One of the most compelling reasons for buying and owning rental investment real estate is the phenomena of expanding value and expanding return on investment. This occurs as a well bought and well maintained property experiences income growth and decreasing debt over the investment period.
As rents increase (modestly) year to year, and mortgages are paid down on a regular, escalating basis, the prudent and patient investor can watch while other people (tenants) work to pay off his property - bought (largely) with other peoples' (the bank's) money.
The following Case Study illustrates dramatically how this can be done. This analysis is of a property that I currently have listed for sale in Vancouver at 225 West 12th Avenue...
The Property: A legal 6-plex containing 3 - 1 bedroom suites and 3 bachelor suites in a well maintained building, with an area of approximately 3650 sq. ft. (including laundry, storage, mechanical areas etc.) It sits on a 50" x 124" RT-6 zoned lot approximately 2 blocks to Vancouver City Hall. The roof is newly replaced, the draintiles have been redone and an underground oil tank has been removed. There is a rear yard garage containing 3 separate single car bays, each with their own doors and electrical power.
The Income and Expenses: The current rental income is $4,030/month from the 6 suites, laundry and garage rental. This income may be immediately increased by renting out 2 of the garage bays (currently used by the owner for storage) for $125/month each.
Current expenses (adjusted for the latest Gas and Hydro increases) are $10,000/year, plus an additional $2,000/year for maintenance reserves. The Net Operating Income (NOI) is:
Rental Income (including garages): $4,280/month
Expenses (including reserves): 1,000/month
Net Operating Income (NOI) $3,280/month or $39,360/year.
We are predicting that Net Income will increase at a rate of 3% each year over the 5 year analysis period. This assumption is supported by historical rental information from CMHC, and by the fact that Vancouver has been experiencing a flat rental (and real estate) market for several years, and is now poised for a period of higher demand. The rental increases may not be as "straight line" as the analysis shows, but will average out over the 5 year period.
At a purchase price of $450,000, the analysis for this property is as follows:
Investment Analysis for Legal 6-plex, 225 West 12th Avenue, Vancouver B.C.
Purchase Price: $450,000 Capitalization Rate: 8.75%
Expense ratio: 23.4%
Net Income (NOI): $3,280/mo. or $39,360/yr Gross Rent Multiplier: 8.76
Financing: Purchased with a $337,500 (75% loan to value) 1st mortgage @ 7% interest, 5 year term, 25 year amortization and payments of $2,364/month or $28,368/year...
Down Payment: $112,500 Net Income (yr. 1): $3,280/mo or $39,360/yr
Closing Costs: 8,000 Less Debt Service: 2,364/mo or 28,368/yr
Total Investment: $120,500 Before Tax Cash:Flow: $916/mo or $10,992/yr
The Mortgage Balances and the mortgage paydowns at the end of each of the 1st 5 years:
Year 1 Year 2 Year 3 Year 4 Year 5
$332,257 $326,641 $320,624 $314,179 $307,275
$5,243 $5,616 $6,017 $6,445 $6,904