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 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.
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 (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!
