Real Estate

The Calculus of Investment Property

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  • Jan 14th, 2022 2:42 pm
[OP]
Deal Fanatic
Sep 23, 2007
5375 posts
1648 upvotes

The Calculus of Investment Property

I want to run my thought process of determining whether an investment property is worth the effort. Here is how I think and valuate. Let me know if there is something else I am not factoring in.

Let's say I want to buy a $500k condo in Toronto, and willing to put in $150k as downpayment (initial investment), resulting in a $350k mortgage. Let's further assume that the rental rate will be a conservative $2000/month.

So annually we talking this, conservatively:
Revenue: $24k (minor increase each year, and assume no vacancy. More than 2.5 months of vacancy and I would have an operating loss)

Less...
Let's say property tax will be $2k (minor increase each year)
Let's say condo fees $500/month = $6k (increasing each year)
Let's say operating costs for misc repairs etc is $1k
Let's say mortgage interest costs is 3% of $350k annual so roughly 10k (decreasing each year)

So right now net profit before tax is only about 5k. Let's say I'm at the highest marginal tax rate and after tax we have about 3k left.

So the net result is I dumped $150k to earn an annual operating profit of $3k in the best case. That's only 2% annual return (at least in the earlier years. Profit should increase as mortgage interest is reduced). If there are any vacancies, tenant issues, or if structural issues with the condo whereby everyone has to foot the bill, I would have an operating loss. Any of the e-banks earn better interest rates than this and it is guaranteed.

On top of the operating return I may or may not have capital appreciation. So let's say after 5 years, the value is now $600k (up from $500k). So on top of the 2% annual in operations, I would have $100k capital gain (50k taxable) and let's say again top tax bracket. So $30k net profit upon sale after 5 years.

So the operating profit is minimal and basically keeps up with inflation. Very possible loss if any vacancies or condo issues occur. We're really just gunning for the appreciation in capital. Stock investing easily beats the annual operating profit. In other words, investment properties in the current Toronto market is not actually very attractive if you consider the risks. There's also double land transfer tax and legal fees upon transfer of ownership. So the net amount you profit from capital sale is actually lower than $30k for an initial investment of $150k. Continued capital appreciation is not a sure thing. But increasing condo fees and mounting structural issues, and eventual vacancies are real and almost certain in the longer term.
42 replies
Deal Addict
User avatar
Dec 16, 2015
3829 posts
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Toronto
Its no calculus...just simple sense
To the moon
Deal Addict
Sep 19, 2009
2153 posts
921 upvotes
Toronto
The way you look at it, for sure does not make sense at all as investment.

People in Toronto see this differently though. You put in $150k and you are getting 10% of $500k, year over year, which is 30% rate of return. With this rate, and increasing of course, you really don't care much about expenses and rent income. If you do the calculation with 5% down only, as most people do, you are actually getting 200% return every year.
Last edited by andrew4321 on Jan 6th, 2020 5:01 pm, edited 1 time in total.
[OP]
Deal Fanatic
Sep 23, 2007
5375 posts
1648 upvotes
thisischris wrote: I stopped reading at down payment. I calculate without putting anything down. I use this calculator as a quick reference.

https://www.calculator.net/rental-prope ... lator.html

Outside the GTA cash flow is possible.
Thanks. This is helpful. Didn't know this existed. When I talk to people I find that most of them follow a different logic. Makes the exercise easier. I mentally separate capital gains with operating gains because appreciation is not certain but expenses are. But I can just put 0% as capital appreciation and do the calculation twice to consider the capital gains.

The result in the calculator matches what I did basically. Minimal operating profit even in the best scenarios. So people are just gunning for capital appreciation which may or may not continue.

How do you calculate without putting anything down? Isn't the initial downpayment(s) most important? Because after that, the investment is supposedly self funding from rental income.

