Welcome to this month’s installment of Dear urbaneer, where we tackle tough housing questions put to us by our very astute clientele.
This month, we help a client who was lured by the potentially lucrative property investment market. We counsel him – as we do all of our clients – to make prudent choices based on hard data and facts. And, as far as 'get-rich-quick' schemes go, in our opinion flipping houses is not one of them; there are a myriad of risks to consider. Read on!
I’ve been thinking about possibly buying a fixer-upper with the intention of making improvements and/or renovating, and then turning it around for a quick sale. Given the fact that the Toronto housing market is so hot and has no signs of slowing down, is it unreasonable to expect to pocket a tidy sum from this venture? Furthermore, I don’t want to go into a renovation project blind. What are prospective buyers really looking for? And, given that my margins are thin, what are the risks here? What do I need to know?
Flipping my Lid
Here's our response:
Excellent question! We are delighted to see that you are considering the pros and cons of this investment opportunity. Bottom line: no matter what your real estate pursuit, knowledge and research are your best tools in achieving success, along with healthy doses of patience and common sense.
First, let’s set the record straight: real estate can be an excellent investment, but more often than not, it’s with an eye to the future. A 'buy and hold' strategy is almost always the way to go, especially in a market like this. We dispelled some of the 'great-rich-quick' myths that persist in property investment in a recent Dear urbaneer post, entitled, “How Can I Keep My Flip From Flopping?” This has some of the nuts and bolts of how to strategically execute a flip, making it a worthy read.
Despite the fact that the supply of housing stock is low (especially freehold single family homes) and there is an influx of buyers competing heartily just to secure a home (as we touched on in our recent post “A Real-time Tale On The Struggle To Buy Toronto Real Estate In Spring”), we have to proclaim loud and clear “Don’t be too cocky!”. Even though it might seem like all the elements are in place to generate huge returns on your investment speedily, there is more to it than that.
As with all investments, there is a relationship between risk and reward. Here are some ways to mitigate that risk through due diligence. Some of your best strategies may involve playing your own personal devil’s advocate.
Don’t Pay Too Much For The House
If your goal is to buy a home and fix it up to make a profit, you are putting yourself in property peril if you pay too much for the home in question. The whole economics of this stem from the ability to find a property that, if anything, is reasonably priced or under market value (if this is even possible in today's real estate market). You then make smart, cost-effective renovations and improvements to boost that value while taking advantage of market momentum to help get you there. If you pay more than your budget allows, or than the market will likely support, you are potentially backing yourself into a corner.
One critical factor to pay attention to right now is that the lack of supply is so limited relative to demand, that most downtown freehold sales are setting a precedent price. A lot of these Buyers acknowledge they're buying for the long term, so they're effectively paying a premium not based on what they believe the house to be worth 'today' but with a value that includes a portion of the property's future escalation. In other words, Buyers who are securing property today with the intention of owning the dwelling for the next ten years are less concerned with where values will be in a year or five. In fact, many will admit they feel they're paying 'too much', while reconciling it's the price of admission one has to pony up to get onto the property ladder. These Buyers have effectively reconciled there's a possibility their home may be worth less than what they've paid in the imminent future, but they're prepared to weather that storm with the commitment to 'buy and hold'. However, if you're trying to acquire and resell a property within the next 24 months, you may not have that luxury. How much prices have escalated in the next 24 months will mean everything to you if you're trying to sell an upgraded property for a profit. In today's intense market, we would recommend you exercise caution. If market conditions were to change, can you also 'buy and hold'?
Do The Dollars Make Sense?
Which brings us to the question of budget. Every house hunter should have a budget, but the prospective property investor should be rigid with their budget. They should also be very detail-oriented, so that all of the costs line up with what would likely (reasonably) be the future value for the newly renovated property.
So, how much do you want to make? (Hint, don’t say as much as possible).
Here's the question. What do you think you’ll be able to sell the home for, post-renovation, based realistically on market conditions, housing location and with comparable sales? While searching for a suitable property to improve, you should also be viewing freshly renovated product in the same location so you have a better understanding of where values are landing, and you can better extrapolate your future potential return on investment. Once you've done that, you can work backwards so you can establish what kind of profit you can potentially make. Next, determine what your costs will be. And take note it's critical you ensure your estimates are accurate, based on actual data.
Part of your house hunting team should include a walk through with your contractor and designer to provide you with a ballpark of what your proposed renovations might cost, because these need to be included in the budget. In your own assessment, you may have underestimated the amount of dollars and level (complexity and time) of repairs and renovations.
Some other line items in your budget beyond the renovation costs should include a contingency fund, professional fees (lawyer, architect, contractor, structural engineer, designer and permits as needed) as well as taxes (HST on renos and Land Transfer Taxes). Don’t forget about potential carrying costs too (like mortgage costs and utilities) while you're holding the property. Oh yeah – and don’t forget any capital gains tax that you’ll need to pay on your venture.
