How To Evaluate ROI and Why I Choose to Never Cash Out!

I have an ongoing joke with my wife about the current real estate market – we call it the ‘wild wild west!’.  Honestly, it is utter insanity out there.  List price doesn’t mean much, and comparable sales analysis – how does one even begin to calculate the fair market value of a property?

I was scouring my Facebook feed the other day, and a Realtor in the GTA had posted something about ‘Sell Your Real Estate Now and Cash Out!”.  It sparked a lot of commentary – and I get it.  Everyone is buzzing about the market, tracking what homes on their street sold for and what the value of their personal home is.  But at the end of the day, if you sell, where are you going to go?  Moreover, my personal belief is that once you exit this market, there is going to be very little chance of getting back in.

The whole concept of selling properties comes down to cash in the bank right?  People like the idea of cashing out – seeing that massive cheque.  I know – the struggle is real.  Even investors who intend to hold long term are getting the itch when they see the market performing the way it is.

But I personally never sell.  I buy and hold, and when the market does well, I refinance.  I am in it for the long haul.  And let me tell you why – where else am I going to put my money?  There is no other investment I know that has the ROI (Return on Investment) that real estate does.  I have done it all – stocks, mutual funds, options trading, forex – and there is no other investment vehicle out there quite like it.

First and foremost it all comes down to one word – leverage.  Think about it – you put 20% of your money down on an investment, and the bank puts up the other 80%.  However, your returns are based on the full 100% of the price.  Your tenants pay down your mortgage every month, you get a little cash flow and over time your property appreciates (even without a crazy spike like the one we are seeing right now!).

When you calculate ROI (Return on Investment) – you are basing it on the 20% of the purchase price that you put into the deal vs the returns you get (cash flow + mortgage pay down).  When we crunch the numbers for some of our deals – this can amount to 15-20% – without even factoring in any appreciation.  Not a bad investment, you think to yourself.

Moreover, every year more of your mortgage payment goes towards your principal (your loan amount is getting smaller) so your ROI actually increases year over year.

And because we are Savvy Investors, we purchase in areas that are poised for growth.  We look at the economic fundamentals of an area including job growth and transportation to buy in areas that are likely to have long term sustained growth.  We call it the ‘good homes in good areas’ strategy!

Sometimes investors get caught up in the purchase price – ‘Wow that’s expensive for that area’ or ‘I was buying in the same area for much less last year’.  And I get it – this market growth is difficult to fathom.

But I like to stick to the fundamentals.  Do the numbers make sense, and what is the ROI.

We cannot control the market, but we can make sure to purchase investments that have good numbers.

I’ll give you an example.  A client of mine just purchased a two unit home in Hamilton. This home has ultra high end finishes and is set up as a two family home with high ceilings in both units.  With a little tweaking, it can likely be legalized without a problem.  Because there are two units (so 2x the rents) and because it is such a rare product (the finishes are one of a kind) it sold for a premium price.  Higher than some of the other homes on the street.

But my client saw beyond that.  They saw the ROI – based on the condition of the home we are going to be able to charge higher than average rents and attract an A+ tenant.  The home is in perfect condition and there will be minimal maintenance expenses.  So the numbers make amazing sense.  And in terms of your investment amount, remember that for every $50,000 increase in price, that is still only $10,000 more out of your pocket (back to the power of leverage).

So if the property is able to cash flow, is in a good area with strong economic fundamentals and is in a condition that will attract good tenants – well, put your scepticism aside.  As the saying goes,” If it looks like a duck, swims like a duck and quacks like a duck…..then it probably is a duck!

The market is the market.  You can’t predict it and you certainly can’t change it.  I know it is easy to get wrapped up in what is happening out there – with bidding wars and properties going for record breaking prices.  But I urge you to leave that all aside and stick to the numbers.  Does the ROI on this property make sense?

People have been using real estate as an investment vehicle since the beginning of time.  You buy, hold, and stick with it as a long term plan.  The market has been through lots of ebbs and flows – from changes in prices to massive fluctuations in interest rates (a whopping 19% in 1991).  But for those tried and true veteran investors, they will tell you that they never let this stop them.  Having a long term vision is key.

In the words of Andrew Carnegie “90% of all Millionaires become so through owning real estate.”

So until next time, happy Canadian Real Estate Investing.

Jose Jafferji, REIA