Ten years ago, I took a stab at real estate investing and jumped into my second rental property, an ugly fixer upper, while juggling a full time engineering career and LIFE.
The property started out as a winning rental property, but then grew into a nagging toothache, exploded into a cavity and finally ended as a bloody root canal.
I wrote this war story not to scare you away from real estate investing but to share the REALITY, the ups and downs so that you are armed with knowledge.
I’ll be sharing:
1) My 10 Year Journey so that you can get insight on realities of real estate investing.
2) Math it up and show you how you can calculate your own investment returns;
3) Highlight my top 12 lessons learned on a painful investment like this one so you are armed with knowledge and can make better investment choices.
If I BOOST your investing journey in some way with EYES WIDE OPEN or at the very least steer you in the right direction, then I’ve done my job by sharing this article.
So let’s dive in on how it all started.
Why I Bought This Property Because of all the Gurus
This house was located in a fancy pants neighbourhood, in one of the most expensive neighbourhoods of Ottawa and it CASHFLOWED.
Remember the global financial crisis in 2007?? A year before the Lehman brothers were broadcasted all over the news for bankruptcy protection, I purchased this property and I truly thought I scored BIG!!
And have you heard of the rule of thumb that gurus preach over and over again, where:
IF 10% of the purchase price is equal to annual rent, then it’s a good deal??
This property was close to that golden 10% rule.
Low and behold -> Annual Rent/Purchase Price -> (34560/390000)*100% is equal to 8.8%
And with a bit of sweat equity, the rents could easily be raised to market value to get closer to the 10% golden rule.
Best part, I got a 40 year mortgage and a low interest rate.
And if you looked at the other factors of this property, it would APPEAR to be AWESOME rental property.
Let’s look at all the WINS this property had, on paper:
Excellent neighbourhood
Growing neighbourhood
Excellent transit
Superb bike paths, trails, parks
Walkscore of 87/100, Bikescore of 100/100,
Located in an area with higher than average appreciation
Good potential for redevelopment
So what’s not to like about this property?? It was basically begging to be invested!!
But before you get too excited (or jump to a conclusion), let’s go through a quick summary of my journey and decide for yourself.
The 10 Year Journey that slowly Evolved into a Massive Nightmare
First 2 years…
I remember walking into my lawyers office, smiling from ear to ear and so excited to pick up my keys.
I remember seeing a bottle of wine, a gift from my lawyer and I was yearning to break it open and celebrate.
But then my lawyer breaks this to me:
‘there’s a problem with title, …the house is not a legal triplex but a duplex with a secondary dwelling. I’ll talk to the sellers and see what we can do. Rest assured your protected with title insurance.’
WTXX?? My heart drops. I thought to myself, how did this happen? All the conditions have been waived, how did this get missed?
Turns out the City was late in confirming title prior to closing and I was rest assured by my lawyer to waive conditions because I had title insurance, which would protect me from potential problems like this.
Since I was so new to this, I had no idea what this really meant legally… this would haunt me years later…
Then a colossal of issues start popping up.
Quick highlights from the first 2 years:
Tenants providing notice within days of closing and leaving the unit a massive mess. Imagine garbage bags piling up all over the unit.
A tenant locks herself out and decides to kick the door down because she ‘forgot’ her key!
A family of mice decide to move in over the winter and a family of squirrels over the summer because the rental house is so warm and lovely.
Year 3
In between tenant changeovers, I upgraded the rental units including flooring, appliances and hardware to boost rent and collect more cash flow. I thought I was learning the ropes and gaining progress.
It was becoming easy to manage, it almost became a process of collecting and depositing cheques.
That feeling of ‘easy’ ended fast.
Here’s a few highlights:
A Tenant having terrible fights with an ex-boyfriend which resulted in a break and entry in her unit and a restraining order against her boyfriend. Police officers visited this rental property 2 to 3 times.
A massive flood which started with a burst pipe in -40 Celsius weather in the top unit which flooded the entire house. I had to relocate all three units and the best part…90k in damages. This property was becoming a bloody nightmare. Thankfully no one was hurt when all of these events happened.
Years 4 to 9
Because of all the MASSIVE hassles and maintenance from this property, I hired a property manager, and fired a couple. I was too busy with my twins and personal health issues to really pay a lot of attention to this property.
Relative to the drama that happened over the last three years, the next five were easy peasy BUT expensive.
