How to Evaluate a Potential Investment Property

Welcome to Canada's Property Management Podcast, your number one resource for investing, managing, and maximizing the value of your real estate assets. And now here's your host, Carla Browne and Adrian Schulz, Canada's rental property experts.

Carla Browne (00:18):

Hello, Adrian.

Adrian Schulz (00:20):

Hi, I'm adjusting ... for some reason, I'm not centered in the screen. And since you routinely make fun of me on these episodes, I think it's really important that people get the full picture.

Carla Browne (00:32):

Yeah, can you be like totally in the middle just like me? Because we're almost wearing the same colour of shirt. 

Adrian Schulz (00:37):

When you said, can I be in the middle? I was thinking politics again, and I wanted to talk politics. But we won't do it today.

Carla Browne (00:46):

Okay, let's get down to business. Today on the podcast, we're going to talk about how to evaluate a potential investment property. Because this is one that comes up where someone ... they want to buy a property, so now all of a sudden they're looking at houses for sale. And there's so much more that goes into this picture to figure out whether or not you are buying a good investment property. So you're an investor, Adrian, let's start at the top and work us through some of the things that you would normally do when you've made the decision that now you're going to buy a property.

Adrian Schulz (01:19):

Well, first of all, I think it's important that we point out the shiny car syndrome, that many real estate investors get ... or shiny house syndrome, I guess. Where you get a listing and it's a rental property or could be one. And it looks like it's in the price range that you think you would be able to do the deal. And you just want another rental so bad, that you go and put in an offer. And you think, "I don't care about the details because long term it's for sure a good investment."

Adrian Schulz (01:50):

And with my first couple of investment properties, I was that way too. And sometimes when there's a little bit of money kicking around, I can sometimes be that way again. But I think it's really, really important that regardless of how much desire, how big the opportunity or how much cash you have available for the down payment. That you really, really put it through these filters. And first and foremost is when you're looking at the potential investment property, think about it as is at that current state. And of course, what it could be if you made necessary capital improvements. Because those are actually two very different investment properties. And keep in mind to get to number two, there's a lot of capital outlay. So, I would argue when you're buying an investment property, even if you're experienced, your as is scenario should probably be the number one priority to work through.

Carla Browne (02:57):

Right. And I would say like ... just going to what you were talking about, it's almost like taking that emotion out of the whole process. So the first thing is, is that investors, we have to understand that this is a business. Whether you're buying your 10th property, your 100th property, or your first property, you have to treat it like a business. So the emotions need to be removed from the equation. So in your mind, you should already have worked through some of the things you know you want and what you don't want.

Carla Browne (03:25):

And I think this is a good time also to talk about the importance of having your power team together. So having your realtor and your mortgage broker ready to go because in the real estate market with it being so active, a lot of investors didn't have time to think. And so you have to have all of this pre-worked out and pre-planned so that when you know this comes available, you're ready to go. Because if you have to sit back and then work through all of the numbers at that point in depth, you're going to lose out on that opportunity. And then emotions go really high when we start losing things.

Adrian Schulz (03:56):

Yeah.

Carla Browne (03:56):

So that was such a great point to start us off with. So let's talk about if we're going to go through the whole process now. So we've determined whether it's going to be as is. Or let's talk about if we're going to do some improvements, what that looks like from a cost base, is what we need to be realizing as we go through that, that process. And even buying, I mean, people don't realize there's some capitally besides your down payment that has to happen just to buy a property as is.

Adrian Schulz (04:22):

Oh, very much so. There's land transfer taxes, depending on the jurisdiction. As well as legal costs. And sometimes there can even be professional fees that are involved if you have multiple investment properties or you need a specific tax structure set up. So all of a sudden, instead of having put down 20% down, because it's an investment property. Maybe your total cash outlay is more like 25% or maybe even 30% after you've made some of those initial capital improvements or repairs as dictated by the home inspection.

Adrian Schulz (04:58):

So really being well equipped. And I think you never want to use all your available capital when you're investing in a property. You should always have fallback. I'm not sure if I've ever bought an investment property and the hot water heater or the furnace or the air conditioner, didn't go in the first 12 months. Like that's my blessing in life is that some mechanical system will fail.

Carla Browne (05:23):

I think there's some allowances that you're going to have to factor in all the time when it comes to that. So you have to factor in the maintenance allowance, you have to factor in vacancy allowance. Like all of these things need to be part of that whole analysis to make sure that what you are buying is something that you really truly can afford to buy. Because you can't buy it and then just think that this is my mortgage payment and I'm going to get that amount for rent and we're going to be sailing. It doesn't work like that. Because it doesn't work like that in your own residence, you have to repair things as time goes on.

Adrian Schulz (05:55):

And then of course, we've got the, do you want to have it vacant? Or do you want to have tenants in place when you're acquiring the property? 

