Saturday, May 31, 2014

Creating a System For Screening Tenants

Sometimes it's hard to say no when you have someone who wants to rent your apartment. The bills still need to be paid but you have a vacancy. That means not only less money coming in, but sometimes increased expenses if your tenants normally pay the hydro or gas bills. Often landlords will jump at the first interested tenant who is ready to sign on the dotted line. I've done it, and I have also learned the hard way how much of a mistake this approach can be. That's why you need a simple and straightforward system to help you find your next tenant.

1) Pull a Credit Report.

I always require a completed application that gives me authorization to pull a credit report. I also get a small deposit to make sure that the applicant is serious. If I reject the applicant I return the deposit, but if they change their mind then it's non-refundable. Before I made this policy change I pulled a few credit bureaus only to be told afterwards that the applicant decided against the apartment. One woman even asked me for a copy of her bureau to show to another potential landlord (you are not allowed to provide a credit report to an applicant by the way)!

I always check references, and I consider a previous landlord's opinion more carefully than the current one if there is a difference of opinion. Keep in mind that a current landlord may see you as the solution to an existing tenant headache. Previous landlords on the other hand have nothing to lose by telling you the truth. I don't care if I have to call a landlord a thousand miles away. A few long distance phone calls are worth it compared to the financial and physical damage the wrong tenant can do to your rental property. Finally, in spite of how tempting it can be I always stick to the system. If an applicant doesn't meet my minimum credit requirements they don't get the apartment without a co-signer (or some other method to cut down on my risk). If I find out they lied about anything on the application they don't get the apartment - period.

Credit reports and tenant applications are beautiful things. There are a few companies where you can sign up and pull credit bureaus. If you check out you will find one of them. A lot of people don't realize just how much information is on their credit report. If someone thinks they can fill out an application and just leave out addresses with unpaid rents guess what? There's a good chance it's on their credit report. Even if the landlord didn't pursue the debt and there is no record of unpaid rent, if the applicant was there for any significant period of time chances are that the address is listed on their credit report as a previous address. If that address is not on the application I want to know why they didn't tell me about it.

It's not that hard anymore to check out a long distance address with free sites like If a previous landlord is listed as a reference at a particular address, you can do a search to see if there is anything fishy about the reference. If I find an address on the credit report that is not listed on the application I might do a reverse lookup by address to get a name and phone number. If I want to see what the building looks like or want to know what type of building it is I can check out Google Maps. Once I found that the street address didn't even exist for the city listed on the application. Doing reference checks is extremely important, so you want to make sure you are not just talking to somebody posing as a past landlord.

That said, once you look over the credit report and do your reference checks keep in mind that people do make mistakes. Often it is a judgement call on how much risk you are willing to take. If you have a less than desirable apartment you might have to be a little less picky. For me, I would rather have a great place in a great neighborhood so that I can attract - you guessed it - great tenants. If you create a desirable unit and take great care of your tenants and the building you will find it much easier to avoid a potential vacancy. You can spend less time second guessing that questionable application and simply move on to the next applicant.

Am I little bit paranoid? Maybe. I have heard all the stories from people who are terrified of becoming landlords. If I am a bit paranoid, in my opinion people who are afraid to get into the game are right off the charts. Rental property is an investment, but it's not really a passive one. Like any job you need to know what you are doing. You won't have all the answers on your first day and likely you won't have them all on your last. I've learned a few hard lessons along the way and no doubt will learn a few more, but I do know that if you are willing to pick yourself up and press on the rewards are worth it.

Friday, January 31, 2014

How My Father-In-Law Saved on Property Taxes

One of the inescapable expenses that come along with property ownership is property tax. Short of selling your investment, you can’t call the city and cancel your property bill or simply switch to a different service provider. What you can do is take a good look at your property taxes and the assessed value of your property.  The example I am about to share shows an approach you can take with a recently purchased property in Ontario whether it be an income property or your own home. This article does not guarantee that you will save on your property taxes, but it does provide a method or two where you may get a reduction in these expenses.  If you are outside of Ontario, call city hall and ask them how property taxes are assessed and how you would go about reviewing your assessment. This example may not give you a cookie cutter approach, but if it causes you to do more than automatically throw your property assessment into a file (or garbage can) unchallenged I will consider my job done.

