this: Gross Yearly Income: $81,600 Less Expenses & Reserves: (12,500) Cash Flow From Operations (CFO): $69,100 Less FC ($625,000 @ 6.5%): (50,240) Cash Flow After Financing (CFAF): $18,860 - Return on Assets (ROA): $69,100/$820,000 = 8.43% - FC: $50,240/($585,000+$30,000) = 8.17% - ROE: $18,860/$205,000 = 9.20%
Case Study #5: "Best Not to Panic When Dealing With Problems." Most property owners know how it feels to discover a sudden problem needing immediate repair in their home or rental property. The following “Case Study” illustrates the importance of taking care when selecting the tradesperson or company to fix the problem. The First Sign: A musty smell filling the dwelling and getting worse each day. The Cause: Standing, stinky water in a portion of the crawlspace. The Fear: Oh no a drain tile problem - call the Bank! The Search: 3 drain tile companies were selected to assess the problem. Company #1 was selected because they were the best known. Company #2 was selected because they had the biggest yellow pages ad. Company #3 was found via personal references from a local plumbing company. The Proposed Solution: Company #1 and Company #2 had a quick look around the outside of the property and recommended the following: Dig through a concrete patio, expose the drain field, scope, roto rooter & flush the drain tile system. The Proposed Cost: Starting at $750 to $850 and climbing as high as $3000 plus, if a portion of the drain field needed replacing. They were ready to begin immediately. Company #3 took some time to inspect the area where the water was in the crawlspace. His Conclusion: The problem wasn’t drain tile, but a broken discharge line from the dishwasher in the kitchen above the crawlspace. The Actual Cost: To remove the water, and disinfect the area: $100. To reinstall a new dishwasher line: $85. Total cost: $185. The Saving: Between $700 and $2700 plus! The Moral: The best thing is not to panic! Get lots of opinions until you are sure the person knows what they are talking about and can do the job for a fair price!
Case Study #6: "Real Estate is an Expanding Investment." One of the most compelling reasons for buying and owning rental investment real estate is the phenomena of expanding value and expanding return on investment. This occurs as a well bought and well maintained property experiences income growth and decreasing debt over the investment period. As rents increase (modestly) year to year, and mortgages are paid down on a regular, escalating basis, the prudent and patient investor can watch while other people (tenants) work to pay off his property - bought (largely) with other peoples' (the bank's) money. The following Case Study illustrates dramatically how this can be done. The Property: A legal 6-plex containing 3 - 1 bedroom apartments and 3 bachelor apartments in a well maintained building, with an area of approximately 3650 sq. ft. (including laundry, storage, mechanical areas etc.) It sits on a 50" x 124" zoned. The roof is newly replaced, the drain tiles have been redone and an underground oil tank has been removed. There is a rear yard garage containing 3 separate single car bays, each with their own doors and electrical power. The Income and Expenses: The current rental income is $4,030/month from the 6 apartments, laundry and garage rental. This income may be immediately increased by renting out 2 of the garage bays (currently used by the owner for storage) for $125/month each. Current expenses (adjusted for the latest Gas, Electric and Water increases) are $10,000/year, plus an additional $2,000/year for maintenance reserves. The Net Operating Income (NOI) is: Rental Income (including garages): $4,280/month At a purchase price of $450,000, the analysis for this property is as follows: Investment Analysis for Legal 6-plex Purchase Price: $450,000 Capitalization Rate: 8.75% Financing: Purchased with a $337,500 (75% loan to value) 1st mortgage @ 7% interest, 5 year term, 25 year amortization and payments of $2,364/month or $28,368/year... Down Payment: $112,500 Net Income (yr. 1): $3,280/mo or $39,360/yr The Mortgage Balances and the mortgage pay downs at the end of each of the 1st 5 years: Year 1 Year 2 Year 3 Year 4 Year 5 5 Year Cash Flow Pro-Forma: Including NOI increasing @ 3% each year illustrates the expanding value and expanding return nature of this investment. Note that these return figures do not include, or rely on, capital appreciation of the property. If the property is sold in year 5, using a capital appreciation factor of 3%, the price would be $522,000 for a net gain (after sales costs) of over $50,000. If the property were sold at a Capitalization Rate of 8%, the price would be $554,000: at 7.5% the price would be $590,000. Its only a question of the amount of return "bonus" the future market will dictate. But why would you want to sell as long as the investment promises to expand?