Here are a few highlights:
I hired three sets of property managers, first two didn’t work out as a good fit so I had to let them go
Experienced three months of total vacancy from the floods but thankfully I had rental loss insurance coverage. I also blinged up the property again.
Massive expenses included replacing a roof, air conditioner, and removing pesky rodents, occasional squirrels and other living creatures that love to hibernate in the attic of the house.
A builder puts in an offer to buy my rental home for $700K plus two of my neighbors but my neighbours were too greedy (wanted a $1M!) so the offer fell through. What’s funny is that the property value plateaued for years and I didn’t even come close to selling it for 700k in 2017!
Year 10
Pretty quiet and boring early in the year. I love boring investments…. but this property is far from boring…
Here are a few highlights;
A tenant argues and fights with another tenant in the house and the police get involved. Thankfully no charges are laid.
A tenant leaves town and stops paying rent, leaving behind all of his belongings in the apartment.
The eviction process takes four months despite the tenant already not living in the property. There was no way of getting ahold of the tenant but all of his belongings were still in the apartment.
Property manager decides to quit the residential property management business so we inherit managing the property again.
Internal battles start happening again between tenants. One of the tenant’s son decides to destroy other people’s furniture in the backyard for fun.
A tenant cracks the shower panel, how do you even do that?
You probably wondered with all this drama and excitement from the last ten years, the return must have really been good to make this all worth it right?
So let’s math it up!
Crunching out the Numbers – Was the Payout Worth it?
Return on my investment: “return” is not just your positive cash flow but also the equity that you received from your tenants paying down the mortgage principal.
But remember that down payment and closing expenses (like lawyers, real estate commissions etc) aren’t part of the ‘return’.
Details:
Purchase price: $390,000
Sale Price: $640,000
Cashflow: $50134
Real Estate Closing Costs is defined as Real Estate Commissions, Lawyer Fees, Land Transfer Tax and Misc. Adjustments
Net Proceeds of Sale (aka equity) is defined as Sale Price – Mortgage – Real Estate Closing Costs = $322,780
Down payment: $70,000.
So the return is calculated as:
Net Proceeds of Sale + Cash flow – down payment/down payment:
Total Return on Investment
(322780+50134-70000)/70000=4.3273 or 433%
Annual Return on Investment
433/10=43.3%
But how about taxes?? To get a full appreciation of your actual return, we need to account for taxes. So let’s assume 40%, assuming the second highest effective tax rate.
And only half of your profits are taxed aka 50% of your capital gains: -> where…
Purchase price: $390,000
Sale Price: $640,000
Depreciation (Capital Cost Allowance) = $20,000 (rounded up)
You have to include depreciation (capital cost allowance) because tax rules say you have to recapture depreciation when you sell the property. I know..it’s confusing.
Here’s my estimates for after tax gains:
50%*(Sale Price – Purchase Price + Capital Cost Allowance)*Effective Tax rate
0.5*($640000-$390000+20000)*40%=$54000
Yikes – $54,000 in taxes – that’s steep!
So my after tax total return is:
((322780+50134-70000-54000)/70000)*100%=355%
After Tax Annual Return on Investment
355%/10 years = 36% ROI Annually
The return looks pretty good, at least it beats the stock market.
But let’s peel the onion one layer deeper to see if it was really, really worth it. Let’s math it up again and figure how much the return was by the hour.
Your time is worth something…
I can’t believe I spent 1134 hours on this house!
ROI by the hour:
Total Management hours approximated: 1134 hrs
After tax return: 322780+50134-70000-54000=$248914
$248914/1134 hrs
= $219.0/hr
What the??…
I was expecting MORE for the blood, sweat, and tears…not to mention the anxiety.
To feel better, I mathed it up again to see what this is equivalent to in the glorious real world jobs.
Annually: $219/hr*40hrs*52 weeks=$456,561,898 After TAXES!!
That’s what you pay a kick ass private plastic surgeon! <–Ok, I feel a bit better.
The Dead Simple Decision to Sell
For a long, long time, I was in a massive denial of how bad this property. Sure, the property was a ‘money generator’, but it had a dark side that couldn’t be quantified by numbers.
I’ve even dreamed of holding onto this house for another ten years to build a brand new fancy pants million dollar plus home with a rental unit or two.
But then I remembered my WHY.