Carla Browne (06:05):

Well, let's talk about this one.

Adrian Schulz (06:06):

Yeah. This is a whole new episode. But personally, I definitely prefer for there to be tenants because I want to immediately be able to cash flow the property. But if you have tenants, you can throw your improved scenario temporarily out the window because you can't just get rid of tenants. What's your preference?

Carla Browne (06:32):

Right. Well, I prefer vacant because I really like to choose the tenants because I'm pretty picky. Because I see problems all the time with what I call inherited tenants. And when you buy a property with a tenant, you to really understand what you're buying. You have to understand what that lease agreement reads. You want to know more about them, as much information that you're able to get them. Because there's some privacy stuff that falls into all of that, as well. And then you now have to gain the trust of them because they might have really liked the owner before you. So there's personalities, there's all of these things. I mean, I think I'm pretty likable, don't you think, Adrian?

Adrian Schulz (07:10):

Yes, but we can have differences of opinions.

Carla Browne (07:13):

Right, exactly.

Adrian Schulz (07:14):

Carla likes her investment property vacant when acquiring and I like mine occupied. Usually we agree, but we're going to disagree on that one.

Adrian Schulz (07:24):

Current expenses. One of the most commonly overlooked expenses and maybe opportunities, I find, is property insurance. Time and time again I have seen proformas reflect the insurance expense. It was actually being insured as a primary residence or as a secondary residence on a homeowner's policy. And the problem with that is twofold. Number one, it's the wrong insurance, so it may not act actually provides you adequate coverage. But number two, it does not contain the necessary tenant coverage and lost rental income coverage if something goes wrong. And in today's residential insurance market, you really want to validate the insurance costs that you're being given.

Adrian Schulz (08:22):

Just recently I saw someone acquire a property, it was a duplex. And the annual insurance premium was $1,400. And when they went to insure it, it was $3,000, more than double. And that's because in fact it had been insured as a primary residents with a second suite. And that's over-

Carla Browne (08:43):

Yeah.

Adrian Schulz (08:43):

A hundred dollars a month. That's a big amount of money on something like a duplex. So really digging into those current expenses line by line to validate them, to assure that those will be your expenses under your ownership, as well.

Carla Browne (09:00):

Yeah. I think insurance is a whole nother topic that we can really talk about to really make people understand. Not the importance of insurance, we all know that. But some things to really watch with different insurance brokers as you're going through this purchasing of an investment property. The other part that comes into play with that is the condo fees, if you are buying a condo or a townhouse. That I've heard a lot of stories of the ability for condos to get insurance is getting harder and harder out there in the marketplace across Canada.

Carla Browne (09:29):

And so if you are buying a property and now, you know what your mortgage amount is and you know what your taxes are and you know your taxes are going to fluctuate a bit. You've got these condo fees. Those condo fees, they're very variable.

Adrian Schulz (09:42):

And they're out of your control.

Carla Browne (09:44):

They're out of your controls, exactly. So you really need to investigate. We all get the Estoppel certificate, people don't necessarily understand what that's all about. Make sure you have a good lawyer that's read through that thoroughly so you understand what you're buying so that you do have that safeguard. But I actually have really been advising our investors to stay away from the condos and townhouses right now, just for that reason is that if you're looking for cashflow, it's hard right now.

Adrian Schulz (10:08):

And just to give our listeners more insight on that condominium corporation insurance in Canada this year on renewal, the average premium is increasing upwards of 40%. Keep in mind that condo fees represents a very large portion. So your condo fees could actually increase theoretically by 40% or more, as well, year over year. And if you have that kind of an uncontrollable expense affect the cash flow of your investment property, it may be more of a place to flush money down the toilet than actually having a financial gain.

Adrian Schulz (10:53):

So I agree with you. I love single family, duplexes, four-plexus, small multifamily where you are in control of the asset. Versus a condo board or a condo manager layered on top of the efforts of a property manager of the rental unit.

Carla Browne (11:11):

Yeah. I feel with this one, Adrian, we could probably have a part two. Because that whole condo part is another thing that I think we should really dive into. Because I don't think people understand, I guess, how the condo fees are really derived, who dictates that, how that all works, what impact that can really have. And so we could probably go on that one on a totally different podcast and give a little bit more information there. So insurance and condos are two more topics, I think, we need to do, I guess. But I think we need to wrap this one up. Is there any last minute things that you wanted to say on this one?

Adrian Schulz (11:42):

Just get your team together and trust the professional advice of your real estate, mortgage, legal and accounting professionals and advisors. There's a reason those professions exist and they will make you as a group more successful.

Carla Browne (11:58):

100%. And I'll add your insurance broker to that, as well. Because I think that they're a pretty important part of that power team. Okay, that's it for today. So, that is Real Property Management.

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