I have been thinking to buy a condo but after this line of thinking, it doesn't seem like an attractive investment and more of a gamble on capital appreciation. The risk of tenant issues seem to be on the rise as government seems to continue to see Landlords as the bad guys. And after 5-10 years you probably have to swallow a big bill because the building have issues.
Newbie
Apr 18, 2009
50 posts
37 upvotes
Sorry i couldnt follow the last bit of math. With 100k profit after capital gains..arent you left with approx 70k.
Member
Jun 10, 2008
499 posts
375 upvotes
Halton Hills
BananaHunter wrote: Thanks. This is helpful. Didn't know this existed. When I talk to people I find that most of them follow a different logic. Makes the exercise easier. I mentally separate capital gains with operating gains because appreciation is not certain but expenses are. But I can just put 0% as capital appreciation and do the calculation twice to consider the capital gains.

The result in the calculator matches what I did basically. Minimal operating profit even in the best scenarios. So people are just gunning for capital appreciation which may or may not continue.

How do you calculate without putting anything down? Isn't the initial downpayment(s) most important? Because after that, the investment is supposedly self funding from rental income.

I have been thinking to buy a condo but after this line of thinking, it doesn't seem like an attractive investment and more of a gamble on capital appreciation. The risk of tenant issues seem to be on the rise as government seems to continue to see Landlords as the bad guys. And after 5-10 years you probably have to swallow a big bill because the building have issues.
I have equity in my primary residence so I borrow from my HELOC for my down payment. It's still tax deductible as long as you keep organized.
Deal Fanatic
Mar 27, 2004
7733 posts
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Toronto
You have to add the principal portion of the mortgage being paid off to your investment calculation. IRR is more important to look at.
Full-time Realtor
Deal Guru
Feb 22, 2011
12484 posts
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Toronto
oasis100 wrote: You have to add the principal portion of the mortgage being paid off to your investment calculation. IRR is more important to look at.
Mortgage pay down also increases every month so the longer you keep the property the more 'profitable' it is.

Or you can refinance and increase cash flow.
Deal Addict
Mar 22, 2010
3520 posts
1350 upvotes
BananaHunter wrote: So the net result is I dumped $150k to earn an annual operating profit of $3k in the best case. That's only 2% annual return (at least in the earlier years. Profit should increase as mortgage interest is reduced). If there are any vacancies, tenant issues, or if structural issues with the condo whereby everyone has to foot the bill, I would have an operating loss. Any of the e-banks earn better interest rates than this and it is guaranteed.

On top of the operating return I may or may not have capital appreciation. So let's say after 5 years, the value is now $600k (up from $500k). So on top of the 2% annual in operations, I would have $100k capital gain (50k taxable) and let's say again top tax bracket. So $30k net profit upon sale after 5 years.

So the operating profit is minimal and basically keeps up with inflation. Very possible loss if any vacancies or condo issues occur. We're really just gunning for the appreciation in capital. Stock investing easily beats the annual operating profit. In other words, investment properties in the current Toronto market is not actually very attractive if you consider the risks. There's also double land transfer tax and legal fees upon transfer of ownership. So the net amount you profit from capital sale is actually lower than $30k for an initial investment of $150k. Continued capital appreciation is not a sure thing. But increasing condo fees and mounting structural issues, and eventual vacancies are real and almost certain in the longer term.
Glad I am not the only who thought ROI on condo investment nowadays are greatly diminishing. Extremely hard to find that could generate even positive cash flow (with 20% down payment, your minimum rent has to be around 2300 to almost break even)

There are quite a few YT videos out there that present higher ROI (say 10% vicinity) and all they are doing is renting "Multi-plex" units (duplex, triplex, multiple housing units in one building) outside of Toronto/GTA.
Newbie
Sep 5, 2018
26 posts
37 upvotes
Maybe I missed something but I don't think your mortgage payment is accurate and is skewing your bottom line cash flow. You need to figure in your total monthly mortgage payment, which is interest and principal. Based on the calculator posted above, you're actually in the red each month (though your rental income is likely a bit conservative, as you said).

Achieving a cash flow rental from a normal condo resale, as others have said in this thread and others, is difficult - even breaking even could be challenging. You can go outside downtown for cheaper condos, but then the rent won't be as high.

