Friday, November 27, 2015

When Maximum Leverage = Negative Leverage

In a world of low interest rates and plenty of commercial mortgage options, how could we ever experience “NEGATIVE LEVERAGE?"

Surprisingly, it happens and when it does - the fall out becomes a cash flow problem and an investment property - which becomes best described as a “POOR INVESTMENT”.

Firstly, here’s how it occurs (mathematically). Consider the following illustration:

Property Purchase 1

I - Price - $100,000 (no mortgage) 
w/ Annual ROI on Cash Invested of 6% (Yields $6,000 /yr.)

II - Price - $100,000 (mortgage of $80,000 @ Int. Rate of 7%) w/ Annual ROI on Cash Invested -1.23% (Yields -$1385.40/yr).

In the above example, NEGATIVE LEVERAGE is created by the fact that the mortgage rate is above the overall return component as shown in ‘I’ (no mortgage). If for whatever reason, the mortgage interest rate exceeds the basic return component for the property, you will find yourself in a NEGATIVE LEVERAGE situation.

Market opportunities where maximum leverage is often promoted, may well lower your initial investment requirements, only to create cash flow problems once mortgaging costs are factored in. Best practice here - is investigate mortgage options available on any prospective investment and compare it back to the basic return component which the cash flow provides.

The concept of LEVERAGE is widely accepted strategy in the real estate industry – keep the focus on “POSITIVE LEVERAGE”!

How does your market area look as we close out 2015.? Has it been a good year to add to your portfolio, or to sell investment properties? 

Ready – Willing - & Able to be of service in Windsor-Essex - give us a call!

Mark Lalovich
Office: (519) 966-0444
Cell: (519) 259-5434

Tuesday, November 24, 2015

Double Taxation - Ontario to Allow Municipalities to Charge Land Transfer Tax

The Ontario Ministry of Municipal Affairs and Housing has indicated they are extending the power of municipalities across the province to charge a land transfer tax according to the Ontario Real Estate Association.

Source: Orea Blog

This additional cost of buying a home, already in place in Toronto, would double the effective tax and could add thousands of dollars to the cost of buying a home in the province.

“Ontario home buyers are already charged a provincial land transfer tax, so by adding a municipal tax, they’re essentially doubling the tax burden on Ontario families,” said Patricia Verge, president of OREA. “If the Ontario Liberals follow through with this plan, home buyers will be forced to pay $10,000 in total land transfer taxes on the average priced home in Ontario, starting as early as next year.”

Here is the breakdown of existing land transfer tax rates in Ontario:
  • 0.5% up to and including $55,000
  • 1% above $55,000 up to and including $250,000
  • 1.5% above $250,000
  • 2% above $400,000 where the land contains one or two single family residences.
So with an Ontario average sale price around $470,000, you are talking about $5875 for land transfer tax and an effective rate rate of approx 1.24%. With this doubling to include municipal land transfer tax we are talking about $11,750 or an almost 2.5% tax rate. This is not an inconsequential amount and will add a significant burden to homebuyers and the housing sector which is a large segement of our economy.

Next week we are going to be talking about the ramification of this potential tax.

In the meantime, we encourage all Ontarians to visit to learn more about the negative impact of the MLTT and stop this tax from spreading province-wide.

Russel Lalovich
Office: (519) 966-0444
Cell: (519) 995-5620

Thursday, November 19, 2015

Property Appreciation - Boosting The Return!

Historically, real estate markets have risen over time – be it 10-20-30+ year periods. Although there have been negative years or periods over time (consider 2008-2010) across many North American markets - but generally the overall trend is up when you look at the big picture. This is a basic ‘principle of investing’ for investors as they consider commercial property alternatives.