As much as I LOVE nice new things, like a fancy pants house with all the bells and whistles…it would OWN me for the next 25 years.
This meant seriously restricting my choices in life like taking mini sabbaticals with my family, volunteering for a year to help others in need, working for a non-profit organization, as my choices would be driven by financial reasons like having to pay down a MEGA mortgage.
It’s a hard pill to swallow especially when I’m so close to paying out my own mortgage.
Money isn’t everything. A mega fancy pants house is not important. The happiest days of my life never involved material things and I suspect for most of the readers here that you feel the same.
Because our mortgage was coming up, and all the massive drama associated with this property and juggling a young family, consulting full-time, plus LIFE, it was a dead simple decision to sell.Timing was great too because it was a sellers’ market. A conditional offer came in a month after listing it privately.
But I had one more dramatic event before closing. I still had a ‘triplex’ title issue and it almost killed the sale.
For several days, the seller’s agent kept emailing, text messaging and calling my agent about the property not being a LEGAL triplex.
I seriously thought the seller would walk away, leaving a $10,000 deposit behind.
Thankfully I showed proof that I paid property taxes on a triplex – my municipal assessment clearly describes this house as a triplex. So I was super lucky!
The house was sold!
In hindsight, were the crazy experiences and money worth it? Absolutely and here’s why…
Experience & Lessons Learned = Success
As you gain more and more rental properties, there’s going to be a greater chance that you experience super awful days where you want to bury your head in the sand and pray that day goes away. There will always be problems. It’s up to you to decide how you want to deal with them.
You may experience days where financing becomes a pain in the ass because lending rules keep changing, or a tenant emails you every week for something new to be fixed, added or replaced like a LIGHTBULB and it’s driving you absolutely bonkers.
And out of nowhere, it feels like all of your rental properties sucker punch you in the stomach.
BIG expenses come up where a terrible storm topples your trees and blows them effortlessly through your roof, or your tenants are left without heat on the coldest day of the year or you experience a flood and your tenants have to vacate the rental property.
Those days will make you question why you bought these rental properties, you will convince yourself that you don’t need the extra income and you start questioning everything you do …
You feel like giving up.
But if you GAVE UP, you would never be great.
It’s how you deal with these events that separate you from the rest of the pack. Overcoming these challenges build your grit, resilience and thick skin.
Rather than dwelling on the mistakes that were made and all the things that costed you a bundle of money & time, you gain crystal clear clarity what is your WHY. If you find the strength inside because of a very strong WHY, you dust off your pants and get back up.
To succeed in anything, you have to face failure and struggle in order to grow.
Real estate investing is not always easy but you can always improve it if you take some to reflect and take action to make it better and better.
With each step you take to becoming better at what you do whether its defining your real estate investment strategy, your target neighbourhoods, and the properties you’re willing to invest in, the simpler your business will get and more focused you become.
Lessons Learned
Reflecting on the past successes and failures, I wanted to share my lessons learned. I strongly believe that knowledge shared helps others. So here are my top 12 lessons learned to help you on your journey:
A rental property can cash flow doesn’t necessarily mean it’s a good investment.
Buy investment properties with good construction.
If you buy multiplexes, always check that they are legally built such that multi-units are allowed, like a duplex, triplex etc.
If you do consider an investment property with illegal suites, always estimate the costs to make it legal and factor this into your estimates
When looking at a property, always think of what type of tenants you are attracting.
If you buy multiplexes, always buy purposely built multiplexes. I learned this the hard way because the house I invested in was converted into shoddy triplex.
Always buy rental loss insurance incase a large unexpected event happens where you have to vacate your tenants for an extended period of time, ex: flood.
If you have a very old house, consider getting coverage for appliances, plumbing and heating for a monthly fixed fee. I used Direct Energy and it saved my butt as they covered many unexpected middle of the night repairs, broken appliances and plumbing issues. It was well worth the peace of mind.
Look beyond the numbers for a rental property, and ask yourself why you want this property. Will this property bring you one step closer to your why or away from your why.
Always buy rental loss insurance.
Find a good property manager, because it can make or break you.
When purchasing a property, evict the tenants if you can (check your local tenant regulations) as inheriting tenants could mean inheriting their baggage. You never know if the previous landlord had conducted the proper due diligence and left you holding the bag. Inheriting tenants, and their baggage is a big NO if you can avoid it.
Back to you! What would you do in my situation? Let me know with your comments.