You and others reading this thread who are serious about investing should look outside the GTA as an option - I'm talking 200km or more. My partner and I used our HELOC to fund 2 down payments for 2 investment properties in a smallish town in Bruce county. The area has seen major growth due to nuclear power and cannabis businesses. Property values have grown nearly 25% in the 1.5 years we've had them (and continue to grow due to a shortage of new housing).

There's a bit more work in going out to see places due to travel of course, and you likely will have to hire a manager (though ours charges only $95 per month). Both properties were instantly cashflow positive due to the low mortgage, high rent, no maintenance fees and rented within less than a week (there's also a shortage of rentals).

So if the GTA pro formas are frustrating you, look outside!
Member
Jun 10, 2008
499 posts
375 upvotes
Halton Hills
Same as chopkins78, I bought in Chatham. Cheap house, high rent. Cash flow with zero down and surprisingly decent appreciation over the past year.
Member
Jul 2, 2018
309 posts
299 upvotes
Chopkins78 wrote: Maybe I missed something but I don't think your mortgage payment is accurate and is skewing your bottom line cash flow. You need to figure in your total monthly mortgage payment, which is interest and principal. Based on the calculator posted above, you're actually in the red each month (though your rental income is likely a bit conservative, as you said).

Achieving a cash flow rental from a normal condo resale, as others have said in this thread and others, is difficult - even breaking even could be challenging. You can go outside downtown for cheaper condos, but then the rent won't be as high.

You and others reading this thread who are serious about investing should look outside the GTA as an option - I'm talking 200km or more. My partner and I used our HELOC to fund 2 down payments for 2 investment properties in a smallish town in Bruce county. The area has seen major growth due to nuclear power and cannabis businesses. Property values have grown nearly 25% in the 1.5 years we've had them (and continue to grow due to a shortage of new housing).

There's a bit more work in going out to see places due to travel of course, and you likely will have to hire a manager (though ours charges only $95 per month). Both properties were instantly cashflow positive due to the low mortgage, high rent, no maintenance fees and rented within less than a week (there's also a shortage of rentals).

So if the GTA pro formas are frustrating you, look outside!
The problem with a lot of "investors" is that they want to make a lot of money without any effort put in at all. Yet they're willing to spend 40 hours working at a job that pays nothing and then spend hours commuting to it. For those that are willing to put in the effort there is always money to be made.

(not direct at the OP as I don't know them, just a general observation)
Realtor + Investor
Member
Sep 15, 2018
439 posts
90 upvotes
BananaHunter wrote: I want to run my thought process of determining whether an investment property is worth the effort. Here is how I think and valuate. Let me know if there is something else I am not factoring in.

Let's say I want to buy a $500k condo in Toronto, and willing to put in $150k as downpayment (initial investment), resulting in a $350k mortgage. Let's further assume that the rental rate will be a conservative $2000/month.

So annually we talking this, conservatively:
Revenue: $24k (minor increase each year, and assume no vacancy. More than 2.5 months of vacancy and I would have an operating loss)

Less...
Let's say property tax will be $2k (minor increase each year)
Let's say condo fees $500/month = $6k (increasing each year)
Let's say operating costs for misc repairs etc is $1k
Let's say mortgage interest costs is 3% of $350k annual so roughly 10k (decreasing each year)

So right now net profit before tax is only about 5k. Let's say I'm at the highest marginal tax rate and after tax we have about 3k left.

So the net result is I dumped $150k to earn an annual operating profit of $3k in the best case. That's only 2% annual return (at least in the earlier years. Profit should increase as mortgage interest is reduced). If there are any vacancies, tenant issues, or if structural issues with the condo whereby everyone has to foot the bill, I would have an operating loss. Any of the e-banks earn better interest rates than this and it is guaranteed.

On top of the operating return I may or may not have capital appreciation. So let's say after 5 years, the value is now $600k (up from $500k). So on top of the 2% annual in operations, I would have $100k capital gain (50k taxable) and let's say again top tax bracket. So $30k net profit upon sale after 5 years.