My father-in-law recently purchased a home. It was listed by a real estate agent on the MLS system and it sat on the market for a while before we stumbled upon it. It was a good, basic war time house but a lot of potential buyers turned up their noses and left without making a single offer. Why? Frankly the house was butt ugly! The walls and ceilings were all painted a baby blue and there were holes here and there in the plaster. The interior doors were not traditional doors. Instead, someone had installed cheap plastic folding doors held closed by a magnet. Even the bathroom was missing that coveted feeling of security. The only thing between you and everyone else while sitting on the toilet was a flimsy piece of plastic and no lock! There was no shower, the electric water heater was on its last legs and the gas furnace was old. There was no air conditioning. The carpet was worn and dirty. Outside the house the only landscaping was a patchy lawn ripe with weeds that made its way right up to the foundation walls. The concrete steps were on a slight angle where you entered the house. In short, my father-in-law purchased an ugly, basic house with zero curb appeal.
Other than that, the house was a gem. If I was buying it as an investment property, I would say that for someone with a little vision it had all the right things wrong with it. The roof was recently done and in pristine condition. The foundation was solid and had been waterproofed within the last 3 years. Floors were level, existing plumbing was in good shape, and the electrical wiring had been updated to 100 amps complete with a breaker panel. All the windows had been replaced within the last 10 years. Anyway, it wasn’t an investment property, but house value is house value, and in the end the perceived value of a property is the standard that city taxes are based on.
In Ontario, Canada a company known as MPAC (Municipal Property Assessment Corporation) is responsible for periodic valuation of homes so that municipalities can determine individual property tax assessments. My father-in-law bought the house for approximately $10,000 below asking price which was about $15,000 below the property’s existing assessed value for tax purposes. Within a few months of the purchase, MPAC sent him a revised assessment saying that the value of his home had increased even more and outlined a higher assessment value that was to be phased in over the next few years. Generally these notices state that if you disagree with the assessed value you can go through an assessment process and file a “Request for Reconsideration” on the value of your home.
If you live in Ontario, Canada then you can and should read up on the suggested methods of submitting your request at the MPAC site here: In this particular case I didn’t worry too much about providing arguments such as comparison values for a reassessment. I simply filled out the form with the argument that the valuation placed on the house as of the date of the assessment greatly exceeded the market value of the house as proven by an arm’s length transaction of the property listed on MLS through a licensed realtor. In plain terms, the house should not be valued at more than what someone can get for it on the open, free market. You do need to fill out quite a bit of information about the house that would impact its value but the main piece of evidence was the paperwork proving the sale price of the home.
Again, I cannot claim to be an expert on property taxes or house evaluations, and I certainly am not guaranteeing that you would get the same results that I have. In our case MPAC reviewed the assessment and came back with a valuation slightly lower than the purchase price of the home. My father-in-law is saving some money on his property taxes and any future increases will take into consideration his reassessed value as a baseline value for any potential future year increases. Even if the story did not turn out the way it did, all he would have been out is the cost of a stamp.
“Never let the fear of striking out keep you from coming up to bat.” (Babe Ruth).

Thursday, July 11, 2013

Rental Properties - Improving Your Bottom Line

The goal of any investor is to make money and there are two ways of achieving this end. One method is to raise your income and the other one is to decrease expenses. A good strategy will be a blend of both approaches, and in the case real estate investing, the right balance is key to making a decent return on your investment while keeping your sanity!

Increasing Income

Like any business, landlords need to be aware of market rents and the kind of income that can be reasonably generated by their rental properties. If you try to charge too much rent your apartments will sit empty generating no income while the regular bills continue to roll in. Charge too little and you may find it difficult to break even let alone make a profit. If you are a landlord, you may have figured out by now that you really bought a business since the time and management required (whether you do it yourself or pay others) definitely disqualifies your property as a passive investment. If you don’t charge enough for your property you may find yourself losing money (paying for expenses out of your regular job) or working a lot of extra hours at your property for free! I don’t know anyone who got into real estate investing with that goal in mind!

There are a few good sources to determine how much your rental property is worth. CMHC regularly produces Rental Market Reports that will give you statistical guidelines based on existing rents and vacancies in your area broken out by apartment type, age, and number of bedrooms. You can download a pdf version in minutes or order a printed copy by dialing a toll free number and specifying the report you are interested in. These reports can be found at under Housing Market Information. Look for Rental Markets Reports – Major Centres. You can also get a good idea from local advertisements related to apartments for rent. Once you have a general idea of the average rents being charged you need to determine how your apartment compares to others on the market. The best way to do this would be to go out and view other apartments but in all honesty I have not taken this approach. Generally I know the condition of my apartments and set the rent a bit higher than the average. When I have showings I always ask if the potential tenant has seen other apartments and how they compare to mine. Usually this is all the feedback I need to determine a decent rental rate to charge.

