Categories
Real Estate

ROI on Investment Condo

As I’m coming up on the 6th month anniversary of purchasing my investment condo, I thought now might be an interesting time to have a look at the ROI (Return On Investment) on my investment.

How to calculate this had me scratching my head a little, so I’ll present the results and my methodology, and if this seems weird to anyone, please feel free to suggest other ways to calculate this.

After *ALL* regular, on-going costs (including condo fees, property taxes, insurance and mortgage INTEREST) I clear $256.62 / month. I took all the money I’ve put into the condo that WASN’T related to these expenses (e.g. ignoring mortgage payments, insurance payments, etc since I’d already accounted for them) and it adds up to $43,811.68 (remember this includes the down payment, legal fees, renovations, maintenance, etc). Therefore I’ve had a ROI of 3.51% (256.62*6/43,811.68) over the last 6 months, which is an annual ROI of 7.03%.

Just for interest’s (pardon the pun) sake, I calculated my ROI WITHOUT mortgage interest factored in and it was 8.88% (17.77% annually). This is interesting just because the interest rate will probably be the largest variable that will change on future deals (it should be a lot more volatile then rent, labour/material costs or other fees involved).

So 61% of the cashflow is going to the bank, and 39% is going to me. I’m not sure if that’s good or bad. Certainly I couldn’t have done the deal without the bank’s capital, and this should shift as time goes on (as the mortgage gets paid off, more of the cashflow will go to me each month). Additionally, any increases in the cashflow will go to me (just as any decreases would come out of my share, not the banks).

Ignoring the mortgage, my ongoing costs are about half the rent I’m collecting. I’ve read that the non-mortgage expenses of a rental property will usually be 45% of the market rate rent (in a normal, balanced rental market). This includes management fees (and people who claim to be running a property for a lot less than 45% usually are doing the management themselves and ignore the value of their time). Property managers usually charge 10% of the gross rent. Therefore I’m either significantly under-charging for rent (which I don’t think is the case as I tried to rent it out for more and couldn’t) or my expenses are very high compared to other rental properties (which I believe IS the case, people often say renting condos isn’t very cost effective).

Certainly not amazing, but nothing to sneeze at either (and I’ve learned quite a bit while earning that 7.03%).

This ignores vacancies (I’m assuming the tenants moved in the instant I bought which wasn’t the case), any maintenance expenses beyond the condo fees (which I’m hoping will be minimal), and my time and effort.

It also ignores appreciation of the value of the property, tax implications (postive and negative) and the discount I purchased the property at.

As much as I love condos and feel much more comfortable investing in them, perhaps I should be looking at a more lucrative form of rental property going into the future…

Q at $1 Million to My Name: You need to hold my hand while I buy my first apartment building! šŸ˜‰

Categories
Investing

Leveraged Investments ā€“ My Grand Plan

This is the first post in the “Leveraged Investments” series.

There has been a lot of discussion lately in blog world about leveraged investing so I thought I would add my take on the situation.I decided at the beginning of this year to look into the feasibility of using some leverage to buy dividend stocks.I figured with my long time line for this project, the favourable dividend taxation rates, and the tax deduction on the interest, that there was a reasonable chance to implement an investment plan which would eventually pay for itself from a cash flow point of view and provide an eventual net profit from the dividend flows and capital gains at the conclusion.

I have three posts prepared on this topic, todayā€™s post outlines ā€œthe planā€, next post will cover all the risks (and thereā€™s a lot of them) and some steps Iā€™m taking to manage the risks, and the last post will look in depth at my analysis of my personal interest rate risk which includes my mortgage as well the investment loan.

The basic plan is to use my home equity line of credit to buy dividend stocks in a taxable account. Stocks would be Canadian dividend stocks, strong record of dividend increases, great companies.Safety of the companies is of utmost concern.

The main reason I was inspired to think of this plan is because of the incredible record of dividend increases that a lot of these companies have had (10% to 20% over the last 10 years).Iā€™m well aware that this is an aberration however thatā€™s what got me interested in this type of investment in the first place.