Case Study #7: "Big Deals Don't Always Require Big Money!" There is a common perception that only those with large net worth's and high incomes may buy significant real estate assets. The following case study defies that logic, and illustrates that the most important factors can be the investors’ will to work with what they have, and their patience to look past the surface of a situation to realize value. The Property: A 4 level, 13 suite apartment block on a 75’ x 120”. The apartments are large, with nine 1 bedrooms over 750 sq.ft each, and four 2 bedrooms over 1,100 sq.ft. Four of the apartments have ocean and City views with the 2 large penthouses having fantastic, unobstructed views from their private, large roof decks. The building had been neglected, with obvious deferred maintenance, especially in a vacant, 2 bedroom suite, and in the owner’s 1,300 sq. ft. penthouse unit. The Revenue: At the time of listing, the “pro-forma” revenue was stated as $158,500/year, which included the vacant suite factored in at $1,100/month and the owner’s penthouse suite at $2,000/month. The yearly expenses were shown at about 33% of gross income, or just over $52,000/year, for a net income of just over $106,000/year. This provided a Capitalization Rate of 6.4% on list price, considered better than the average market. The Buyers: A mother and son, both school teachers, were immediately interested in the property. Both persons lived modest lifestyles and had a total, combined yearly income of approximately $90,000. They own, jointly, 2 houses - one as a family home, and one as a rental. The houses are vintage, and sit on 25’ x 120’ lots. One of the houses is clear title, the other is encumbered by a mortgage. The Sale: The property was listed at $1,650,000, and it was assessed at $1,733,000. Because of the location and income, there were many showings to qualified buyers. Two factors, however, caused these persons not to purchase the property. First was the shabby appearance of the building and the 2 apartments mentioned above, which caused the fear that a large budget would be required to “fix” the building. The second concern was that the seller, as a condition of sale, insisted on remaining as a resident in the building. Because the seller had 2 large dogs, and because of the condition of his suite and building, most buyers considered this requirement as too large of a risk. The successful buyers, however, were patient, and able to look and work past these obstacles. After a very long negotiation, and a number of options explored, a simple contract was achieved at a price of $1,550,000. The agreement included the provision that the seller would remain as a tenant (paying market rent), and move into the vacant suite once the Buyers had renovated it. The Financing: Except for an initial deposit of $5,000, the Buyers were able to 100% finance the purchase! Their mortgage brokerage team structured the financing in 2 stages: A NMHC insured 1st mortgage of approximately 74% of the value, at a rate of 6.65% was secured by the property. The balance of monies required, including down payment, property purchase tax, closing costs, plus a “renovation fund” to begin building repair immediately, was achieved by a conventional refinancing of the 2 Kitsilano houses. Summary: The Buyers were extremely pleased with the purchase. Upon inspection, they discovered that the repair requirements of the building were not as onerous as indicated at 1st glance, with much of the work being cosmetic, or within the scope of their own abilities. They also identified savings of several thousand dollars in the expense schedule of the building, and an updated rent roll delivered to them just before closing indicated that the adjusted yearly rental would be closer to $164,000 - approx. $5,000 more than the original pro-forma! The owner remained in the penthouse suite at $2,000/mo, and they were able to rent the renovated suite for $1,350/mo, or $3,000/year more than planned. The combination of savings and increased rent pushed their net income projections above $120,000, giving a Capitalization Rate in the 1st year of ownership of almost 8% - an exceptional return for this 1st class area!
Case Study #8: "Don't Overlook The Ugly Ducklings!" |