One of the big challenges a landlord will face in Ontario is rent control. If you have a vacant unit you can set the rent based on market rates; however, once a tenant is in place there are is an annual percentage that you are allowed to legally increase the rent and it can be done only once a year. If you have a great tenant and your rent is not too far out of line with market rents this limitation should not be a big concern. If you have an existing tenant that for whatever reason is paying substantially less than market rent one way or another you are losing money. Often you may find this situation with long term tenants that you may have inherited when you purchased the property. Unfortunately, in these types of situations you are limited to increasing your rent by the legal maximum or finding a way for your tenant to move. If it makes financial sense one suggestion might be to offer a cash incentive for vacating your property.

Now that you have taken the necessary steps to increase the income your property is generating it is time to look at expenses.

Decreasing Expenses

Rent control is a nice concept since no one wants to see hard-working families forced out of their homes. Unfortunately, like so many well intentioned programs some of the consequences can end up hurting the very people they are intended to protect. If expenses increase and revenue is limited, then a common solution landlords may take is to cut other expenses wherever possible. Although it is important to watch your costs, eliminating expenses indiscriminately can often cost a real estate investor more money in the long run. Contrary to what some people may think, smart spending on maintenance and strategic upgrades to the property can be good for both landlords and tenants. A well maintained property leads to higher quality tenants and reduced turnover (which in turn translates into more money). It’s a cycle that is worth repeating for both landlords and tenants.

For example, let’s say you decide that you want to improve your bottom line by running your property in a typical “slumlord” style. That means that you are going to take all the money you can out of the property and put only what you legally have to (some would say only what you are court ordered to) pay in expenses. If we want to be nice about it we could say you are deferring as much maintenance as possible. The short term result is that you are maximizing your cash flow which is/or should be the long-term goal of every landlord. However, over time a poorly maintained property will lead to increased maintenance costs, higher turnover, declining rents, and poorer quality tenants. E.g. Ignoring maintenance items like a roof could lead to more expensive repairs once the problem spreads. Now you need a new roof and interior repairs due to water damage. Your best tenant who has never complained and always paid on time gives you a vacate notice and a bill for that water-damaged television, and the only way you can re-rent you apartment is to lower the rent and the quality of your tenants . Now you have a lower quality building filled with lower quality tenants that will cost you a lot more time and money to manage.

Hopefully you are convinced about the necessity of proper maintenance on your property and how it will help your bottom line as well as keeping your tenants happy. Smart spending does not stop with basic maintenance though. Take a good look at your existing expenses to figure out where you are spending your money each month. Are there areas where you can improve? Often a little bit of money up front can save you more money long term. For example, one of the big areas where I try to save money is in my heating costs. I pay the gas heat for my triplex and the initial cost was a factor that brought down the price of my property when I purchased it (due to the property being less profitable). There was little to no insulation in the building so one of my first priorities was to take on this project. The cost was a couple thousand dollars up front but I cut my heating bill in half! By reducing my heating expenses I increased my cash flow, improved my property value, and made my tenants a little toastier all at once! Some landlords would say just put in meters and make the tenants pay their own gas bill. You can take this approach, but just keep in mind that money spent by your tenants on heat will be factored into the rent they are willing to pay you.

Generally look at improvements you can do where you will make your money back in a short period of time. As much as you don’t want to be a slumlord, if you over improve your property you are cutting into your income at best, and you may find yourself losing money if you are not careful. If you have a rundown apartment where you can double the rent after doing a total gut job and your cash flow will increase once renovations are done, by all means do it! Then again, if you are thinking about spending $27,000 and the best you are going to do is another $100 in rent, you might want to rethink your renovation budget. Also keep in mind the overall value of your property. When I looked at redoing one of my apartments as a gut I figured that it would take me 25 years for the increased rent to pay for the renovation. In addition to that, if I was to sell the property I definitely would not get my money back. The apartment wasn’t in perfect condition but it was still better than many in the area. I spent a couple thousand on materials such as baseboards, drywall and paint to refresh the unit and a new tenant moved in a week after I was done.

