Category: Real Estate

I recently guest post about refinancing home mortgages that is a topic I’ve recently been interested in. As with many financial issues, there isn’t an easy answer whether you should do this or not, and it depends heavily on your personal situation and how much risk you’re willing to expose yourself to with respect to future inflation and interest rate changes.

If you *DO* decide to break your mortgage, there’s an easy way you can save yourself a chunk of the penalty, assuming you have the right mortgage features.

Refinancing your home mortgage

First, to give a general overview, breaking a mortgage typically entails paying the lender three months interest as a penalty (in Canada at least). More recently, they have begun using an alternative method for calculating the penalty called the interest rate differential (IRD). This is simply how much they WOULD have made off of you if you’d kept paying on the mortgage (and these days is higher than 3 months interest).

Whether or not to make the change is a fairly simple calculation (compare the penalty to the interest savings). The big additional benefits that attract me to the idea is that it’s a great time to get a fixed rate (in case interest rates take off). I’d actually be tempted to pay a premium and get a 10 year mortgage and not have to worry about interest rates for the next decade.

Some might try to make this a moral issue, claiming you’ve made a commitment to the lender and should honour it. This is garbage. Part of your commitment (check your mortgage documents) is that you can break the mortgage if you’re willing to pay the penalty. If they didn’t want you doing so, they shouldn’t have included it as part of the agreement.

I’m currently house hunting, so getting a new mortgage would be a dangerous thing. I will definitely investigate any impact refinancing might have on getting a new mortgage before I did anything.

Getting back how to save money when breaking a mortgage. When I called PC Financial (my mortgage holder), and asked about refinancing they told me it would cost $1,190.19 for me to break it (my mortgage is a little more than $89 K). I am allowed an annual 20% pre-payment, so I asked the rep what the penalty would be if I maxed out the prepayment first, which promptly dropped it to $882.70. He certainly didn’t volunteer this information, but he had it right there, so definitely ask (if you can pre-pay) how much it would lower the penalty fees.

For me personally, I’d just get the 20% out of my line-of-credit (then pay this off with the new mortgage). Even if you got the money from a high interest source (like a credit card cash advance or something) I think it would still be a good way to lower the penalty (in my case it’d save me 25%), as long as you quickly paid it back.

I’m gearing up to buy my second investment property. Now that I’ve been at the university for a year, settled in pretty well (it’s not looking like they’re going to kick me out) and know the area a bit better, it’s time to consider buying instead of renting.

My plan is to be here at least another 3 years (PhD programs can take 4-7 years). I’m leaning towards a condo townhouse, with 3 or 4 rooms total. I’ll live in whichever is the least desirable room, and hope to rent out the other rooms for $400 / month each (+/- a little bit if some are better or worse than the others). I’d *CONSIDER* a unit with a separate basement unit (which I might live in myself if I decide to splurge).

I’m hoping to get a property for less than $40k / room (which I suspect will make it far more likely that I buy a 4 bedroom townhouse than a 3). I’m ok with a condo townhouse (they seem quite a bit cheaper locally than houses, but if there’s a detached house selling cheap I’ll take a look). Ideally I’d like something within a 15 minute walk from the University of Waterloo or Wilfrid Laurier University (I can walk further if its closer to WLU), but would consider something up to 30 minutes walk away. I’d consider a property one bus ride away from the universities if it was a VERY good price. Cosmetic damage is ok, and more serious damage MAY be ok.

I’m hoping to keep better track of how much time I put into the house hunt this time. Currently I’ve looked at two properties and have invested about 2 hours in the process.

My plan is to put in offers on multiple properties, much as I did last time (I may elaborate on this in a future post, as I think its a really great idea).

Some of the downsides, which I’ll be happy to tell any agents / sellers asking how I arrived at my offer price, is that real estate is going down everywhere, including the Kitchener / Waterloo area. I’m hoping to deal with this by getting a good price on the purchase (and accepting the risk that it may keep dropping after my purchase). Many multi-unit buildings catering to students have popped up recently and there seem to be a number of vacancies in the properties around the campuses. I’ll deal with this risk by being willing to adjust my rents to whatever price point gets me tenants, being willing to add some extra amenities (such as wireless internet, cable TV and maybe a bi-monthly cleaning service) and being on-campus and hopefully able to recruit tenants from people I know and “friends of friends”.

If anyone knows of a property that meets this criteria, that is either currently available for sale or might be soon, please encourage the owner to contact me at cheapcanuck@gmail.com. I certainly won’t promise top dollar, but I’m not picky about the minor details, and will be ready to buy for the right price (cash offer, minimal conditions which will be quickly removed, flexible on closing date).