The other reasons Iā€™m keen on the plan are because of the tax deductibility of the interest on the investment loan and the light tax on dividends. Another attraction is that if the plan is at least moderately successful, it wonā€™t cost me anything to implement.

Here is a model of a scenario that I’ve analyzed.In actual practice I wouldnā€™t buy $100k all at once, accumulation will be much more gradual and I donā€™t have a specific upper limit.

Some numbers – my marginal tax rate is 43%, tax rate on dividends is 21%. I set up a model where I buy $100k of stock yielding 3.1% and the dividends increase 5% per year. Interest rate is 6% and never changes.All figures have been discounted to 2007 dollars using a 3% discount rate.

$6000 is paid in interest each year, $2603 tax rebate received each year.

In the first year the dividend income is $3100, after tax dividend income is $2449 so the profit for me is the interest – tax rebate – net dividend income = -$948 for the first year.

In the second year, the dividends have increased by 5% so the annual profit = -$826.

In year eight the annual profit is now positive at $49 and it continues to grow after that.

At the end of year 14 ā€“ the total of all the cash flows in todayā€™s dollars add up to $436 which means that at that point in time, my overall cost at that point is zero and I have $436 in profit from the dividends.

By the end of the plan (25 years), the total of all the annual net profits/losses from dividends is $17,866 in 2007 dollars.To calculate the potential capital gain I took the gross dividend income in year 25 ($9,998), divide by 0.05 (Iā€™m assuming a 5% yield) which gives me a $200k valuation of the equities.I calculate that if I were to sell all the stocks at that time and pay off the loan I would have a 2007 present value of $38,500.Adding the net dividend income + net gains gives me $56,374 in 2007 dollars.

Bottom line is that in this model I’m paying only $3620in today’s dollars over the first seven years to get things started. Even in year one, 84% of the interest cost is covered by the tax rebate and net dividend. By the end of year 8 my cash flow is now positive and by year 14 I’ve broken even in that the annual profits I’ve received from the dividends have paid for my initial costs.If the plan works exactly as the model does then I would make a profit equivalent to $56,374 in 2007 dollars.

You might have noticed that like most leveraged plans this one didnā€™t mention any of the risks involvedā€¦.that will change tomorrow when I will go through every risk I could think of and how Iā€™m planning to mitigate those risks.

Here is my spreadsheet for this model: Div Sheet

See the next post in this series “The Risks”.

Categories
Real Estate

Getting Started With Investment Real Estate – Part 6

To start at the beginning – please see part 1 of this series.

Its amazing to me how this series of posts has grown. I’m half-tempted to work them into a more coherent essay format once I’m finished and have a permanent link on my side-bar.

I needed to find tenants at this point, which was suddenly a totally new (and totally scary) activity. I joked with my friends and family going through this process that each time I felt I had become somewhat proficient in a part of the process (condo hunting, negotiating, renovations, tenants screening, landlording) I then moved on to the next stage which required totally different skills and had me starting as a novice again.

My buddy who already owned buildings was good enough to keep advising me throughout the process. His feeling was that many property owners got scared when a unit was vacant and would jump for the first potential tenants. Often this just lead to problems down the line, which would cost more than having the unit sit vacant for a couple of months. He said EVERY time he’d accepted a tenant in haste, he had regretted it later, so I decided to learn from his experiences and hold out for a tenant that passed his screening process.

I signed up for Rent Check Credit Bureau (http://www.rentcheckcorp.com), which certainly wasn’t cheap ($75 annual membership, $20 per credit check), but it was a necessary part of the process. I got applicants to fill out an application form (that I got from my buddy) and had a standard lease (also from my friend).

Basically if you get someone’s SIN or their driver’s license you can look up FAR more information about them then you’d ever imagine (things like current balance on their Mastercard and student loans, it made me uncomfortable what I was able to look up).

