Real Estate Investing For Fun and Profit (Part I)
First, I want to start off by saying I am in no way an expert on real estate investing. This is a case study of my recent experience in purchasing an investment property, that’s generating me at least an 8% annual return.*
Second, the strategy I present here is not the ‘best’ strategy, nor the strategy that will get the highest return on your investment property. It’s simply a strategy that I’ve found that will deliver stable, predictable rental income while working a couple hours every weekend. The point is to not spend all of your free time doing major renovations and managing difficult tenants, but letting the investment property add to your quality of life.
Third, my real estate investment process revolves around the core concept of margin of safety. Margin of safety is defined as buying assets at a discount (below intrinsic value). Warren Buffett, the most successful investor of the 20th century, buys stocks with a margin of safety, so that even in disastrous scenarios, he can do well.
Late last year, I decided to set up base in the city of Ottawa (Ottawa gets a lot of misunderstood hate mostly from Torontonians, but it’s honestly a beautiful city). The reason for setting up base in Ottawa is because the real estate prices are not as inflated as they are in other major cities. The downside is the real estate price appreciation will be lower than Toronto, Vancouver, Calgary, etc. A few reasons for the slower growth in Ottawa real estate may be attributed several factors, including, lower levels of immigration, lack of growing industries in tech, finance, science, and engineering, and possibly, the frigid winter weather!
Searching For a House
I started looking for a house with the help of several real estate agents in early December of 2014. My goal was to find a house that I could rent to university students. My first assignment was learning the real estate market in Ottawa. This included studying different neighbourhoods and their communities. Driving around in areas of the city certainly helped me get a sense of the atmosphere and culture of a particular neighbourhood.
I had a few criteria for selecting a neighbourhood.
1. The house must be in an up and coming neighbourhood (i.e., a neighbourhood going through gentrification). Gentrification is the process of urban renewal of lower class neighbourhoods. Real estate investors generally see it as a positive change because new developments (apartments, condos, restaurants, etc.) attract young professionals as tenants, driving up rents and also displacing lower income residents.
2. The house must be located to close proximity to schools (universities preferably), shopping centers, commercial development sites, and expanding services from the City.
3. Ideally, the house is close to brand name stores such as Whole Foods. Dubbed the Whole Foods Effect, there were studies performed to show that whenever Whole Foods came into a neighbourhood, the surrounding property prices increased because Whole Foods brings in many of the same types of retailers into the neighbourhood.
4. I also took into account the ease of transportation and the time to travel from house to respective universities as I was looking for a home to rent to students.
Type of neighbourhoods I avoided:
1. Deep into the center of a neighbourhood with high poverty and crime rates, and the residents are of lower socioeconomic statuses. This is often called a “distressed” neighbourhood. The edge of a distressed neighbourhood is acceptable. However, properties in the center of a distressed neighbourhood run the risk of low and even negative price appreciation. In addition, managing investment properties in distressed neighbourhoods will require more attention due to the type of residents (e.g. , upkeep, damages, and tenant affairs). Remember, I was looking for an investment that requires only a few hours of attention on the weekend at most.
2. Conversely, I also avoided neighbourhoods that were most sought out by families and young professionals. The homes and condos in these areas are much more expensive.
After working with several real estate agents over December, I saw a total of 7 houses. Let me say that the right real estate agent will make a huge difference in finding your investment property. Since I didn’t have any experience working with realtors before, I wasn’t sure which one fully understood my investment criteria. In the end, I went with my gut feeling and ended up working with a realtor that had impressed me on our first meeting (if anyone is looking to invest in the Ottawa area, I’d be glad make a referral). This realtor impressed me with his knowledge of up and coming neighbourhoods in Ottawa, where the important commercial development sites are, and where the City is expanding services. He understood the subtle factors that caused property values to appreciate, and I think that’s where he won against the other realtors.
I also had a few criteria for selecting a house:
1. The house itself must be structurally solid. By this I mean the foundation is strong and sealed, the floors of the house were as flat as possible, and the joists are not compromised. By the way, I’m not an engineer or a house inspector so I cannot say with certainty that I know how to detect these issues. My humble methods were: checking if the basement walls show moisture or leaks, putting a ball on the floor and seeing if it rolls quickly in any direction, and eyeing any visible joists. And obviously, I hired a house inspector after I narrowed my choices down to my favourite property. However, remember that sometimes even house inspectors miss things.