The last point I want to make about controlling expenses depends a lot on you, your time, and your handyperson skills. Look at each project and determine when you need to hire out to a contractor and what you can do yourself. Recently I had some quotes to redo a roof that needed replacing. I am not exactly a roofer so I didn’t want to tackle this job myself. Then again, there is a lot of grunt work that needs to be done when you do a roof (tear off, lugging bundles of shingles, clean up, and disposal). I discovered that by purchasing all the materials, doing some of the grunt work myself and hiring a professional roofer looking for extra work I could save substantially on the job. There are insurance issues that you should consider but the main point is that the more work you can do yourself the more you save. The added bonus of purchasing materials yourself is that you know exactly what you installed. This gives you peace of mind (no cheaper substitutes or excessively marked up materials) and you know exactly what you need to buy in the event that you need to do a repair or tie into some existing work down the road. Terry Sprouse, the author of “Fix em Up, Rent em Out” has some great insights when it comes to tackling renovations on your own (

Hopefully you will have a few more ideas on how you can improve the return on your rental property. You will find that you can have a huge impact on your income if you buy your property right, price the rents correctly, and manage your expenses. I love real estate investing for this very reason and I would bet that a little bit of time and effort learning how to be a landlord will pay huge dividends for anyone committed to the task.

Of course, you can’t just read about it…get out there and do it!

Sunday, January 1, 2012

The Great Apartment Turnaround Play

Almost 6 years ago I purchased a triplex and became a first time landlord. The building was in a great area of town and I thought I had stumbled on a fantastic deal. Here were some of the reasons why I bought it:

1) It was cash flow positive after all expenses. I took into account everything and even received a year’s worth of gas and water bills from the previous owner to be sure (hydro was paid by the tenants).
2) The building had all long term tenants. I figured that I wouldn’t need to worry about renting the place every year since the newest tenant had been there 5 years and the most senior tenant had a good 16 years history in the place.
3) Although the apartments looked a bit run down, the building was located in a great part of town.
4) I bought the triplex for less than the appraised value for property tax purposes.

Out of all these reasons, I would still consider most to be great reasons for owning the property. Since the place was cash flow positive I was never out of pocket and over time cash flow only increased on my investment. Since I bought the place for much less than the appraised value, I had no problems financing it, and as a bonus I was able to get my taxes reduced (the property was reappraised based on its current condition and my purchase price). Although the building was a bit run down, it was surrounded by many nicer, owner occupied homes in a great area. There was potential to attract better tenants and increase rents with some work when a place became vacant.

You might have noticed that I skipped over point #2. What I originally thought was a great reason for buying may have been one of the reasons why the previous owner was selling.

Challenges and Mistakes That I Made

What I didn’t factor in as a new real estate investor was that long term tenants can come with their own set of issues. My tenants had a history with previous landlords (undisclosed to me) where it was acceptable to pay the rent sometime during the month instead of promptly on the first. There were no leases or rental agreements, but I did have a statement signed by each of the tenants acknowledging that rent was due the first of each month. Being new and not wanting to rock the boat right away, I told my existing tenants that I would accept rents by the 15th of each month after which time I would have to proceed with the eviction process. The 15th became the new 1st of the month, and I found each and every tenant would push the envelope on my newly imposed deadline date. Another quirk I found with long term tenants is that they tend to become territorial. Since they have been there much longer than the new landlord (and even the previous landlord) they tend to see your property as THEIR property. That doesn’t mean that they will take care of it any better, but if you are trying the change things (no more derelict cars in the driveway for example) each change comes with a bit of a struggle. I am not saying that you can’t remedy these types of issues with existing tenants; all I am saying is that one way or another you are going to have to deal with them.

If I had to do it over again, I would opt for vacant possession if I could get it so that I can set my own rents, pick my own tenants, and write up my own lease agreements. In my case that is not what happened since as a brand new (and somewhat na├»ve) landlord the thought of 3 vacant apartments and a new mortgage concerned me. Because of my inexperience, I ended up running the property pretty much using the same landlord style as the former owner. This approach meant frequently late rent payments after numerous collection calls and in-person visits. One difference between me and the former owner was maintenance as he was milking the property and did minimal upkeep. Although I don’t agree with this approach, I soon had a better understanding of why he operated that way. Rents were well below market, and rent controls limited my ability to increase funds to pay for significant upgrades. If I wanted to maintain a positive cash flow, the key was to maintain what needed to be done and leave what did not. I did splurge a bit by installing new windows and insulation, but this renovation cut my heating bill in half. I also did what I could with some improvements (like a new bathroom), figuring that if I improved the property tenants would appreciate what I had done and make more of an effort to be better tenants (e.g. pay their rent on time). What I failed to understand was that long-term tenants and below market rents were the root of my problem. Improving the property was not going to magically transform my residents into model occupants, and this became evident when improvements I made quickly degenerated to levels almost as bad as they were before I started. As a result, I stopped doing expensive renovations unless they were necessary or I thought they would save time and money over the long run.