In recent blogs we’ve highlighted the importance of ‘ CASH FLOW ‘, but when you factor in ‘FUTURE APPRECIATION’ – the result is an unbelievable money-making & return-boosting combo. Consider the following simple illustration –

See Blog from 11/5/15 – same illustration

2000’ Building – Price - $180,000 (acquired in 2014)
Net Rental Income - $16,000
Cash on cash return - 13.4% - 5 yr return
Projected Sale Price (2019) - $230,000
Capital Gain at time of Sale - $50,000 (+ annualized return of $10,000/yr over the ownership period)

Source: Vancouver Sun


$10,000/$54,000 (original cash investment) adds an additional 19% return at time of sale

Lots of assumptions made here - biggest of which is a 5% per year growth expectation on the real estate value itself. But this is made based on an assessment of the local market / economy, current stability of the leases /cash flow, and any anticipated capital needs for the property. Can this projection be off – sure, appreciation may be restricted to 2-3% per year or unexpected capital improvements on the property may arise , which can curb or impact our projected boost. But the bottom – line is , we believe in the investment property on a ‘forward thinking basis’ and fully expect it to appreciate over this 5 year period.

Based on our experience, property investors come to us with various criteria, investing models, and expectations. But the one common denominator is consistently the expectation of “PROPERTY APPRECIATION” – meaning it will be worth more down the road and they pursue property investments according.

An expectation of APPRECIATION over time is fundamental to property investing – and real estate markets historically have delivered for the most part. Again, our illustration is actual and we will continue to report on it in future posts.

How are things ‘forward thinking’ in your market?

Again, always ON CALL to respond to your interest in the Windsor – Essex market.

Mark Lalovich
Office: (519) 966-0444
Cell: (519) 259-5434

Tuesday, November 17, 2015

6 Things You Should Look For In A Stable Condo

When you own a condo, you own your individual unit, but you are also entitled to use the common areas of the building. Compared to a single family home, when decision making regarding the property is generally your own, in condos most decisions are made by the condo corporation.

This brings with it an element of partnership among your common condo owners. Considering this ownership structure, it is important to feel comfortable with the future stability of the property and the condo corporation.

Source: Ottawa Citizen

6 Factors To Look For:
  1. Professional management by a management company with experience managing condos. This is important because they run the financials of the building, reserve fund studies, board meetings, implementing of operational changes, etc.
  2. An engaged board of directors of the condo corp (who live in the building) and who will act in the best interests of the condo owners.
  3. A low to moderate amount of sale turnover. Generally it is positive for a building to have a limited amount of annual sales in the building and have a building with a majority of long term owners. This is indicative of happy owners and with long time horizons of ownership. Buildings that always have several units for sale is sometimes a red flag of problems and there is always a steady supply of people looking to sell.
  4. Low to moderate amount of units that are tenanted. Having a large supply of owner occupants is usually indicative of pride of ownership in the building and lesser ‘wear and tear’ of the building. Tenants also usually will not be long term, which from #3 above, hurts stability of the building. Having a large supply of tenanted units in the building can also be a red flag that there is an overhang of units for sale that sellers are unable to unload.
  5. Generally stable condo fees. Stable condo fees are indicative of good financial management of the costs and liabilities of the condo corp. If they are changing, make sure they are for a good reason (like increasing hydro and water costs in Ontario, which are out of control of management).
  6. Limited history of special assessments. A special assessment usually comes down when an item or items needs to be replaced or repaired in the building and aren’t budgeted for as part of the reserve fund. We will do an in depth post of special assessments in an upcoming post. Having a limited history of this is generally positive and ties in with #5 of good financial management and maintenance of the building. Having a long history of special assessments can be a major red flag as the building may have serious physical/structural issues.

This is far from an exhaustive list but give you a few general things to look for in a stable condo building. Always make sure to do your due diligence!

Is there something you look for in a stable condo that's not on this list? We'd love to know - leave us a comment!

Russel Lalovich
Office: (519) 966-0444
Cell: (519) 995-5620

Thursday, November 12, 2015

Positive Cash Flow = Positive Debt Coverage Ratio (DCR)

After you determine an income property yields a POSITIVE CASH FLOW, the next step is to calculate the property’s ability to service mortgage financing costs out of this cash flow.

The standard measurement within the investing world is referred to as the DEBT COVERAGE RATIO (DCR). DCR is simply comparing the property’s net operating income (NOI) to the projected mortgage financing costs – typically on both a monthly and annual basis.

