If Real Estate is Not Appreciating, is it Still a Good Investment?

Most of us have “heard a story”, or “know a guy”, who bought a house for $100,000 and sold it for $500,000 just a few short years later.   We don’t know all the details and don’t know how he got to this point, but all we know is that he had some huge capital appreciation.

So the question is….if real estate stops appreciating, is it still a good investment????

I won’t pretend to know the exact answer to this because no one can guarantee any investment…especially one that has so many external factors such as owning your own investment property, but I will try to crunch some numbers for you.

Take, for example, a student rental in Barrie, Ontario.  I will make some assumptions here for argument’s sake:

-          Typical homes near the college are selling in the $225,000 range.   

-          If there are 5 bedrooms, 400 + utilities per room is fairly typical.

Using these numbers, I have put together a pro-forma below.

Purchase price 225,000 Mortgage 180,000 Down payment 45,000 Land transfer tax 1,975 Legal fees, etc 2,000 Total investment 48,975 Mortgage pmt (25 year @ 3.2%) 870 Property tax 225 Insurance 150 Misc 200 Utilities 0 Total cost 1,445 Rent 2,000 Monthly cash flow 555 Yearly cash flow 6,660 Cash on cash return 13.6%

***Cash on cash return is calculated by dividing the yearly cashflow by the total initial investment***

The other thing to note here is that each month, a portion of the principal owing on the property will be paid down.  For this particular case, it would be approximately $300 per month ($3600 per year) on the conservative end.

This brings the yearly return to $10,260 per year.   This brings the yearly return to 21%!!!

Remember…..no appreciation!

Housing going under?

All over the news, you hear about the coming market correction….

“10, 20…even 30% drops are coming”…..Thanks Kevin O’Leary

Today on News Talk 1010 there was a guest speaking about the last time there was a significant correction (late 1980s), the apartment building he was living in had 90% vacancy!......not 90% occupancy…90% vacancy!...Must have been lonely in that building!

His argument was that today’s market, while being slightly overvalued, is not being plagued by high vacancy.  In fact, it is quite the opposite.

Another good point (one I have mentioned before) was made regarding the “generalization” made by the media about the “Canadian” housing market.

The truth is that there is no “Canadian market”….real estate markets are so specific, that one could not possibly generalize them, even within a city!

If I am looking for a condo on King Street in downtown Toronto, would that be different than looking near High Park? Absolutely!

Each city has markets.  Each market has submarkets.  Each submarket has several products (condo, townhouse, detached, semi-detached).  Each product has unique features.    Am I making my point here?

Yes I feel like real estate is WAY overheated in some areas….specifically Vancouver and Toronto… and most notably the condo market.

Do I think the market will crash? No

Would a decline in prices affect other areas? Maybe…but I don’t know how much.

The reality is that almost no one can accurately predict what the housing market will do. 

For someone looking to invest in real estate, my humble advice would be the following:

-          stay away from speculation (pre-construction anything)

-          invest in ‘starter’ homes

-          invest for cash flow, not appreciation (more on this in my next post)

Thoughts? :)