One of my first big challenges came after my first apartment vacated. Initially I thought I had a great opportunity to improve the property, raise the rent to a market level, and start turning the property around. What I found out was that I had a tough time attracting new, desirable tenants. I cleaned up the vacated apartment with some new drywall, paint and a brand new bathroom. It looked decent on the inside, but my other residents turned off a lot of prospects. It was an uphill battle, but I even managed to get my one tenant to part with the junked car sitting in the driveway (city bylaws fine landlords, not tenants). When I did find someone, my long term tenants would invariably gang up on whoever moved in and plague me with telephone calls about how noisy and disrespectful they were. It always struck me as interesting since I checked out references in each case and previous landlords (not just current ones) had always given my new tenants a decent recommendation. One day when I was working on the flower beds my most senior tenant confided in me that she heard the tenant upstairs trashing the place. When I knocked on the door my new tenant let me in for an inspection and the place was spotless! After going through a few new tenants I finally rented the apartment to a couple that my wife and I knew personally. I warned them that it might be rough in the beginning, but by now I had every intention of turning the property around as soon as possible.

I finally came to the conclusion that if you have a rundown property and you want to improve it a key step is getting rid of your existing tenants. First, with your existing tenants you will have difficulty raising your rents enough to pay for all of the improvements you need to make (thank you rent control). Secondly, even if you could raise the rents and did make the improvements, do you think that the tenants who neglected your place before would all of a sudden become model occupants? The big question is on the best way to vacate your apartments. Lucky for me, I was given a gift when the tenant in my second unit gave me notice (2 down, 1 to go).

The Turnaround

I didn’t waste any time lining up a contractor because the apartment was a total gut job. Even the interior framing was redone (and yes there were structural issues to address). The renovation process was a real education for me. I did get a couple of quotes on the job from contractors I had used before, and I ended up going with the same contractor who refreshed my upstairs apartment. We got the city permits ahead of time and he was able to start work the day after my tenant moved out.

I didn’t want to waste any time getting the apartment rented, so I placed some advertisements with the explanation that the apartment would be all new construction on the inside. I showed the place a few times before my existing tenant moved out to give prospects a sense of the space with explanations on future improvements. Admittedly, the place looked like a dump when I showed it and I soon discovered that most people either didn’t share my vision or they had some doubts about whether I could deliver. The general reaction was that people would turn up their noses and beat it out of there as soon as time permitted. Two short months later when construction was completed I had prospects fighting over the place! The end result was a brand new apartment that everyone loved and it ended up renting for 33% more that I was getting before.

Finally I set my sights on the last remaining apartment. In spite of ongoing complaints (my newest tenants were apparently horrible and loud as well) my last long term tenant didn’t seem to be moving. She “threatened” to move and she threatened me with lawyers. I encouraged her to move and even waved the 2 months notice if she found a new place to live. It wasn’t working. After concluding that she probably could not afford to move I finally made her a deal. I could have used consistent late payment as grounds for eviction, but I was not keen on the pain of going through the Landlord Tenant Board. It was unpredictable and it was going to cost me time and money. Instead, I decided to offer my tenant a free month’s rent to help her relocate. She negotiated me up to 2 months free rent with the argument that she was going to need the money to move all her stuff out. I figured that although you could consider me a bit of a pushover, it was a win-win deal. My tenant leaves willingly and I have a signed vacate notice that ensures she cannot claim the unit back. In Ontario, if you make a tenant move out to complete major renovations potentially they have the option to move back in (but that’s a whole other issue). Additionally, there was a better chance that I would have less stuff to get rid of after she left. Plus I had a definitive date and could line up the contractor to plan for my brand new apartment.

The last time I tried to rent an apartment under renovation people did not seem very receptive because they could not envision the final product. I had even lowered the rent a little bit in an effort to avoid a month or two of vacancy after it was finished. This time I tried a different approach. I had taken pictures of the completed one bedroom so I posted an advertisement including these pictures. In the ad I explained that although the apartment shown was a different layout and a 1 bedroom, this 2 bedroom unit would be completed in 2 months and would be finished with the same general style and quality as the first one. I had a flood of responses. How many were serious? I will never know. Not wanting to waste my time like I did the first time around, my intention was to hold off on showing the apartment until it was closer to completion. However, I did get a couple of people who were very insistent on seeing the place ahead of time as they were planning their move for the approximate month I expected to have the unit ready. I reluctantly agreed to these appointments as the apartment had been gutted but didn’t even have the walls framed in yet. I explained the best I could what the intended layout was going to be along with all the extras that were being done (soundproofing, high end dishwasher, laundry hookup, etc.).The second person who saw the apartment filled out an application and gave me a deposit on the spot. The apartment rented for 68% more than I was getting from my previous tenant!

