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Welcome back to part 2 of our 3 part series on how to build wealth and retire early by investing in real estate. In this second part of our series we're going to start to look at the numbers and show you the income potential from a cash flowing rental property. We'll then delve into the investment potential of renovating and improving a run down property. Finally, we'll start to look at the power of refinancing and how it can allow you to pull cash out of your investment property in order to help you buy your next investment property. For Part 1 click here.
3. Fix up and add value to your new property - Rehab
Now that you've made your first rental property purchase, you may be thinking, let's get this rented out so the cashflow can start flowing, but not so fast! If you can give yourself 1-2 months to do some minor renovations and improvements, this will set you up for a much bigger pay out down the road. With that in mind your third step will be to renovate and improve your property. This will make it worth more in the long-term and feed into our next step. When you're doing this you want to focus on simple renovations, aesthtic improvements not structural overhalls. For example, new paint, floors, lighting, new tile, landscaping, etc. things that are cheap and quick to add, but provide a high Return On Investment (ROI). You don't want to be to be ripping out walls, replacing roofs, or repairing a cracked foundation, so try to find a property that's in good overall shape, with no major structural issues. If it's a bit tired or dated that's fine. Although every property will be a bit different, let's look at one example to give you an idea of what's possible in terms of cashflow, equity from paying your mortgage, and appreciation from renovation and improvement:
Cashflow:
Alright, now that we've found, purchased, and renovated your first rental property, what does that look like by the numbers? We'll let's take an example from the Calgary real estate market. Today (Feb, 2023), there is a 7 bedroom 2 suite home for sale in Calgary listed for $320k. If you were to purchase this property and move into one suite while renting the other here's what it could look like based on today's interest rates.
Purchase price: $320k = 2 unit house
Down payment: 10% on $320k = $32k
Mortgage/financing: on the remainder = $288k
Interest rate: 5.78% on a 5 year term amortized over 25 years
Mortgage: $1,805/month
Property taxes: $1,994/12 = $166/month
Insurance: $120/month
repairs/maintenance: $200/month
Total cost: $2,291/month
Total revenue: $1,800/month
Cost: -$491/month
Upon first glance this venture doesn't seem to be looking that hot since you are now losing almost $500 each month. But keep in mind that most people need somewhere to live, so instead of paying $1,800/month to have a place to stay, it's now only costing you $491/month which is a huge cost savings; and that's before accounting for the monthly equity you gain by paying your own mortgage.
Mortgage Equity:
$5,351 during the first year, or $446/month.
So now your monthly housing cost has dropped to only $45/month! Or put a different way, you are now ahead by $1,755/month when accounting for equity compared to renting, since you're now keeping that additional money in cashflow and equity instead of just losing it to rent. Then there's the additional equity you built by renovating and improving your property.
Renovation Appreciation:
Let's see what happens when you renovate and improve your property. If for example you renovate your new home and make it more appealing to future buyers, you can substantially increase it's resale value. Let's take the following example:
Renovation cost: $38k
Increased value: $101k
Net increase; $63k
So,if you could do some relatively low cost, but high ROI renovations to your home and increase it's value by $101k while only spending $38k, then your potential net gain upon reselling could be an additional $63k. Even if you don't sell that equity is still there. This is where refinancing can come into play, let's look at the next step of this process.
4. Cash out Refinance - Refinance
Now that you have substantially improved your home, you can reassess your home at a higher value, and use this reassessment to qualify for a higher loan, but why would you want to do that? Well this is how you leverage your first property to grow your real estate portfolio. Taking our previous example, lets say that by putting in $38k of renovation into your home, you've now increased it's value from $320k to $421k. What does that look like from a refinancing perspective? We'll here's what happens when we revist our previous example:
Purchase price: $320k = 2 unit house
Down payment: 10% on $320k = $32k
Mortgage/financing: on the remainder = $288k
Interest rate: 5.78% on a 5 year term amortized over 25 years
Renovation cost: $38k
New home value:
$288k borrowed + $133k in equity ($32k down payment + $101k improvement) = $421k
If you are able to refinance and get a new bank loan at 85% of the new value, then your new mortgage loan on the property would be about $358k
With the new loan, you can then pay off your old loan of $288k, and keep the remaining cash balance of $70k. Using this money, you can start the process over again and look into buying your next property. Here is what we'll talk about next in our final installment of this series:
How do you use your cash out refinancing to repeat the process and buy your next investment property?
What does that do for your growing cash flow situation?
What are some other factors to consider as you steadily grow your real estate portfolio?
Stay tuned for Part 3!
I am a Victoria based local realtor with eXp Realty. My commitment to honesty, integrity, loyalty and hard work have been important pillars for me because they drive a high standard of excellent service for my clients. Helping you realize your dream is my goal!
I service Vancouver Island, but my focus is on: Victoria, Sooke, Saanich, Malahat, Shawnigan Lake, Cobble Hill, Duncan, and the rest of the Cowichan Valley.