Thursday, July 11, 2013
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!
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 https://www03.cmhc-schl.gc.ca 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.
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 (http://fixemuprentemout.com).
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!