Rent-to-own (also known as lease-option) is a popular real estate strategy in the US and has been making its way into Canada in “get-rich-quick through real estate” circles.

This agreement, between a landlord and tenant, involves the landlord selling the tenant the OPTION to buy the property at a fixed price at some point in the future (much like a call option for stocks).  Often there will be an initial payment as well as a portion of the monthly rent payments being credited to the tenant.  This might be useful for a tenant who has trouble getting a down payment together (but can afford to put away a little bit each month) or a buyer with credit issues that they’re working out (who expects to be in a position to buy within the option period).

As an example, pretend I’m renting you my condo (which has been assessed at $156K) for $1350 / month.  We agree that I will give you the OPTION (not the obligation) to purchase it for $160K at any time for the next 3 years, with an initial payment of $5K with $150 from each rent payment being credited towards the down payment.  At the end of 3 years say the condo is now worth $165K and you have accumulated a $10,400 down payment (5000+150*12*3).  You arrange for a 5% down mortgage, using the credit you’ve accumulated over the 3 years (which is worth 6.5% of the $160K ) with me using the other 1.5% to cover your closing costs (so you pay nothing more out of pocket and are now the owner of the property).

Say, instead, the real estate market tanks and you decide you don’t want to pay $160K for a condo now worth $130K, you don’t execute the option and at the end of the 3 years there are no further obligations (although the $10,400 is forfeit, the tenant does NOT get it back).

From the sellers perspective, they get to either sell at a price acceptable to them or earn a premium over market rental rates if the sale doesn’t go through.  Additionally, the tenants will take better care of the property (since they expect to own it) and will be very motivated to pay rent on time and honour their lease (since they could jeopardize the purchase if they don’t).

From one perspective, between financially sophisticated individuals, this is a reasonable way to allow the seller to earn a premium by acting like an insurance company, taking on more risk in exchange for payment.  Sadly, rent-to-own is often instead used to take advantage of unsophisticated renters who want to become buyers but don’t have the means.

Often the tenant who isn’t in a position to buy at the beginning of the lease term STILL won’t be at the end of it (and will be $10K poorer for having gone through the exercise).  Unsurprisingly tenants will be annoyed when this money is gone, and will often become destructive or difficult tenants if they aren’t able to close on the deal (and the seller refuses to return their option payments).

From the sellers position it’s a pretty good deal, as they can set the sale price higher than they expect it will be worth within the option period, and they get paid a premium over what they’d usually earn in rent.  The law is often on their side if the market takes off and they decide to not honour the deal and fight the sale.  That being said, judges will NOT be impressed by these sorts of shenanigans and will be looking for any excuse to rule in the tenant’s favour.

I saw a classified ad from a woman who wanted to do a rent-to-own deal (with her as the tenant) in Toronto so I contacted her.  Turns out her expectation was that she’d pay market rent, but her ENTIRE rent would be credited towards the eventual purchase of the property.  Why she would expect any landlord to agree to this is beyond me, but she did.

I talked to a lawyer friend who talked to a lawyer friends of her’s who specializes in real estate and they were of the opinion that lease-options were too untested legally in Canada to get into unless you were doing them in a big way (in which case they felt it might be worth the expense to research all the legal ramifications and develop the right contracts to make it a business).  Their advice was to do a vendor-take-back mortgage if I wanted to provide seller financing.  In the US, where these deals are far more common, there are also legal and ethical pitfalls.  John T. Reed outlines some of them in an article about lease options (and offers a report for sale with more info).

More information about lease options is available here (general overview), here (with a bunch of links to more articles at the bottom) and here (details lease options in BC with a couple of quotes from Mr. Reed).

I recently enjoyed a post about a tenant referring her friends as potential new tenants on Single Guy and Money.  It might just be a specialized case of what I’ve wrote about before as “statistical karma” but I’ve found that being a good landlord to your tenants is a good way to help YOURSELF out.

My current (and first) tenants in my condo just extended their lease for a second time.  After we had updated the lease and when I was leaving, they told me that a friend wanted to move into the building, but they’d warned her that I just owned their unit, other landlords in the building might not be the same as me.  They told me I was “the nicest landlord they’d ever had”.

Everyone likes being told they’re a good boy (except girls maybe), but my motivations for treating my tenants well are very self-serving.  I view my condo as a business, and they’re my customers.  They’ve been good customers for the last two years (never bounced a check or paid late, have maintained the unit well, and haven’t bothered me with frivolous problems), and I want to keep them.