Banks/Lenders typically look at DCR closely, wanting to confirm that the cash flow is sufficient to cover the related debt cost (aka monthly mortgage payment). In fact, most often they are looking to see a positive margin, which exceeds the mortgage servicing costs.

Source: Politico

Using a ‘break –even’ analogy, if the cash flow just meets the debt service costs - this would be a simple ‘break even’ outcome.

Consider the following illustration:

Property 1 
Net Operating Income - $75000
Mortgage Costs (Debt) - $50,000
DCR – 1.5

Property 2
Net Operating Income - $45,000
Mortgage Costs - $50,000
DCR - .9

*All $ amounts are annual

In the case of property 1, the cash flow exceeds the funds required to cover the mortgage requirement. In the case of property 2, a deficit is created ($5,000) which is not only an annual loss, but creates a negative return on actual cash invested.

In layman’s terms, a DCR of (1) is a ‘break-even’ - a DCR of (1.5) is ‘positive’ - a DCR of (.9) is ‘negative’. For investment purposes, this is how you should approach your analysis.

Just a final word on the bankers/lenders, you’re ability to negotiate favourable mortgage terms are clearly impacted by the property’s DCR. This gives you some insight as to how they evaluate risk in underwriting mortgages and how it ultimately impacts your proposed purchase.

How are lenders approaching DCR in your area? How does it affect rates offered and other terms proposed? 

Feel free to reach out to us, should you have interest in the Windsor-Essex market. As always, appreciate any feedback in the comments!

Mark Lalovich
Office: (519) 966-0444
Cell: (519) 259-5434

Tuesday, November 10, 2015

Breaking News - Vacancy Rates in Windsor Drop Below 4%!

CMHC (Canada Mortgage and Housing Corporation) released its latest rental market survey last week and Windsor’s vacancy rate has declined again.

Last year’s vacancy rate of 4.3% is now down to 3.9%.

Source: Urbanite News
This marks the 7th straight year that vacancy rates in the area are down in the area. Average rents also edged up by 2.8% year over year. The final report will be released in December.

How can we interpret this news? Here are some of the takeaways:
  1. This is good news for the multifamily sector as they have lower vacancy and therefore higher net incomes. This is also good for property values as this translates into higher valuations based on the income approach.
  2. The population must be growing again as more and more units are being occupied.
  3. This moves the Windsor market further inline with the Ontario average of 3.1%.
  4. The vacancy rate has continued its decline since 2008, toping out north of 14%. This is a remarkable turnaround.
  5. This puts Windsor vacancy rate below those of large markets such as Calgary (5.3%) and Edmonton (4.2%).
  6. This could put further demand pressure on the housing market as more and more renters decide to leave a tight rental market and buy a home.
  7. Landlords could begin looking to build rental units as the economics improve with these lower vacancy rates. We have already seen one starting in the suburb of Lasalle this year.
  8. Tenants will have a harder time finding units to rent and will be looking at paying higher rents than they have been.
Overall this is very positive news for Windsor, its economy and investors in the community.

Readers, what do you make of this news?

Russel Lalovich
Office: (519) 966-0444
Cell: (519) 995-5620

Friday, November 6, 2015

Property Investing - CASH FLOW IS KING

Better yet -- “POSITIVE” CASH FLOW is king.

In any financial analysis of a potential investment, this should be at the top of the list as you review the opportunity it presents. In fact, as markets and prices continue to march higher, cash flow margins continue to feel the squeeze which only increases the overall investment risk.

