After my post on Wednesday about entry-level condos and the sub-$225,000 bracket, a reader commented and asked how this scenario would play out for investment purposes.
I’m going to attempt to break down the numbers in what will result in a crude financial analysis of a theoretical property.
I’m hoping my accountant, actuary, and investment banker readers will poke holes in everything I write…
Some of my buyers get so caught up with the investment portion of their purchase that I have to remind them, “You know, you have to actually live here as well.”
Purchasing a condo brings many factors into play, such as:
-potential resale value
-maintenance fees, taxes, utilities
-neighborhood & infrastructure
-layout & living space
-potential rental income
You can’t buy any condo in any area just because “the numbers” make sense, can you?
Are you only looking for a condo that will out-appreciate the market? Or do you want to live in a specific neighborhood or a specific building, regardless of the cost?
It all depends on why you are buying the condo.
1. Primary Residence
2. Investment Property
If you plan on living in the condo, maybe you couldn’t care less what the unit would rent for. 1-bedroom units and 2-bedroom units bring in a great return on investment, whereas 1-bedroom-plus-den’s don’t because they are too expensive for one person, and not enough space for two.
But if you’re looking purely for investment, you might not care what or where you buy, so long as you get a good return.
For the purposes of this example, let’s ignore the potential resale value just for now. Obviously, you’ll consider what the condo will be worth when you sell it in 1, 5, 10, or 20 years. But that’s not easy to forecast since we don’t have a crystal ball to see where the market is going, and we don’t know which buildings will out-appreciate the others (although we could probably hazard a guess).
Take a unit at 11 Brunel Court, listed at $206,900.
Looking up the recent lease prices for units in this building, at this size, I can see $1150, $1160, $1200, $1200, $1250, and $1200.
Let’s assume that we buy a condo for $200,000, and lease it out for $1200/month.
First, how much are we going to put down on the condo?
Let’s assume 10%, or $20,000.
There is Provincial Land Transfer Tax payable on the condo of $1,725, but let’s assume we are an astute investor who is also responsible for the Municipal portion of an additional $1,725.
Add this to the $20,000 downpayment, and out total cost up front is $23,450.
Make the following assumptions about the mortgage:
Term: 5 years
Amortization: 35 years
Total Payment: $777.62
We’ll also be responsible for a CMHC Insurance premium of $3,600 (since the downpayment is less than 20%), which will cost $8.57 per month amortized over the 35-year term.
This brings the total carrying cost to $786.19 per month.
Maintenance fees on this unit are $202.45 per month, not including hydro, but the tenant is responsible for that.
Taxes are approximately $1200 per year.
This leaves a monthly profit of $111.36.
Per year, you’re making $1,336.32.
But also consider that of the $786.19 per month mortgage payment, approximately $210 of that is principal.
Add this into the mix, and your monthly profit is $321.36, and your yearly profit is $3,856.32.
How much did this property cost us up front?
That’s a return of 16.4%.
I like it!
Had you been able to amortize the cost of the Land Transfer Tax (which some lenders may do), things could have been different.
Consider putting down 10% of the total $203, 450 (the $200,000 purchase price plus the $3,450 LTT), which amounts to $20,345.
Now re-run the numbers:
Mortgage Amount: $183,105
Monthly Payment: $794.42
Principal Portion: $214.00
Yearly profit is $3,805.56 but the initial investment was only $20,345!
That’s a return of 18.7%.
I like it even more!
There are a hundred assumptions, another hundred variables, and everybody would work their investment paramaters differently.
A downpayment of only 5% would result in a profit of $3,378.48 per year on an initial investment of $10,173.
That’s a return of 33.2%.
How do you turn that down?
Why is there no lineup for people to jump on board this money train?
Well not everybody qualifies for a mortgage with 5% downpayment, and not every lender will allow you to amortize the cost of your Land Transfer Tax.
There are also personal income tax considerations, and closing costs such as legal fees, renovations, and of course the fee you’ll pay a good-hearted Realtor to lease your condo for you.
And some might argue that you can’t include the principal portion of your mortgage payment in your calculation of return on investment. I’m not sure why, or why not, I just know that there are many different schools of thought.
Speaking of school, it’s been a long time since I’ve calculated EBITA. What the heck does that stand for anyways?
So, how did I do?
Any comments from the peanut gallery?
I probably should have consulted my brother before I ever picked up my calculator…