You also need to collect references and whatnot on the application form. These aren’t QUITE what you think they’re for, but they’re quite important. The previous (current) landlord must be contacted. If they had late payments to them, they’re cut. I was going to rent to one small family, and their current landlord had 2 late-payments on record and they HADN’T GIVEN NOTICE (yet they wanted to move into my place in 1.5 weeks). That’s going to be a great situation when they move in to my place, then stiff their old landlord. If they lose the court battle, they’re going to be short paying me, and if they somehow weasel out of it, they’re going to leave me without proper notice. Forget that!

I also had a woman who gave me her current landlord’s contact info. While we were talking she mentioned that her father did engineering work for the government and was a property owner. I did a Google search on her “current landlords” phone number (always do this), and sure enough, it was an electrical engineer’s company with the same last name as her (hmm, quite a coincidence). When I called up and talked to her “landlord” I got a glowing reference. I asked if they knew her before she’d moved in, and they promised me, “no, no, she’s a great tenant and we first met her when she moved in”. If someone needs to use their MOTHER as a reference (AND lie about it), you’re going to have trouble with them.

The personal references are mostly just names / contact info that you can use to track down people who know the tenant if needed (e.g. if they run off without notice or payment).

I started advertising my unit at a price that was average on http://www.rentometer.com. I showed it to about 10 people and not one of them filled out an application. My buddy told me that if 1/2 the people who view it don’t fill out an application there’s a problem (usually its overpriced). If people don’t fill out an application ON-THE-SPOT they’re not interested. They’ll say they’ll think about it and get back to you (but they’re just being nice).

I dropped the price, showed it some more (and still wasn’t getting anyone to fill it out). I was starting to feel a little desparate, so I talked a woman who worked at the condo corporation office and she told me what the average 2 bedroom was renting for in the building. I added a little bit extra to this (assuming her experience was over a longer time and the current rent should be a bit higher). I also charged a little bit extra for smokers (since I’d have to repaint) and pet-owners.

One line of thought is that its worth underpricing your unit. My experience is that renters are VERY savvy about what the going rate is (more then I am probably, since they’ve been looking at lots of units). If you charge a little bit below market, you’ll get a TON of applicants. Being able to pick someone who looks really good (great credit history and reference from past landlord) and get them in there quickly will easily make up for losing $50 / month on rent. The last place I rented, I eventually moved because the landlord increased the rent $50 (I was paying $650 and he raised it to $700). I was thinking about moving anyway, and the increase just got me to move sooner. He wasn’t able to rent it for 2 months after I moved out, so from trying to get an extra $50 / month, he lost $1300 (it’d take him over 2 years to recoup that if he was able to get the new higher rent from the next tenant.

Having a unit sit empty is expensive, but putting a bad tenant into it is far worse. Renting under-market is the best way to quickly get a good tenant (the good tenants will also know when a place is a deal – paying your bills on time and understanding the cost of things go hand-in-hand).

In the end I found a delightful young couple with excellent credit, who paid $1300 / month for my condo (they had a cat so they paid the “pet premium”). So far so good (they’ve been there for 2.5 months so far).

In the next part I’ll talk a little bit about the repair issues that came up after they moved in.

(continued in part 7).

Categories
Investing

Why Iā€™m Not Crazy About Emerging Markets

Emerging markets are supposed to be the ā€˜hotā€™ markets, the place where the adventurous can get more return for more risk which is a tenet of many investment books including Four Pillars of Investing.

Iā€™ve noticed that there are quite a few funds particularly Latin American funds which are extremely volatile but donā€™t necessarily have ā€œbetterā€ long term returns although they have very good recent returns.

I decided to try doing some extremely unscientific research on emerging market mutual funds, using GlobeFund.com ā€“ ā€œemerging market fundsā€ category.

When I did the query on the emerging market funds, there were 71 funds available. I sorted by 10 year returns to get all the funds that have been around for at least 10 years which does not include funds which no longer exist but should be counted in the study (survivorship bias).

I got the ā€œsince inceptionā€ return ā€“ this is not all that scientific since the dates are not the same but the idea is that if people bought at the beginning of the fund ā€“ thatā€™s the long term return they would have. I took all these funds which have been around 10+ years and put the data on a spreadsheet. This group seems to be mostly Latin American funds.