Source: Polus Capital

Look at the following simple illustration to better understand what we refer to as CASH FLOW –

2000’ – 2 unit building
Purchase Price - $180,000
Net Rental Income - $16,000 (*)
(* NRI after all property operating costs – ie. taxes, mgmt., ins. are recovered from the Tenants)

This $16,000 represents an 8.9% return ($16,000 divided by $180,000), if we are looking at a straight cash purchase. However, when we consider arranging financing on the property, this cash flow becomes the source of dollars to make the monthly mortgage payment. If we assume a 3.5% mortgage rate on 70% of the purchase price ($126,000 - 5 year term & 20 year amortization) – the monthly payment is $729.12. After covering the monthly mortgage payment, the net annual income (after debt) is approximately $7250. Based on the cash flow in this example and the mortgage assumptions , the cash-on-cash return increases to 13.4%. This again highlights LEVERAGE, but it is only made possible based on the strength of the CASH FLOW.

Seasoned investment pros focus almost exclusively on properties that are cash-flow positive and make any assumptions based only on realistic projections. What assumptions are we referring to:

• Lease rate projections on upcoming renewals
• Leasing current vacancies and based on what rates
• Improvement allowances/incentives required to keep or attract tenants
• Impact of overall property upgrades (ie. roof , parking lot replacements) on cash flow
• Cash flow requirements to service the financing on the investment (aka DEBT SERVICE)
• Market trending up/down/sideways and its effect on your “EXIT STRATEGY”

Be a KING - a POSITIVE CASH FLOW KING, and wear your crown as you pursue every property investment! And for the record, the above example is an actual deal from 2014 and the investors are very pleased with this particular investment.

Let us know how you see things from your market area, and of course, we are always ON CALL to respond to your interest in the Windsor-Essex market.

Mark Lalovich
Office: 519-966-0444
Cell: 519-259-5434

Tuesday, November 3, 2015

Condo Living - What Is A Reserve Fund?

For many people, THE MOST CONFUSING aspect of condo living comes from the reserve fund.

When looking at purchasing a condo in a specific building, it is general practice to review the latest reserve fund study. But what exactly is a reserve fund? And what should one look for when reviewing a reserve fund study?

‘Reserve Fund’ - An account set aside by an individual or business to meet any unexpected costs that may arise in the future as well as the future costs of upkeep.

“Reserve Fund Study” - A reserve study is a long-term capital budget planning tool which identifies the current status of the reserve fund and a stable and equitable funding plan to offset ongoing deterioration, resulting in sufficient funds when those anticipated major common area expenditures actually occur. The reserve study consists of two parts: the physical analysis and the financial analysis. This document is often prepared by an outside independent consultant for the benefit of administrators (Board of Directors or Strata Council Members) of a property with multiple owners, such as a condominium association or homeowners' association (HOA), strata, containing an assessment of the state of the commonly owned property components as determined by the particular association's CC&Rs and bylaws.

Source: Houzz

Reserve studies are in essence planning tools designed to help the board anticipate, and prepare for, the property's major repair and replacement projects. For example, such projects would include: replacement of the roof on the building(s), replacement of the boiler, retrofit of the fire alarm devices, and resurfacing of the roadways.

The reserve fund, as we know from last week’s post, is funded through the monthly condo fees of the residents. This reserve fund essentially smoothes out the costs of the major repairs and replacement projects.

Proper planning and financial management is essential in making sure funds are accessible as the need for these projects arise.

Subsection 94 (1) of the Condominium Act, 1998, requires the corporation to conduct periodic studies to determine whether the amount of money in the reserve fund and the amount of contributions collected by the corporation are adequate to provide for the expected costs of major repair and replacement of the common elements and assets of the corporation.

Source: Malvern

These periodic reviews, are important to ensure the existing reserve fund and planned reserve fund contributions (assets of the corporation), meet the expected costs of major repairs and replacement (liabiliities of the corporation).

Otherwise, the corporation could be surprised one day and not be able to meet its obligations, and be required to levy special assessments on the residents, who may have problems in paying.

Make sure when you are looking to purchase a condo in a specific building, that you review the reserve fund and latest reserve fund study, to make sure the condo corporation “has their financial house in order”. Otherwise you could be looking at unexpected future costs.

It is also a good idea to have your lawyer review these documents to ensure there are no irregularities. Better safe than sorry.

Next up we look at what factors to look for in a stable condo building.

Russel Lalovich
Office: (519) 966-0444
Cell: (519) 995-5620