If you have been a landlord for a while you know that you will have your ups and downs. My hope is that by improving the quality of my property and the tenants at the same time there will be more ups then there are downs. Even if the level of headaches was the same as before (which I doubt), at least now I am cash flowing more as compensation for any Tylenol I may need to take.
Here are my revised rules for buying a property:

1) It is cash flow positive after all expenses using the current rents.

This is the “golden” rule. Take into account everything and get the last year’s worth of any bills you will be assuming from the previous owner to be sure. On days when you are feeling abused, you don’t want to be paying for the privilege.

2) The apartments and/or building could benefit from cosmetic repairs and may be a bit run down; however, the building is located in a great area.

Ideally this is the building the neighbors all hate. Get a home inspection so you can get a better idea of how much money you will need to sink into the property to bring it up to par. Don’t worry; the neighbors are going to love you once you are done!

3) Make sure that you do not overpay. Build in some cushion for vacancies and unexpected expenses. Get some quotes on what it will cost you to make repairs and factor these amounts into your purchase price.

Don’t ever let the seller make the repairs unless you want to risk a poor quality job. I made this mistake once and it cost me even more to redo the original job plus fix the resulting water damage (but that is another story).

4) Assuming that the building is a bit run down with below market rents and long term tenants – get rid of them. If you can get vacant possession that’s great; if not, find a legal way to encourage them to move.

Fixing up apartments and keeping your existing slum tenants in them is like filling a bucket with a gaping hole in it; your apartments will be right back where you started in no time. If you are in a rent control environment like Ontario (Canada) this rule is especially critical. Make sure that you can actually increase your cash flow enough (increase rents) after spending all that time and money. Additionally, make sure that you are not forced to offer the apartment back to your existing tenant at a ridiculous rent once renovations are completed.

I just want to finish off with a conversation I had at the hardware store the other day. I was looking for a high quality toilet to put into my renovated apartment because I do not want the hassle that comes with a toilet that does not flush as well as it should or easily plugs. The employee told me how so many landlords just want to put the cheapest of everything in their apartments because “the tenants will just destroy it anyway.” I like to think that I have a more positive view on human nature. The quality of your apartment will determine the quality of the tenants you attract. Just as a poor quality tenant (in point #4) will wreck a good apartment, a poor quality apartment will attract just this type of tenant. By improving your property and your tenants you will improve your cash flow and reduce your headaches associated with being a landlord.

The only remaining point to be successful; don’t just read about it – you need to DO IT!

Wednesday, December 16, 2009

Why do the Rich Get Richer?

I am sure that everyone has heard this line before: “The rich get richer while the poor get poorer.” Whether this comment is fact or fiction is a matter of opinion. Many self-made millionaires were once arguably “poor.” A number of “rich” people have also become poor, especially if they did not create their own wealth. That said, why is it that rich people like Donald Trump can go from broke to billionaire more than once while many people cannot seem to get past living paycheck to paycheck?One big reason is that rich people buy assets; poor and middle class people buy liabilities. The really rich buy assets with other people's money but that's a topic for another day.

Personally, I like the definition for both give by Robert T. Kiyosaki. Assets put money in your pocket; liabilities take money out of your pocket (or use cash). I received a letter the other day from my bank encouraging me to increase the limit on my secured line of credit. This letter from one of our big Canadian banks suggested that I could use the extra money to “renovate [my] kitchen, consolidate debt, or take the family on that much-needed winter vacation!” No wonder most of us get poorer. Even our esteemed banks that we look to for financial advice encourage us to get into debt so that we can buy liabilities!

Meanwhile, what do rich people like Warren Buffet, Donald Trump, and Robert Kiyosaki do that the poor and middle class don’t? While the general public punches the clock trading time for money so they can pay back that vacation (with interest!), the rich buy assets like stocks, businesses, and real estate. They make their money work for them instead of working for their money.

This strategy is not just for the rich. You and I can do it too. I know that it can be scary, especially since we were never really taught this concept in school. As kids, weren’t our parents always telling us to work hard to get good grades and a safe, secure job? Did your dad or teacher ever tell you how to buy a property or a business and let the investment pay for itself? If so, you are definitely one of the lucky few.

