Saturday, January 8, 2011

Overlooked Calgary Real Estate

I have not written a lot about real estate lately. Frankly, this is not because I have given up on it. To the contrary, after waiting out the Calgary market for months on end, I finally made two purchases late in the year, both in Calgary. While buying properties is often exciting (my wife says: when Godfried gets bored he buys a new property), reality is that rental investments are boring and hence, I tend to write less about them. Once rented and properly managed, you just hold up your hand once a month and then go back to sleep.
I don't like buying around the new construction site of the new West LRT line. I think too many current real estate owners seem to think that any profits of the LRT construction is theirs, not that of future owners. So the asking price of these properties is simply too high for an investor such as myself. If you invest in Calgary, consider NW Calgary along that LRT line. Especially near the university and other low priced rental apartment and condo complexes in that quarter. For the more adventuresome, consider NE Calgary. Prices of townhouses in that part are much lower compared to the rest of the city. Yet an enormous expansion of infrastructure and industrial development has taken place in that part of the city and seems to have gone unnoticed by many investors. The rental clientele of that quarter of the City may be a bit rougher; but the area will experience even more growth in the years to come. Major Nenshi is already pushing for a major tunnel below the run way expansion of the airport to accommodate this anticipated growth.
Although value appreciation of real estate is often higher near key infrastructure expansion points (e.g. within 800 meter radius of a new LRT station or traffic artery exit), one should not under estimate the profitability of real estate at more modest rates of appreciation. Flat rates or modest appreciation rates of 3% can still be quite rewarding, as often pointed out by REIN's Don Campbell. This does not count the positive cash flow from rental operations which in relative terms also may be boosted by leverage. Ah, I said it! Leverage, well it is the steroid that boosts your real estate return on equity.
Cash flow finances your operational and debt service costs. If positive it even adds to your profits. But rather than cash flow, it is profits that you want at the end of the day. The rate of profit growth (ROI) determines the rate at which your net worth increases. Profit itself represents your increased net worth. If cash flow is analogous to your blood circulation detected by measuring your heart rate, your height and weight increase measures your physical net worth while an adolescent. When older, you may not wish to grow in weight any longerJ; neither will you grow any taller. But then the emphasis is about the improving quality of your life and your personal mental growth and your contribution to society overall (something much more difficult to measure). Sorry, I digress.
Real Estate ROI? Eh, yes... So what would be the source of ROI, if only little comes from cash flow and asset valuation growth? Well, I only said that you do not need a lot of appreciation to get a decent rate of return! There are 2 profit centers that depend on the steroids of our real estate growth – i.e. leverage. Both relate to equity growth (not necessarily on a lot of property appreciation):
  1. Rental Income
  2. Modest appreciation
Rental income does not only go to pay for operational expenses, it also goes to pay for financing expenses. This is what many forget! Your debt service payments (except when using a line-of-credit), comprise interest expense and ... repayment of your mortgage principal. That repayment of principal goes towards your net worth, i.e. your equity in the investment.
Here's a typical monthly statement:
Monthly mortgage Payment:                            $    772.36
  1. Principal balance at start of month:           $ 63,795.04
  2. Interest payment:                                   $     330.68
  3. Principal repayment $772.36 – 330.68:       $     441.68
  4. Principal balance at end of month:             $ 63,353.36
Yep, part of your monthly mortgage payment pays off your debt and thus increases your equity in the property; and thus goes to your net worth. In the above example it is $441.68 and with future payments your debt principal continues to fall, your interest payment decreases and your monthly net worth growths accordingly.
Modest appreciation is the second source of ROI which is also leverage dependant. Your property may appreciate 'only' 3% but your ROI growths a lot faster!
  1. Property value at start of year:         $100,000
  2. Appreciation 3%:                            $    3,000
  3. Loan to Value 75%: your equity:       $  25,000
Your ROI is $3,000/$25,000 = 3/25 = 12% plus... your annual principal reduction. According to Don Campbell's calculation your total annual ROI on a 75% LTV for a property that appreciates at 3% is 14.6%, not counting your positive cash flow (rent minus operating and financing costs).
Today's Calgary real estate market, especially older (1980s) apartment units in well managed condo complexes in the NW or town houses in the NE are right now priced and receive rents that are fairly attractive. Cap rates on single units are 4 to 5% (Net Operating Income/Property Value). With the improving economy, rents and appreciation are set to rise in the coming years and this winter may be the last opportunity to buy properties for a very good price in a long time to come.
The same is true for Edmonton and Red Deer. I am writing specifically about Calgary because that is the area where it is most practical for me to operate rental properties and which I know best – I specialize in northwest Calgary around the LRT line; hence my examples.

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