2. Additional points were given for: newer energy efficient windows, new or recently installed roof, natural gas heating and cooling system, and new or recently installed flooring and carpeting. In case you were wondering why I placed importance on these items, it’s so I wouldn’t have to spend large sums of money after I buy the house. Last thing I’d want is to incur additional expenses and stress over replacing a roof right after I buy the house.
3. I did not place much emphasis on cosmetic work to be done in the interior of the house as these are things that are easily done.
After looking at several houses, I finally settled on a detached, 5-bedroom house located at the edge of a distressed neighbourhood. This neighbourhood is called Overbrook. The negotiations were done by my realtor and both parties settled on the final price of $387,000. The original list price of the house was $399,900.
There were several main factors in why I chose this house:
1. A new Rideau River crossing bridge was being built to connect the neighbourhood to University of Ottawa. The current method of transportation from this house to U of Ottawa is a 20 minute bus ride. After the completion of this bridge, I estimated that a student can walk to the U of Ottawa in 20 minutes or bike there in 10 minutes. In effect, the construction of this bridge opens up more rental opportunities east of U of O. This potential influx of renters may increase the price of real estate in the area.
2. The construction of a small apartment building right down the same street signaled to me that some (smarter) investors also took interest in this area. In addition, there were 3–4 custom residential home constructions on adjacent streets. These custom homes bring a fresh look to a neighbourhood and demands premium selling prices. My realtor showed me the sales history of these custom homes and they sold for approximately $650,000. The average selling price of a single detached house in Overbrook was $400,000. Note that I’m unaware of any studies that demonstrate if custom built homes will increase the value of surrounding houses.
3. The Ottawa Confederation Line subway, currently under construction, connects the whole city from West to East and North to South. One of the train stations is being built near the St-Laurent Mall, a shopping center 10 minutes away from the house. Due to this massive commercial development, Ottawa property prices as a whole will appreciate. In addition, being close to a station is an added benefit for my house value.
4. The rental rate of a room in my neighbourhood ranges from $400 — $550. I estimated that I can rent out each room in my house for approximately $450-$500 per room, bringing my potential monthly revenue to $2250-$2500. The market rental rate was determined using Kijiji, Craigslist, and Padmapper for similar rooms in the Overbrook area. Also, my realtor assisted by contacting a property management company regarding rental rates in the area.
5. The house itself was in excellent shape, totally suited for a student rental. The basement is fully finished and there no were signs of moisture and leakage. There is new hardwood flooring properly installed in the living room, coupled with new carpeting in all rooms on the second floor. The house is fitted with natural gas heating and cooling. The roofing was re-done in the last 4 years, and there were new energy efficient windows installed in the last 3 years. The minor downsides to the house were the old appliances (still worked, but will need to be replaced next year), and the old fashioned kitchen cabinets. However, the attractiveness of the appliances and kitchen cabinets was not going to raise my rental rates substantially (if at all), so I didn’t really care.
6. Sadly, no Whole Foods or trendy restaurants exist in the area ☹. However, grocery stores and a shopping mall were nearby.
Fast forward to after I took possession of the house. I aggressively marketed the property as a student rental on various online marketplaces. Kijiji, Craigslist, Padmapper, and free local online websites were the main channels I used for a detailed posting. However, Facebook groups (Off-Campus Housing groups) proved to be a great funnel to the postings on Kijiji and Craigslist. And the beauty of posting on Facebook groups is that your ad will not disappear into oblivion after a few hours. I never spent money for online postings as I’m not doing enough volume for paid marketing to be worth it.
In the end, I found a great group of 5 students to rent out the house for $2400/month ($480/room) for a year lease. The work that I have to do now is spend a couple hours each weekend doing landscaping, grass cutting in the summer or snow shoveling in the winter, and taking out the trash (I could go a step further and delegate all of these chores and only manage client issues, but that’s another topic). In the meantime, I’m collecting rent money and waiting for the price to appreciate with time. Bringing it full circle, back to the concept of margin of safety, this investment property will do great even if property prices do not increase at all. I am still earning 8%* annual return on the rental income, and if property prices increase, I’ll be more delighted!
Part II will go deeper into the financials and determine the rate of return on investment with actual numbers!
*8% annual return is roughly calculated using back of the napkin math.
To read Part II, click here.