Not all debt is created equal. Good debt is where you borrow other people’s money and use it to create wealth. Bad debt drains your cash and forces you to work harder to pay it back. As an added bonus, the government generally allows you to write off interest when you borrow to purchase assets making your loan even less expensive. Be sure to talk to your accountant before making any assumptions though, and never make an investment purely for tax savings. After all, your goal is investing to make money – not lose it!

Personally, I would argue that debt to acquire a property that does not produce positive cash flow is NOT good debt (it takes money out of your pocket). How many of these properties could you afford to own? Negative cash flow can eat you alive! On the other hand, if you borrow to purchase a property that gives you a small amount of money in your bank account after all bills are paid each month, how many of these properties could you afford! As many as you can get! Negative cash flow can also force you to sell your “asset” at the worst possible time if you cannot afford to keep it. If you have positive cash flow each month (assuming you want to sell), you can afford to wait as long as you want to hold out for a better offer.

Do you have a plan that transitions you from working for your money to your money working for you?

Friday, November 13, 2009

Rental Property - Our Cash Machine for Retirement

About 4-5 years ago our family purchased our first rental property. You have likely heard the infomercials where you can pay “nothing down” and tenants take wheelbarrows full of money to your bank account every month. Isn’t being a landlord the easy path to a million dollars? In my experience, that would be a bit of a lie.

I could also tell you the down side and how this property drives us crazy with repairs and tenant issues. Landlords are commonly found with a toilet plunger in one hand or staking out their property as they wait for delinquent tenants to come home on payday. Again, this would be stretching the truth.

The reality is that being a landlord has its ups and downs. Not everyone is cut out to do it, and quite honestly I have days when I wonder why I got into property. You get an education on every reason why the rent is not available the first of the month. A few calls to the Landlord Tenant Board can also be a real eye opener. I have to admit that the first 2 years or so I routinely debated about putting a “for sale” sign on the front lawn.

So why do I still have the property? Thankfully, once you buy a rental property it is not something you can easily dump when you have a bad day. Selling your property can be a drawn out and expensive business. I say thankfully because if you buy right and you can “suck it up”, I know of no other investments where you can put so little money down and let someone else pay off your retirement plan. When I bought the property it was cash flow positive from day 1. This is the “golden rule” in my opinion. Although I didn’t make much more than my expenses initially, the property did not cost me anything out of my pocket after closing. Any pain I experienced as a landlord was more emotional than financial. Critics will say that in their areas you can’t find properties cheap enough to be cash flow positive right away. I once had that problem. We moved.

The other reason is that in spite of the challenges you might face as a landlord, and although it may not be an “easy” path to wealth, maybe it is easier than a lot of the alternatives. Preventative maintenance can cut down on your phone calls. You can also improve the property. Even if government bureaucracy limits your rent increases there is no law that says you can’t make improvements to better your cash flow. Our triplex had zero insulation when we bought it and the gas bill was murder. It was a cheap fix. Any reduction in expenses is an increase to your cash flow, and as a bonus the tenants looked a lot more comfortable too!

As net cash flow increases so does the value of your property. If you ever decided you wanted to cash out another investor would look at the condition of the property and the return on his/her investment. Every year that rents go up and every improvement you make that drives down expenses will add to the value of your property. Taxes on my net income so far have been zero thanks to depreciation. Definitely get yourself a good accountant who routinely deals with property investors. If and when we sell, we will pay capital gains tax, but this tax is a far better deal than income tax. I might change my mind, but right now I can’t imagine selling anytime soon.

Another real estate investor I know has told me that eventually you wake up and discover that the property you bought for X a number of years ago is worth way more today. The mortgages are paid off and you have a healthy stream of cash coming in each month. It’s a bit like buying an annuity, except you make only the down payment and your tenants make the rest of your contributions for you. You have gone beyond “paying yourself first”; your investment feeds itself each and every month.

So far I have limited myself to one property since I am also working very hard to eliminate personal debt (e.g. our personal mortgage). Our rental property has been a huge help on this quest as well. I also work full time and my family might get a bit annoyed if I spend all of my “off” hours handling my landlord responsibilities. These are my own personal excuses as to why I have not added any more properties to my portfolio so far.

One final point I thought I would mention. People joke about the toilet plunger when you become a landlord, but you won’t find me plunging any toilets outside of my own house. I have purchased and dropped off a plunger as a favor, but I have a clause in my rental agreement that specifies “toilet plunging” as a tenant responsibility!

Have you ever thought about taking the plunge as a landlord?

