Steady returns in the real estate market
In early 2020 I bought an investment property in the lower mainland for $450,000.
It’s been 2 full years since I’ve owned it.
Let’s see the numbers for this past year.
Second year operating profit = 6.74%
My rental income was $1,800 a month or $21,600 a year.
The cost to manage the property was $11,900 in total, which include:
*Mortgage interest = $7,450
*Strata fee $2,460
*Property tax $1,600
So my net gain from operations is ($21,600-$11,900) which is $9,700/year.
Annual Profit = Net gain / Cost of investment
Net gain = $9,700
Cost of investment: $144,000 (The initial capital I put into this property)
Annual Profit = $9,700 / $144,000 = 6.74%
Operating profit is only part of the story. I’m counting on price appreciation as well.
According to the most recent BC Assessment data, my investment condo is worth $750 per square feet. Up from $725 last year.
This puts the value of my condo at roughly $479,000. Which is $15,000 more than last year.
With my net operating income of $9,700 and an additional $15,000 of appreciation, my second year of being a landlord produced $24,700 of gains before taxes. 🙂
My initial investment was $144,000, so my ROI is ($24,700/$144,000) = $17.15 for 2021.
I’m pretty happy about the 17% return. This is slightly higher than the 16% return I earned in the previous year.
Year 3 Expected ROI = 18%
For this third year in 2022, I’m expecting the ROI to be 18%.
I don’t want to count all my chickens before they hatch. But there are a few reasons for this higher guidance.
- Lower mortgage expense. Every month my mortgage balance shrinks by roughly $900. This means my interest cost gradually decreases throughout the year.
-In 2020 I paid $7,680 in mortgage interest.
-In 2021 I paid $7,450.
-In 2022 I expect to pay just $7,200.
Every year this expense falls by a larger amount. I have a 5 year fixed rate mortgage at 2.44%.
- I’m raising the rent from $1,800 to $1,825 per month. I hope my tenant won’t mind too much. 😅
- Higher condo valuations in 2022. Prices of detached houses and townhouses increased a lot last year. Condo price growth lagged by comparison. I think this year is when condo prices will play catch up. So I expect at least 5% price growth for apartments in 2022.
As I’ve mentioned in previous posts, even in an expensive real estate market there are still profitable real estate investment opportunities. 🙂
That being said, there are a few important points to disclose. Most of my readers are too kind to voice critical opinions, so let me plays devil’s advocate.
Why real estate investing is not for everyone
First, the idea that you can buy a rental unit in the GTA or Metro Vancouver and earn 17% ROI is probably not going to happen, unless you’re willing to put in the initial work and planning. I don’t want to give the impression that you can buy any random listing on the MLS, and watch the money come in, lol.
In my case I was searching specifically for low-rise apartments with high cap rates. I then vetted many potential renters before choosing a suitable tenant.
If you don’t have the patience to put in tens of hours of initial work, then you may only get a 10% return on your investment property. Maybe that’s perfectly acceptable depending on your goals. 🙂
And if you work even harder than I did, and renovate/rehab an older unit, you can probably earn 20% ROI or higher. The real estate market rewards any investor who’s willing to put in the time and effort to learn how it works. Like any other venture, the more sweat equity you put in, the greater the financial benefits you will receive over time. 🙂
The second critique would be that despite a decent 17% ROI, I would have made more money had I just invested in a diversified equity index fund. Last year the TSX, Canada’s stock market benchmark, returned 22%. And the U.S. S&P 500 returned 29% completely passively to investors. Those are much better returns than what my investment condo produced.
I like to own both asset classes because I don’t want to miss out on gains either in real estate or the stock market, lol.
The third issue is the high transactional costs associated with real estate investing, which can be 5% to 10% of a property’s price. I have a personal policy of holding real estate for at least 6 years before selling, which helps to mitigate the friction cost.
This is why you need to make a relatively higher return on real estate than for financial assets. For example, if you buy a stock and it goes up 10%, your after tax return might be 8% if you sell it. However if you buy and sell a rental property with a 10% price appreciation, your net return after closing costs, agent’s commission, and land transfer tax, might be whittled down to just 4% or 5%, depending on your holding period. 🙁
Real estate prices look to be going higher over the next few years, especially in larger cities. The Bank of Canada had the chance to make the cost of borrowing more expensive last week and they showed their true colours. They left the benchmark rate unchanged despite inflation running at 4.8%, which is a 31 year high.
This is not a surprise. Many times I’ve mentioned the forecasted 3 to 4 hikes this year sounds way too optimistic.
Let’s not forget, the people who set these monetary policies have their financial assets in the stock market just like other investors. There’s no incentive for them to suppress the market by raising rates unless they really have to. Oh well. I don’t make the rules. I just play the game to win. 😉
Here’s a 5 year progression of my investment property annual returns.
- 2020 – 16% actual
- 2021 – 17% actual
- 2022 – 18% expected
- 2023 – 20% expected
- 2024 – 22% expected
The next time I renew this mortgage I will probably go with a variable rate.
Random Useless Fact:
Emmanuel Macron’s stepson is older than he is.