I didn’t raise their rent again, and I think John T. Reed would chastise me for not doing so (he advocates always raising rents to market rate).  My reasons included not being sure that the Toronto rental market could sustain a higher rate (I didn’t want to drive them out, then end up with new tenants paying the same rate) and not wanting to go through the aggravation and expense of finding a new tenant (and having to travel to Toronto to do so).  With the recent real estate turmoil, I wasn’t sure what the rental market looked like (Thicken My Wallet had an interesting post on this topic recently) and decided it was better to keep the tenants I had then risk finding new ones.

I don’t think they’re staying because of the lack of a rent increase, instead the examples they cited as bad behaviour on the part of their previous landlords were all long delays in making repairs. They told me at one place they had a closet door that wouldn’t open and close properly, and although they lived there 8 months and the landlord lived UPSTAIRS, he never fixed it.

At the current place I’m staying our landlord took 2.5 months to replace a broken dryer (I was smelling pretty ripe by the time the new one was installed).  The $375 dryer she bought isn’t any cheaper this month than it would have been in December.  All she accomplished was saving a TINY bit of depreciation of the dryer and aggravating the women who live upstairs and myself.  We’re all debating whether to stay here at the end of our leases or not, and this is a BIG part of why we’re considering leaving.

To me promptly making repairs doesn’t cost any more than delaying, and it isn’t any more work to deal with it now instead of later.  I can’t for the life of me figure out why landlords don’t make prompt repairs as a free way to keep tenants happy.

The one concern a property owner MIGHT have is that the tenants are making a frivalous repair request and that if he honours it he’ll just get a whole bunch more.  This is fair, but if the repair request is a reasonable one (like a broken dryer), FIX IT! If its an unreasonable request (one of my buddies had a tenant complain to him that another tenant’s children wouldn’t play with her kids) explain that it’s unreasonable and tell them you won’t take responsibility for it (instead of just delaying and hoping they give up on the request).

I came across the idea of “Condotels” (also know as hotel-condos or Condo Hotels) a couple of years ago when a man was advertising them on craigslist Toronto. More recently a real estate club that I’m on their mailing list sent out a solicitation for people to invest in a Muskoka condo hotel and I thought it might be an interesting topic for those who haven’t heard of them.

Certainly distinct from timeshares, the idea behind condotels is that a group of investors each buy one or more rooms in a hotel under development (much as how pre-construction condos are sold). A corporation operates the hotel, and will maintain the facilities and your unit in it. You have the choice of staying in your room when you want (say it’s in a city you regularly visit) and having the hotel rent it out when you’re not there. Rooms are rented out in rotation, so owners should do well or poorly based on how the hotels does as a whole. From the guests’ perspective they can’t even tell that it’s different from a traditional hotel.

Two years ago when I was talking to the gentleman trying to sell them on craigslist he was singing their praises. After talking to him and being assured it was a spectacular way to make a lot of money (a good way to get rid of Mr. Cheap is to offer him a free lunch) I didn’t bother going on the site visit and forgot about it. A similar “very positive” overview of the concept can be read at this interview with Joel Green (who runs a brokerage specializing in condo hotels).

The obvious counter-argument is that if there was a ton of easy money to be made, someone with deep pockets would just build the hotel themselves (or buy all the units). Clearly the fact that a sales staff is needed to market and advertise the units tells us this isn’t the risk free way to easy money they try to imply it is.

The potential pitfalls in this concept is that you share quite a bit of the revenue with the hotel corporation (at some sites it’s 50%) and you’re required to pay very large Homeowner’s association fees to maintain the hotel and your room in peak condition (it’s a hotel, so they can’t let it get as shabby as many condos get).

Forbes published “A Room Of Your Own” which considers condotels good second homes but bad investments. In it they point out that the numbers needed to evaluate them as investments aren’t provided, and that a miscalculation (like occupancy rate) can dramatically adjust your return. They also point out a glut of resales that could saturate the market (and this was in 2006, I shudder to think what the situation is like today) and do the math showing it’s a better way to lose money than make it after all fees are totaled.

The Wall Street Journal answers a letter providing “Tips on Buying a Condotel As a Rental Residence” which also quotes Mr. Green and provides some suggestions on how to evaluate the potential of an pre-construction condotel.

Although the Wall Street Journal cites Florida as one of the markets where condotels have performed well, the South Florida Business Journal offers an article titled Condo-hotels seen as poor investments. They depressingly quote a National Association of Condo Hotel Owners (NACHO) report that says “We maintain that owning a condo-hotel unit will most likely require injection of capital periodically”. If the national association is saying that they’ll cost you money instead of making you money, I’m not sure if it would be wise to view them as an investment: consider it a consumer purchase if you still want one.

