Million Dollar Freedom

The Great Apartment Turnaround Play

2012-01-01T14:27:00.000-08:00

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 naïve) 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!

Why do the Rich Get Richer?

2009-12-16T17:58:00.000-08:00

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?

Rental Property - Our Cash Machine for Retirement

2009-11-13T19:59:00.000-08:00

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?

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

2009-11-12T18:22:00.000-08:00

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?

The Financial Treadmill of Life

2009-11-08T08:38:00.000-08:00

Does lack of money hold you hostage? Here’s a clue. If you don’t absolutely love your job and yet you show up to work religiously every day…the answer is probably yes.

A job can be like a drug. We grow up in an educational system that is generally designed to turn out wage slaves. Go to school, work hard, and get a good JOB! A good job means more money and supposedly a good future for you, your future spouse, and the 2.2 kids you will eventually have. So you follow the age-old advice and work your tail off in high school. Good job! You move on to college or university so that 2-4 years later (with a little more hard work) you can leave with your ticket to a solid, entry-level position at a great company. It’s a good thing you got your education but there’s just one more snag; now you’re going to have to work some long hours to pay back that monstrous student loan you took out!

Life goes on. You impress a few people at work and maybe get a couple of pay increases under your belt. Good thing too, because now you have that car loan to pay. Hey, you have to get to work somehow, right? A bit more time passes, and you make the biggest investment of your life. Your parents always told you that a house was the best investment they ever made so you decide to make the move to home ownership yourself. Nice house, shame about the big 25-year mortgage attached to it. The credit cards also get a little workout as you add furniture. After all, who wants to live in an empty house? The Big Box stores always have those “don’t pay a cent” events on anyway. It’s practically free money, right? Then the “no payment no interest” party ends and is replaced by “monthly payments, high interest.” It’s a good thing that you have that job.

I could go on but I think you get my point. Life can seem like a financial treadmill, and yet somehow we are ill prepared to deal with it. It seems odd to me that basic money management never made it’s way into the high school curriculum.

This blog is dedicated to exploring ways to break free from wage slavery. Maybe you like your job. If so, that’s great! Maybe you always wanted to write a novel but figured out that the only way you were going to get ahead was to stick it out in engineering. You may hate it, but people depend on you, and you depend on your paycheck.

I am not going to tell you that you should quit your job tomorrow. My goal is to explore some ideas that will hopefully give you some more options. A job is an option, but so is starting a business, saving money, investing, and digging yourself out of consumer debt. It’s probably going to take some time. Personally, one of my biggest challenges has been a lack of patience so I am always looking for ways to reach financial freedom sooner. There are always trade-offs with each potential solution. Is it worth the sacrifice? You could work 60-hour workweeks and commute 1 ½ hours each way to make more money. Many people do it every day. The price? You may never see your family. I did this for a time until I realized it was killing my home life and me in the process. My 4 year old daughter begged me every night not to go to work the next day. We found another way. There are always options; you just have to be open to them.

The ultimate freedom is to be able to choose the work you want to do without regard for compensation (in some cases this choice may be no work at all). To get to this point we need a plan that will answer two basic questions.

How much money do you need?

The amount of money you need depends a lot on lifestyle and where you live. If you live in Toronto and like to vacation in Europe frequently you are going to need much more than someone living in Northern Ontario who likes to read and maybe camp on occasion. If you can cut your expenses the amount of income you will need goes down accordingly. Then again, if you want to shoot for a million it sounds like a nice round number. This goal may not be as out of reach as you think.

How can you acquire this amount?

Right now you may be earning this amount by putting in a lot of hours at work. Once you stop working your incomes stops along with it. This is one way, and in many cases the only way that Canadians know. We work hard and maybe put some of our money into a RRSP with hope and a prayer that this will see us through a traditional retirement. If a traditional retirement where you live off of a fraction of your "pre-retirement" earnings is not good enough for you, then you need to find a better way to transition from a life of working for money to one where money works for you.

I expect that this blog will evolve over time but these two questions should remain as its foundation. I look forward to sharing my thoughts with you and invite you to share your own thoughts on each topic as we go along.