So the operating profit is minimal and basically keeps up with inflation. Very possible loss if any vacancies or condo issues occur. We're really just gunning for the appreciation in capital. Stock investing easily beats the annual operating profit. In other words, investment properties in the current Toronto market is not actually very attractive if you consider the risks. There's also double land transfer tax and legal fees upon transfer of ownership. So the net amount you profit from capital sale is actually lower than $30k for an initial investment of $150k. Continued capital appreciation is not a sure thing. But increasing condo fees and mounting structural issues, and eventual vacancies are real and almost certain in the longer term.
rammar wrote: Sorry i couldnt follow the last bit of math. With 100k profit after capital gains..arent you left with approx 70k.
Was wondering the same thing, what happened to the other $50k?
Sr. Member
Jun 19, 2007
974 posts
1052 upvotes
Halifax
BananaHunter wrote: I want to run my thought process of determining whether an investment property is worth the effort. Here is how I think and valuate. Let me know if there is something else I am not factoring in.

Let's say I want to buy a $500k condo in Toronto, and willing to put in $150k as downpayment (initial investment), resulting in a $350k mortgage. Let's further assume that the rental rate will be a conservative $2000/month.

So annually we talking this, conservatively:
Revenue: $24k (minor increase each year, and assume no vacancy. More than 2.5 months of vacancy and I would have an operating loss)

Less...
Let's say property tax will be $2k (minor increase each year)
Let's say condo fees $500/month = $6k (increasing each year)
Let's say operating costs for misc repairs etc is $1k
Let's say mortgage interest costs is 3% of $350k annual so roughly 10k (decreasing each year)

So right now net profit before tax is only about 5k. Let's say I'm at the highest marginal tax rate and after tax we have about 3k left.

So the net result is I dumped $150k to earn an annual operating profit of $3k in the best case. That's only 2% annual return (at least in the earlier years. Profit should increase as mortgage interest is reduced). If there are any vacancies, tenant issues, or if structural issues with the condo whereby everyone has to foot the bill, I would have an operating loss. Any of the e-banks earn better interest rates than this and it is guaranteed.

On top of the operating return I may or may not have capital appreciation. So let's say after 5 years, the value is now $600k (up from $500k). So on top of the 2% annual in operations, I would have $100k capital gain (50k taxable) and let's say again top tax bracket. So $30k net profit upon sale after 5 years.

So the operating profit is minimal and basically keeps up with inflation. Very possible loss if any vacancies or condo issues occur. We're really just gunning for the appreciation in capital. Stock investing easily beats the annual operating profit. In other words, investment properties in the current Toronto market is not actually very attractive if you consider the risks. There's also double land transfer tax and legal fees upon transfer of ownership. So the net amount you profit from capital sale is actually lower than $30k for an initial investment of $150k. Continued capital appreciation is not a sure thing. But increasing condo fees and mounting structural issues, and eventual vacancies are real and almost certain in the longer term.
You're math is pretty good, while rents are conservative, I think your expenses/vacancy/maintenance are similarly so. Keep in mind too that most of those things are going to go up. (interest/tax/maintenance).

As others have pointed out, you are describing 5k of cash flow, while profit would be basically that, plus any equity built in the unit. It's very possible that your tax bill could be higher than 5k, resulting in negative net cash flow, but a profitable operation.

RE forums have become more and more like the bitcoin ones of 2 years ago. Despite supposedly being a currency, it is in reality a piss poor one, and many people were straight up arguing that it would be foolish to use it as such. "Sure, you could use that $5k worth of bit coin to buy a truck (presumably after going to the hassle and expense of converting it to fiat...) or the much smarter play I was told was to simply hoard it, and that 5k will be worth 15k of fiat in a year." Despite allegedly being a currency, using it as such was stupid. The smart play was to hoard it while it continues to appreciate relative to fiat to the moon.

Houses have become the same. The purpose of a house apparently is no longer to live in. It isn't to rent out to make money. It's to simply get your name on the ownership slip so that you can cash in on appreciation. Any money wasted by subsidizing a tenant, through egregious transactional costs, or having to take on high rate debt since your below average home eats up 120% of your disposable, above average income is moot, since as I read in another thread you're basically assured to be making almost $1k a day in appreciation. Bitcoin was the same. That it takes hours and $20 worth of electricity to conduct a simple transaction buying a bag of chips is irrelevant since despite being a currency, it's not to be used as such.

