Monday, May 2, 2011

Response: Rescue your retirement

I was reading the latest edition of Canadian Real Estate Magazine (May 2011) and an article by Gord Lemon and Daryl Hemingway caught my eye. It was titled "Rescue your retirement".

This caught my eye because I'm always interested in retiring early and the gist of the article is that you only need 5 properties, 17 years and you would be making $7376/month (not accounting for inflation still enough for most of us to live comfortably).

The properties they would be buying are duplexes @ $266,000 each per year... with a 25% down or $66,000 for each of the 5 years and rental income of $2300 per month. Mortgage of 5%.

Property Taxes : $250/month
Property Insurance: $100/month
Heating (gas) $325/month
Water/Sewer: $35/month
Vacancy allowance: 5% or $115/month
Total Expenses: $825

The numbers definitely sound very good, but I did have a few things that I believe would fairly difficult to overcome.

1. Where to find $66,000 a year?
Average family income of two or more people in 2008 was 74,600... so under 40,000 per person... then accounting for %35 housing costs... the average household would have difficulty saving up $66K a year for the down payment. Not that this is impossible, there are definitely households that make much more than this. As well this is an article targeting those in their 50's and many people of that age do own their own home and might have $330,000 equity in their house to take out in the course of 5 years. But definitely not a viable strategy for those without a decent nest egg or equity already built up.

2. Where to find duplexes with over 10% cap rate and at $266,000?
Average Canadian single family house prices were $327,000 excluding Vancouver. To find a duplex at $266,000 (meaning $133,000 per side) which also rents at $2300 (or $1150 per side) seems like it might be a tad difficult. It might be possible in the US market... but there are definitely other concerns when buying in the US (financing for one, currency risk, I'll try and get into more in another article). Plus this article was written on Canadian Real Estate Magazine so I'm assuming Canadian deals can be found. I guess if you're only looking for ONE deal a year there might be a very motivated seller every year that you can find. Possibly with creative solutions. Just seems very difficult even in a fairly cheap market like Regina where I am looking.

3. Missing a few numbers like Repairs and Maintenance, Property Management and Cash to close?
It's usually good to budget 3 to 5% for repairs and maintenance every year... because properties do require maintenance (roof, furnace, windows, yard, etc)... I do like their fairly conservative vacancy allowance of 5%... so lets add another 5% to maintenance. (Another $115). While you can manage your own properties... I for one know I can't find duplexes in Yellowknife for that price (more like double that price bare minimum... or close to 800K for the one I currently live in... 400K a side)... which is why I am buying in Regina. Property Management is usually around 8 to 12%... with many just charging a flat 10% of gross rents so to be conservative lets say $230. Their net cashflow is already down to $63... still positive and with all the conservative numbers probably more than that in reality... but still.

My other concern is how they just pay the $66000 a year and are able to own the property... There's still the lawyers fees, appraisal for the bank, Inspections (house, sewer lines, furnace, possibly electrical and plumbing, structural), title insurance and I like to have at least a months rent reserved (will you really rent it out the DAY you gain possession or will you have to correct details brought up in the house inspection first?). I'd say you'd need closer to 72K for cash to close a year for a $266,000 property. (or about 9% more)

I have a minor quip about the insurance as well. Rental properties are higher insurance risks than normal owner occupied properties. My insurance on my $140,000 property in Regina is $1064 a year... I'm guessing it would cost me more than the $100/month they have budgeted for a duplex at $266,000. This of course depends on the age of the property, location of the property (different jurisdictions have different costs... and even different locations in a city could have an effect on the cost).

4. What kind of mortgage allows THAT much of a pay down every year?
I don't know where they are getting their mortgage terms, but they seem VERY flexible. I mean I have a mortgage that lets me double my payments and put up to %15 a year on my mortgage... but near the middle of the plan they seem to already be putting a lot more money into each mortgage then can be done without penalty. I guess theoretically they could be spreading it out amongst the mortgages and it is LIKE they've paid off each property in year 8, 12,14, and 16... in terms of the amount of equity they have in the properties... anyways this one is minor... if the other 3 points didn't get you... this 4th point is minor.

It was an interesting article that I think makes investing in real estate sound a bit too easy. A good little thought provoking exercise IF you everything in the article was taken at face value. So you have $330,000 (or$360,000 that I believe you would need) AND you can find duplexes at that price ever year for that amount of rent AND you manage the properties yourself AND your houses never need maintenance... anyways you get my point.

If we're looking at thought exercises and not having to account for inflation... you can grow $330K into 1.5 million at 10% a year... which was what the stock market traditionally returned before inflation. Meaning on the 18th year you would make 151K... or about $12600 a month... which is quite a bit more than the $7376 / month with the real estate. (I also didn't account for taxes... but neither did this article... though there are more ways to shelter from taxes in real estate... hopefully I'll remember to get into that later as well)

Both are fairly nebulous in my opinion, but the basic concept is the same... basically have a plan, keep saving and eventually with time your money will compound and you can be financially free! Which I do totally believe in... so the message is good.

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