None of these articles provide well grounded information about the resale value of condo hotels, so it’s POSSIBLE that there’s money to be made by running them at a loss then making money on the appreciation (hmm, why does that sound like a familiar strategy?). I wouldn’t be comfortable betting on this personally.

Have you every bought or considered purchasing a condotel?  Have you ever been to a sales presentation for one?  What did you think?

I’ve written before about quotes being twisted for various purposes and being misleading.  One witticism for real estate investing which means what it says is “Buy land!  They aren’t making any more of it”.  The wisdom that’s supposedly encapsulated in this saying is that there is a finite amount of space on planet Earth and by staking your claim to some of it you stand a good chance of getting higher returns in the future (as scarcity drives up the price).  I think this is the wrong perspective for a great many reasons.

They *ARE* making more of it

A variety of artificial islands have been created.  These can be made using sand dredged up from the sea.  Cost is certainly a consideration, with some construction being estimated at a billion dollars.  However, if land started to get scarce this is an option.  As more islands are created, the techniques and technologies supporting it would become better understood and it would get cheaper to make more.

Beyond making more, we are continually getting better at supporting a higher population density.  While a person with modest needs might live in a 600 sq ft living space, if they live in a 6 story apartment building, 6 times as many people are using that same plot of land.  A 44 story building has just allowed the land below it to be utilized 44 times over.  Construction techniques are also always improving to allow higher and larger buildings.

If for some reason we hit a limit on going up, there’s always the possibility to dig down.  With 101 floors above ground and 7 floors below ground Taipei 101 is the tallest habitable building in the world.  This allows 108 times the usage of every square foot of land where this building is located.

Demand isn’t uniform

In some ways it might seem odd that we’re devoting billions of dollars of resources to make islands and 44 story apartment buildings when there’s so much land going unused.  With 3.3 people / sq. km Canada has a crazy low population density.  We could cram TONS of people into the Northwest Territories (which currently has a roomy density of 0.02 people / sq. km – I wonder if anyone up there ever sees anyone else? 😉 ).

The unfortunately reality is that people want to live in the areas where they’re making islands and skyscrapers, not in the Canadian wilderness.  If someone is blindly buying land “because they aren’t making any more of it” they’re going to be sadly disappointed when developers keep focusing on maximizing the usage of high demand areas (instead of blindly buying all land for sale).

Heck, during the recent run up in oil prices people started talking about the death of the suburb.  Even the well known idea of buying a big plot of land on the edge of town, then selling it decades later when the city has grown around it may or may not work in the future, it all depends where people want to live.

The father of one of my dad’s friends moved into a retirement home a couple of years ago.  His house in the small town he came from is STILL sitting unsold.  Everyone who lives there already has a place to live and no one is buying.

Rate of demand growth is slowing

While the human population is definitely growing, that rate of growth is slowing and has been for some time.  We’re moving towards a point where births will equal deaths and we’ll have a stable population number.  People used to talk a lot about over-population, but the math just isn’t there to support it.  Already Japan has a negative population growth (if it wasn’t for immigrants their population would be shrinking).  Other countries are following this trend.  This doesn’t say much about other resource demands, as more of the world is leading an increasingly affluent lifestyle.  Slower (or no) population growth certainly won’t allow the whole world to live a Western lifestyle, but land isn’t going to be the limiting element.

What if it IS true?

Even if this statement was true and if eventually people would be standing back-to-back covering the globe, I’m still not sure it would mean that pouring all your money into real estate is the way to go.

All sorts of finite resources exist, and the market finds efficient ways to price them.  We’re running low on oil, but I think putting all your money into an oil stockpile and hoping to massively profit in the future is a mistake.  The current reserves, as well as usage and growth in usage, are all very well known factors and are incorporated into the price.  New refining technologies and gaining access to previously unattainable fields (such as Alberta’s oil sands or underwater oil wells) are also factored into the price and could limit the gains your oil stockpile could make.  Alternative energy technologies would also threaten it.

Similar considerations are there for other finite resources.

What to do from an investment perspective

My view is to treat real estate investing like any other investment,  look at the deal in and of itself (or the allocation of REITs if you’re more of a passive investor).  Future scarcity of specific land is going to be VERY hard to predict, so unless you have some special skill in this area you’re just speculating.  Giving real estate investments preference because of some imagined inevitable payoff is a strategy that I think is very likely to disappoint.