I removed all the duplicates (ie US$ versions, different classes) and calculated the average return from inception which came out to 6.3%, if we add 2.75% mer that gives us approximately a 9.05% gross return.

Given the extreme ups and downs of this group ā€“ the returns donā€™t seem to match the risk whether you bought the index or a retail mutual fund. By way of comparison the TSX total return for the last 10 years is 10.33% and 15 yrs is 11.88% which is not only higher but with less volatility.Ā  MSCI Europe (Cdn$) was 8.93% for 10 years and 11.78% for 15 yrs.Ā  *S&P 500 Composite Total Return Idx($Cdn) was 5.56% for 10 years and 10.41% for 15 years.

Of course with emerging markets doing so well over the last 4 to 5 years it seems silly to worry about the long term returns but for someone who is thinking about starting an emerging market position now, they should be very cautious.

Are emerging markets worth their volatility? These markets are much more volatile than developed markets so if they donā€™t outperform over the long term then you are better off sticking with developed markets.

Iā€™m still planning to have a portion of my equity in emerging markets but I plan to err on the side of caution and will go a bit underweight in this sector.

Categories
Personal Finance

Passive Income

In addition to my networth statement, I thought I’d do some more details calculations on my passive income. As always, I realize my condo isn’t really passive (since I have to manage it), but the work is infrequent enough (hopefully) that I’m going to classify it as passive instead of treating it like a second job.

I’m calculating (and trying to decrease) my cost of living as well. When my after-tax passive income exceeds my cost-of-living I’ll be able to retire (on the assumptions that my passive income will increase at least as much as inflation and my lifestyle costs will stay the same or decrease).

BMO (136) – current dividend 2.72 – income: $369.92 / a, $30.83 / m ($25.90 after taxes)
ROC (471) – current dividend 1.20 – income: $565.20 / a, $47.10 / m ($39.56 after taxes)
E-trade margin debt – 9,188.30 – interest $648.18 / a, $53.60 / m ($35.38 after taxes)
Net: $24.33 / m (before taxes) $30.08 (after taxes)

Condo – $3000 / a, $250 / m – should be many deductions, including depreciation, such that I can get this tax free (hopefully, we’ll see how it works out when I’m doing my taxes).

Total passive income: $280.08 / m

Categories
Investing

My Portfolio ā€“ Summary

This is basically a summary of the last four posts where I described different parts of my portfolio using exchange traded funds.

For the equity/bonds split I decided to have 75% equity and 25% bonds. This is a reflection of my fairly long investment time horizon, I wonā€™t be retiring for about 17 years and will hopefully live a long, long time after that. This was also the recommendation by Bernstein as the ideal percentage of equities to own in a portfolio. There will be quite a bit of volatility with this mix so hopefully my risk tolerance is up to the task!

In the bond section which is 25% of the portfolio,

XSB ā€“ 8% – short term bond ETF which I decided was a better choice than a long term bond ETF.

GICs ā€“ 7% – canā€™t get much safer than this.

Bond fund ā€“ 5% – MER is 0.65% so a reasonable deal.

Real return bonds ā€“ 5% – This will be implemented by buying the ETF XRB ā€“ the iShares real return bond ETF.

In the equities section which is 75% of the portfolio we haveā€¦

Canadian: 20% – low cost mutual fund + one lot of BMO

U.S. 33% – VTI ā€“ Vanguard US equity ETF

International: 33% – new Vanguard EAFA ETF (not out yet) + low cost Europe fund

Emerging Market: 8% – VWO ā€“ Vanguard emerging market ETF ā€“ Iā€™m still thinking about this allocation.

Reits: 5% – XRE ā€“ iShares Reit index or possibly some Vanguard VNQ.

Total MER for the portfolio is 0.38% which is pretty good considering the current MER is about 1.2%. I will be tracking (pun intended) the tracking errors of the ETFs to see if that has a negative effect on the performance. The tracking error on ETFs is basically the difference between the index return minus the MER and the return of the ETF.