Thursday, November 12, 2009

Eliminating Debt - How Much RENT Do You Pay Every Month?

A home is one of the biggest purchases that you can make. Many people see it as one of their biggest and best investments, but for most of us it comes with a huge liability: a mortgage. Either way, we all need to live somewhere and many people argue that owning your own home is far better than paying rent. Although I am a fan of home ownership, maybe we should consider that we all pay rent of some sort. Everyone knows that a tenant pays monthly rent to the landlord, but few stop to consider their mortgage interest payments in the same light.

Mortgages are at worst a forced savings plan unless somehow you have secured one that is "interest only." Your principal payments get you closer to financial freedom, and the interest portion is the rent that you pay to the bank. In Canada, mortgage interest on a personal residence is not tax deductible, so the only real benefit you get from the interest portion is the use of your home for another month. Another portion of your rent is property taxes. You can potentially reduce your taxes with a reassessment but you will never entirely eliminate them.

There are many online mortgage calculators on the internet that will break down your monthly principal and interest payments. You can also get an amortization schedule from your bank or mortgage holder. Let’s look at an example based on ING Direct’s 5 year fixed rate of 4.19%. If you had a $200,000 mortgage with a 25-year amortization your monthly payments would be just over $1,072. A whopping 65% of your first payment would be interest paid to the bank. Add in your monthly property taxes and you have your total equivalent to rent payment. In this case you have $692 + property taxes. The good news is that your interest amount will shrink as you pay down the loan; the bad news is that based on 25 years it’s a slow process. Based on this amortization schedule, assuming the same interest rate holds steady, more than half your payment goes to interest until well into year 9. Keep in mind that this example is based on record low interest rates offered to people with the best credit ratings!

If the above example seems depressing, there are a number of ways you can get ahead of the game. You can do accelerated bi-weekly payments, lump sum payments, and even double down (pay twice your normal payment) depending on the lender and your mortgage terms. Let’s look at an example where you decide to set your payment at a higher amount each month and leave it there for the duration of your mortgage.

Based on our $200,000 mortgage (at a 25 year amortization) the first payment of $1,072 eliminates only $380 of the principal; $692 is interest! The good news is that you can skip payment 2’s interest payment forever by paying an extra $382 in addition to payment 1. Less than $400 buys you 1 whole month off of your mortgage! If you were to continue with this extra amount every month you would reduce your total interest over the life of your mortgage by just under $50,000 and you would be mortgage free in 15 years and 8 months!

Some critics may argue that they cannot possibly pay any more than they already are against their mortgage. My suggestion is to contact your bank and see what options are available. Often you are allowed to increase your payment at least once a year within limits set by the lender. Play with a mortgage amortization calculator such as the one at ING Direct and see the potential benefits of even a slight increase. A runner does not run a marathon on the first day. The trick is to DO SOMETHING. Maybe you only increase your payment a few dollars or add a portion of annual pay increases to your payments. The online mortgage calculator will show you how a few dollars early on can be huge over the long term. Before you know it this strategy will become easier and you won’t even miss the money. If you are concerned that you may not be able to maintain the higher payment, confirm with your lender that you can always drop it to the lower amount if the need occurs. If you have not yet bought your house, you might consider a slightly less expensive home (and mortgage) to help make these strategies less painful.

Maybe you are torn between paying down your mortgage and investing. Consider that your existing interest rate on your mortgage is your guaranteed return when it comes to debt repayment. Even better, the government will never penalize you with taxes on the money you save. These are essentially "after tax" returns. In non-registered accounts, a guaranteed rate in the form of interest is taxed at the highest possible rate, and in an RRSP you will still pay CRA a chunk in income tax when you withdraw the money. Again this will be at the highest tax rate based on your income. I am not saying that you shouldn’t invest or put money into RRSPs, but definitely consider these points when you look at the benefits of debt elimination and investment. If you are really savvy, you might want to google a strategy known as the Smith Manoeuvre. This alternative can help you take advantage of the best of both worlds.

There is one final thing to consider before you go ahead with this strategy. If you have credit card or higher interest debt these amounts need to be eliminated first. When it comes to debt elimination the general rule is to pay off the highest to lowest rate. As you pay off each debt add the payment amount you were making to the next debt. Once higher interest debt is gone you can move on to your mortgage.

Again, the key to moving towards your goal of financial freedom is to TAKE ACTION. Analysis is good, but if you spend too much time analyzing and never put your strategies into action you may know more but you are no further ahead then before.

What actions have you taken to eliminate your consumer debt?