Underestimating costs and overestimating what you might receive in a sale will effectively squeeze your profit. Your purchase price must support a healthy space between costs and likely future value. You’ll never get ahead if you start out behind with a pricey purchase. And worse, we've seen lots of instances where flippers are making a 'profit', but it's not because of all their time, effort and capital investment, it's because market values simply went up. If they had simply purchased the property and rented it out 'as-is', they would have generated the same return on investment. Which would you rather do?
The Issue Of Financing
You may or may not know this already, but the financing options and requirements for an investment or second property can vary from those that apply to your principal residence. We’ve covered some of this in a recent post called On Financing An Investment Property.
The real question is – how much of a 'fixer upper' is the property? For instance, if it needs a lot of work (i.e. isn’t habitable), you may have to put a substantially large down payment down (which could eat into your renovation capital). You potentially may not even be able to secure conventional financing through your bank – which means you'll need to turn to the pool of mortgage brokers and private lenders. In some instances the rates and terms will be competitive, but in others you may be charged a higher rate or incur additional fees.
You’ve got to make sure that not only will your renovations viable, but much you need to consider how much financing them (and the home in question) could ultimately cost you. How does your bottom line look now?
What Are The Real Costs?
As part of your budget, it's essential you keep an itemized accounting of all your acquisition, carrying and selling costs. Don't forget those double land transfer taxes, which are horrific. Plus your legal, realtor and staging fees. Here's one of our posts called What Are The Closing Costs For A Property Purchase? that offers the basics from which to begin. We also have a must-read post called How Much Profit Should I Expect Climbing The Property Ladder? that shares some of the misnomers on how much money people are really making in real estate.
In conjunction with this, don't forget to put a value on your own time. As we mentioned above, there's a good chance you're paying a lawyer, lender/appraiser, realtor, designer (and/or urban planner and architect depending on the scope of work), contractor, landscaper, stager, and cleaner (even we're suspect we've missed some of the other essential trades here), but are you building in a reasonable value for your own time, or is that what you're calling 'profit' (this is important if you've paired up with someone too, who may not be as committed as you are but wants to split the profits equally)? Presumably this endeavour is in addition to your existing '''job', so be realistic on how much time you'll need to dedicate to the project to make it happen (hint – pretty much every waking moment). Alternatively, if you're attached and you intend to live in the dwelling while you're doing the improvements, this post called Help! We Want to Renovate, And Keep Our Relationship Intact! is a worthy-read.
No question, the Toronto property market is hot, hot, hot (Did you read our post Why Is The Toronto Real Estate Market So Hot?). The speed and intensity of its upward movement grabs headlines on a regular basis. But know this – markets are, by their very nature, cyclical. We don’t even have to look too far to the past to see the disasters that have befallen overvalued markets and overly indebted homeowners. The global sub-prime mortgage crisis that sunk a lot of people around the world was not that long ago.
Point being is that while indicators currently seem to suggest that the market will continue to be robust, what if it isn’t? What if you’re buying in a sellers’ market and selling in a buyers’ market? What would that do to your financial plan? Do you have the financial stability to keep the property and rent it, if required?
While you can’t predict conclusively the future value of a home or the trajectory of the market, you can do some things when purchasing a property to help it sustain and increase its value. Namely- location, location, location. Wherever possible, select a home close to amenities, like shopping, public transit, schools and green space. Here's one of our past posts called On Choosing A Winning Location
The Power of the Unique
We’ve had the opportunity to see the “creative” side of some flippers and the end product of their homes, which we’ve written about in various posts, including our tongue-in-cheek rants “We Flip Quesadillas, Not Houses”, “We Flip Flapjacks, Not Houses,” and “We Flip Burgers, Not Houses.”
When you want to charge a premium for a home, you’ve got to give Buyers something to shoot for, beyond location and proximity to amenities. One thing Buyers will gladly pay for? The unique. Everyone likes to feel special, which is one of the emotional components to the concept of custom made. Whether it is a thoughtful layout, tasteful décor or quality finishes. And be careful not to fall prey to I See Ya, Ikea, which can limit your profit potential by being too recognizable. If you're looking for some guidelines, here's an essential read called Seven Home Runs To Achieve Top Dollar!
Doing shoddy work and cutting corners may seem insignificant, or a way to save on expenses, but you’ll be placing a barrier between a Buyer's decision to purchase – and their decision to pay top dollar. And rest assured, with the intensive housing education House and Garden TV provides on a continuous loop, there are a number of observant eyes in circulation. Think you're the only one looking to upgrade a property? Here's some interesting stats in this post Behold The HGTV Effect On Toronto Real Estate.
Are you consider a property investment, but wondering if it is the right move for you? At urbaneer.com, we’ve got decades of experience professionally and personally with buying, renovating and then selling again (check out Steve's current endeavour called the Tales From Tennis Crescent or his transformation of a dilapidated vintage triplex in Charlottetown, PEI called the Tales Of Upper Hillsborough). Rest assured, we’ve got the winning skill set to help you navigate this market, with an eye towards a sound investment and peace of mind.
Have questions? Please know we’re here to help, all without pressure or hassle!
~ Steven and the urbaneer team
earn your trust, then your business
** Did you also know Steve leads a Student Mentorship and Internship Program for Canadians being educated in the field of housing? Consider visiting our sister site called Houseporn.ca