So there you have it, I still havenā€™t actually bought any of the ETFs yet since Iā€™m waiting for the new Vanguard EAFE ETF, so if you have any suggestions for changesā€¦itā€™s not too late!

Categories
Investing

Borrowing to Invest

I keep thinking there are some real opportunities to take advantage based on the idea of borrowing to invest (and the tax write offs revenue Canada offers for them).

Say I owned my house free-and-clear, and pay a 40% marginal tax rate (20% on dividend income). I could get a fixed-rate mortgage for 80% of the value of my home for 5.75% right now (3.3% after taxes, since I’m borrowing to invest and this is deductible). If I can safely get a 4.125% after taxes dividend-yield on my investment, then my dividends will pay for my mortgage.

Say instead, I deliberately sacrifice some yield and buy equal amounts of the big-6 banks (average dividend yield on them is around 3.25%, 2.73% after taxes in this case, right now I think). I’m now paying 0.57% on my mortgage (and the dividends are covering the rest). This is certainly a loss (since the 0.57% is coming out of my pocket), and people always say “don’t lose money just to spite revenue canada”, which makes good sense. HOWEVER I haven’t considered any capital gains or dividend increases in this situation. As long as the AVERAGE increase on these 6 bank stocks is greater than 0.57% a year (very likely if I’m holding for the long term), I should come out ahead. I will have to pay capital gains when I sell, but that will hopefully be at a point when I’m earning less income (or else why would I be selling?). Additionally, since I’m in a fixed rate mortgage, hopefully the dividends will increase (but the interest rate can’t), so if the dividends go up a little bit then I’m not out any money any more.

You could maximize this “risk protection” by going with a longer mortgage term (currently you could get a 10 year mortgage for 6.04%).

On a $200,000 mortgage this would cost $1140 / year, a nice little investment for $100 / month.

Obviously I’d be paying taxes when I sold the stocks (capital gains) or when the dividends increased, but that seems to be shifting my tax burden into the future (the same way an RRSP would), which people generally seem to feel is a good idea.

The risk to this is that the banks cut their dividends and all go bankrupt, then you’re back to paying a mortgage from scratch (as if you’d just bought the house). That would certainly suck, but I think the chance of *all* the banks dropping significantly is pretty small.

If I accept this risk, and want to get even more aggressive, I could choose a cash-back mortgage which would increase the interest rate (and hence the deduction) and provide more cash to buy dividends with (I would be counting on an increasing dividend / capital gains to compensate for this). This would cost more right now on a monthly basis, but that’s what I want (to shift income and taxation into the future). Getting EVEN MORE aggressive (I’m scaring myself now) would be to get the mortgage with the cashback, then buy the stock, then buy even more of the stock on margin (E*Trade would allows you to buy 70% on margin for stocks valued above $5). In theory you could buy $363,800 worth of bank stock (with a 200K mortgage, 7% cashback and 70% on margin). The stock could drop 41% before there was a margin call (and if you were earning a good income or had other liquid investments you could probably meet the call if this happened).

You could (if you had the extra income and wanted to maximize the future income) even keep buying additional stock (on margin) with the dividends and pay the mortgage payments with your income (assuming you could afford the full mortgage payments). This would be more a forced-savings / dollar-cost-averaging strategy rather then a taxation strategy though.

The “reasonable expectation of profit” that Canada Revenue insists on is certainly there (it wouldn’t be unreasonable to expect the stocks to go up 1% over the next year in the least aggressive situtation detailed above).

Does this work as I understand? Why don’t people do more of this (buying on margin / on mortgage for tax purposes instead of for leverage purposes) once they’ve maxed out their RRSP’s?

Thanks in advance for any thoughts or pointers to relevant books / articles!

Categories
Investing

DRiP at a Discount

I’d been looking for something like this and just found it: http://cdndrips.blogspot.com/

Its basically a listing of all the Canadian DRiPs, along with the discount (sweet!) they offer for shares purchased through the DRiP.