Saturday, June 16, 2012

A Viable Investment

By now, regular readers should already have a good idea about what I mean when talking about a viable investment. But let me spell it out in general terms. Then we will discuss what a viable real estate investment should entail. In one of the following posts we’ll do the same for a stock market investment.
A viable investment should throw off sufficient cash flow so that it makes a significant contribution to the overall portfolio and provides funds for future investment, my costs of living (in the lifestyle that I consider desirable) and so that it provides sufficient cash reserves preventing a forced sale during down turns. 
Let me elaborate on ‘forced sales’. Investing is like the rest of life – mostly it proceeds uneventful and hopefully along the lines that one desires. That is basically what I call ‘being happy’. Most people don’t realize when they’re happy because they think that ‘being happy’ means to be on a never-ending high. That is impossible, something can be thrilling and euphoric for the first time, possible even up to the 10th time, but after the hundredth time experiencing something you will consider the event normal. That is why we often don’t realize that we already are leading a happy live. Also, you need from time to time a challenge to not only appreciate what you have but also to do something meaningful with your live. Most people are happiest when they are in the process of achieving something worthwhile and you cannot do something worthwhile if it does not pose a challenge. Maybe review your own life and your own current challenges and see whether you are not already happy but just don’t realize it.

Forced sales, are like the flue. You may live an uneventful healthy life. Then suddenly you get the flue. In a matter of hours you can feel like you're dying and some of the less healthy amongst us actually do. The same with investing, you mosey happily along, then you get hit by the financial flue and are forced to sell because you are not financially strong. In no time you're fighting for your investor survival.

Money and wealth do not make you healthy nor does it make you happy. What it does is providing you with a multitude of opportunities to pursue and maintain your happiness. In the end, the goal is to lead a rich, satisfying meaningful and a happy life. Money, education, family and friends are the wealth that provides you the means to lead such a life. I can tell you, luckily not first-hand though, that you cannot take your earthly asset with you into the hereafter! So why pursue more than your need to buy groceries? By now you know the answer: because wealth provides you with a multitude of ways to pursue a rich, fulfilling and happy life.  At REIN they call that your personal Belize!
Oh… so sorry, master; I digressed from the topic: a viable real estate investment. Maybe it takes more than one post to get the story out, but then my regular readers know that my thoughts do wander off from time to time to the more important things in life. Worse, sometimes they just wander. Oh… I digress now twice in one paragraph!

The answer to determine whether you have a viable real estate investment is to become a member of REIN… I mean, the answer lies in the numbers and REIN will teach you that much better than I can in a tiny blog. But since blog readers are always in a hurry, let’s use an APOD for now. APOD stands for Annual Property Operating Data and you may have already seen it on this blog in various forms. Let’s use one of my favorite real estate investments as an example: the two bedroom apartment in a condominium complex in Calgary.

Typical monthly rent is currently $1050 per month, thus the annual gross rental income is 12 x $1050 = $12,600. After subtracting ‘Vacancy and Bad Debt’, which currently are in Calgary as low as 3%, the remainder is called Effective Rent, which in our example amounts to $12,571.20 per year.
Out of this money you have to pay the operating costs. This is where the nickel and diming begins! You have to ask yourself what kind of a landlord you want to be. Personally, my goal is to provide a comfortable home for a reasonable rent to my friends the tenants. The tenants are my friends, because they pay for all my costs in return for my down payment and for me helping to keep their place in good shape. They will not only pay for the operating costs, they also pay off my mortgage and even put some cash in my pocket every month. To top it off, I can keep all the appreciation of the property during the years I own it. Finally, my friends the tenants index their contributions with inflation and if there is a lot of demand for rentals they pay me even a bit extra so that I get similar rents as the other greedy landlords around me charge. They do all that out of the goodness of their tenants hearts and I don’t want to pee them off. Because when my tenant friends get annoyed, they can cause a lot of damage instead of benefits to my $200,000 plus property. How eager are you to let your teenage son drive in your new Lamborghini? Same with my tenant friends, I have to feel really good about them to hand them over the keys to my rental dive!

It is all in the friendly numbers. Below is the APOD’s Effective Rent portion. One more thing to note; you have to be precise in what you actually rent out. You may rent out the apartment to your tenant friends but does that include the parking spot(s)? In today’s cities, people may want to rent your parking spot separately especially when you are near an LRT station. So, a parking spot requires due diligence upon purchase and you may rent it sometimes out in addition to your apartment!
(click on the image to magnify)

I guess this is a good point for a break. See you at the next post.

No comments:

Post a Comment