RE can be a great investment, but there is a reason why the rule of thumb is you want units to gross 10%/yr. (other's say 1%/mth or 12%/yr). Without appreciation as you correctly pointed out, you will be earning far less than a bank GIC, let alone a bank stock. Even the dividends alone would far eclipse to operating returns of RE, with a hassle factor that's at least 2 orders of magnitude less (unless your time is worthless I suppose....).
Banned
Dec 4, 2019
68 posts
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thisischris wrote: Same as chopkins78, I bought in Chatham. Cheap house, high rent. Cash flow with zero down and surprisingly decent appreciation over the past year.
What do you think about buying a detached in Niagara region?
Deal Fanatic
Jul 3, 2011
6517 posts
3788 upvotes
Thornhill
BananaHunter wrote: On top of the operating return I may or may not have capital appreciation. So let's say after 5 years, the value is now $600k (up from $500k). So on top of the 2% annual in operations, I would have $100k capital gain (50k taxable) and let's say again top tax bracket. So $30k net profit upon sale after 5 years.

So the operating profit is minimal and basically keeps up with inflation. Very possible loss if any vacancies or condo issues occur. We're really just gunning for the appreciation in capital. Stock investing easily beats the annual operating profit. In other words, investment properties in the current Toronto market is not actually very attractive if you consider the risks. There's also double land transfer tax and legal fees upon transfer of ownership. So the net amount you profit from capital sale is actually lower than $30k for an initial investment of $150k. Continued capital appreciation is not a sure thing. But increasing condo fees and mounting structural issues, and eventual vacancies are real and almost certain in the longer term.
Well not really.

Let's presume for a minute there is no taxable income which is very likely but your gain and tax bracket is as you say it is and the net tax rate on your capital gain is 50%.

Your gain would be the 100,000 - 25,000 =75,000/150,000 = 50% or 10% average per year.
Member
Jun 10, 2008
499 posts
375 upvotes
Halton Hills
Tornado32 wrote: What do you think about buying a detached in Niagara region?
I haven't monitored Niagara region. Closes I've watched was Crystal Lake for STR but was turned off when the beach was closed for a few weeks.
Deal Fanatic
Dec 20, 2018
7178 posts
6353 upvotes
BananaHunter wrote: Thanks. This is helpful. Didn't know this existed. When I talk to people I find that most of them follow a different logic. Makes the exercise easier. I mentally separate capital gains with operating gains because appreciation is not certain but expenses are. But I can just put 0% as capital appreciation and do the calculation twice to consider the capital gains.

The result in the calculator matches what I did basically. Minimal operating profit even in the best scenarios. So people are just gunning for capital appreciation which may or may not continue.

How do you calculate without putting anything down? Isn't the initial downpayment(s) most important? Because after that, the investment is supposedly self funding from rental income.

I have been thinking to buy a condo but after this line of thinking, it doesn't seem like an attractive investment and more of a gamble on capital appreciation. The risk of tenant issues seem to be on the rise as government seems to continue to see Landlords as the bad guys. And after 5-10 years you probably have to swallow a big bill because the building have issues.
It's about capital appreciation, just like buying most stocks.

As well, your acquisition costs are locked in (purchase price), but rent isn't and capital appreciation is expected (just like in stocks) and all the expenses like interest, condo fee, property tax etc are tax deductible

Also you failed to include principal portion of your mortgage. The mortgage payments is paying off principal as well as interest. You seem to treat the whole mortgage payment as interest only?

I mean , do you do same calculation buying stocks? Most don't pay a dividend or much of one. But instead, investors be it stocks or real estate is looking for capital gains

The rent much like dividend is just bonus

But yes, if you're risk adverse, stick with GIC and high interest savings account and avoid stocks or real estate, you're just statistically going to get a much lower return

And your rent assumption is not just conservative but absurdly low

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