Using Real Estate as a Tool
Dylan Dallaire - Director of Mentorship of the Real Estate Student Association
Whether you are an Art, English, Science, Law, Psychology, Engineering, or Business major you need real estate. Although you have other needs like food and clothing, real estate is a need that can be used and adapted to generate money. In other words, you can leverage the power of your own home as a tool to create an income. Although many people view buying a home as one of life’s greatest investments, how many people view this investment with an actual return? As a result, the point of this article is to provoke and inspire the thought of real estate as not an item, but a tool to create wealth.
Speaking of wealth, did you know that over the last 2 decades 90% of the people who became millionaires did so through real estate? Evidently, this large proportion of individuals indicates that there are proven methods and systems to create a significant income from the basic need of shelter. It may seem arbitrary of how so many people can make so much money through real estate, but there are fundamental methods of real estate that make this possible. I will discuss these fundamental methods of how money can be made through your home and what steps you should consider following.
Remember: anyone can do this because everyone needs real estate.
Renovations
What it is:
Renovating is the process in which a building is restored to a value maximizing level. This often involves restoring the less desirable features of the home for the most desirable ones, such as replacing old flooring.
Why it matters:
Renovating a house should make it more desirable, which in turn, can increase the price of your home. Furthermore, buyers are often willing to pay more than the cost of the renovations in order to move into a “nicer” home. Let me explain.
I remember during the topic of negotiations in my OBHR 317 class at the University of Calgary we had to pair up and negotiate the sale of a house. In my situation I was acting as the seller and my partner was acting as the buyer. During this negotiation we came upon the topic of painting the house (which it desperately needed). I asked my partner, “how much more would you be willing to pay if I painted the house for you?” She replied, “$10,000.” What my partner did not know is that I could get the house painted for only $2000 (according to the exercise guidelines). That was an extra $8000 that I was able to walk away from our deal with for making a phone call to my painter. So why is there such a large price gap between her desired price and my actual cost?
My partner used her intuition to make an offer because she desired moving into a house with fewer problems. She is willing to pay more to get it done before she moves in. This emphasizes that buying a house is largely an emotional decision. That is, buyers may be willing to pay more for a “nicer” or updated home in order to avoid any problems after moving in. After all, the process of buying a house can be stressful in itself, so reducing stress where possible (i.e. fewer cosmetic problems) can be very desirable for a buyer.
Therefore, profiting from a renovated house comes down to the difference between the buyers perceived value of an updated home and your actual cost of buying and renovating the home. As a result, finding the area or houses in your market that has the largest gap between these values have the most opportunity to create an income. Yet, there are still some very important factors to consider.
What to consider:
I am sure you have seen or heard of TV shows like flip or flop and property brothers. Often, these shows portray their hosts turning a run-down home into the most beautiful house on the block while selling it for a profit. Although these shows are very educational as to how a renovating process works, they should not be used as an exact guide. This is because renovating a home to a value maximizing level is dependent other comparable houses in your area.
For example, if your community has houses that sell for $200,000 with 2 bedrooms and 2 washrooms and $300,000 for houses with 4 bedrooms and 3 washrooms, then there is opportunity to renovate a house with 2 bedrooms and 2 washrooms. The addition of 2 more bedrooms and 1 more washroom might cost $50,000 (determined on further analysis), but your house price will increase by $100,000.
Cautiously, you must follow the model of home comparisons in order to increase the price of your home. For instance, if I only decide to renovate because I think it is “nice” (such as getting granite counter tops) my home’s value may not increase in price at all. This is because I did not examine any evidence (comparable homes) to show that my home price could increase with this addition. As a result, increasing a home price through renovations is completely dependent on comparable homes within your local area. The same can be said about updating an old house to a modern one. It depends on the demand in your community. If there are no modern houses in your community then you can not determine if this renovation will be profitable. The best way to determine exactly what to renovate is to work with a realtor. Realtors have access to what types of houses are sold in your community and how much they sold for, so you can determine what renovations are most profitable.
Appreciation
What it is:
Unlike most business assets, real estate does not depreciate because, as described in the opening paragraphs, real estate is a basic need. As in, people will always need a place to live and therefore the value of a place to live does not diminish. Rather, real estate is subject to the changes of its market (supply and demand). Appreciation therefore is simply a reflection of increasing house prices (often increased demand) on a “heating up” market or area.
Why it matters:
Appreciation can be an effective contributor to wealth growth. For example, if you bought a house in California in 1980 for $500,000, according to federal economic data now it would now be worth approximately $3,400,000 . This emphasizes that appreciation is a game changer and buy and hold investments might be something to look deeper into.
What to consider:
Before we all jump headfirst into a house to hold onto for the rest of our lives there are some very important metrics to consider before buying your next house. Although appreciation can accelerate the price of your home it is not easy to find a house or area that will appreciate. Here is why:
A) Not all areas are the same. Cities are different from each other and individual communities are different from each other. Appreciation tends to occur due to an increase in population and job growth within a certain area. These factors create a larger demand for a limited supply of homes in already existing communities. As a result, house prices have to increase in order to meet this increased demand and income.
B) It is all about time frame. House prices will go up eventually. They have to because humanity does not stop growing. Evidently, on average home prices in Canada increase at about 1.7% each year.
The tough part therefore is determining when your specific area increase in value and by how much. This is very difficult to concretely pinpoint because you have to determine if the path of progress (job and population growth) is coming your way in the near future, what impact it will have, what specific area it will impact, if there will be a recession before this occurs, and what specific house to buy and hold until it does come. As a result, most real estate investors do not buy just for appreciation but use this strategy in a combination with others.
Here is a good question to demonstrate:
Imagine a very desirable location anywhere in the world, like Maui, Hawaii. Do you think that in the next 20 years the prices of houses in this area will grow or shrink? It will grow. This is a good first question to ask your potential community.
In summary, appreciation can contribute to your wealth, but it is very hard to determine if a home will increase in value to a significant level. Therefore, most professional investors believe that buying a house for appreciation is similar to gambling. That being said, if you are in the path of progress of population and job growth, demand is sure to eventually go up and so will the price of your home.
Renting
What it is:
Renting is allowing someone to live in your house in exchange for an often-monthly payment. This can range from renting individual rooms out in your house to your entire home.
Why it matters:
Renting, even with just one room mate, allows you to fight your mortgage payment. Significantly, for most a mortgage is the most expensive payment made each month. As a result, being able to reduce this payment while still building the same amount of equity in your home can greatly increase your opportunity to save money.
Here is a great example: Say that you own a home at the beginning of your University of Calgary degree and rent a few rooms out for a total of $1000 per month. If you graduate in in 4 years and rented these rooms out the entire time, then you would have gained $48,000 in rent to be put against your mortgage. The cost of tuition at the University of Calgary is $45,000. In a sense, by renting you can get your room mates to pay your tuition!
What to consider
Not all houses are made equal. Some houses will have positive rent cashflow (rental income minus expenses is positive) and some have negative cashflow. Well, most have negative cashflow. You will have to put in the work to find a house that can make positive cashflow each month. That being said, if you only get room mates to reduce your mortgage payment it is still way more effective for your savings than paying the full price of your mortgage.
Here is a good rule of thumb to quickly see if your home could be a good deal: the 1% rule. This rule states that if your monthly rental income is 1% or more of your home value, it has the potential to have a rent higher than your mortgage payment. You can find house prices on sites like realtor.ca and area rental prices on sites like rent faster. If a home meets the 1% rule, it is worthy of further analysis.
Another important step is to make sure renting is allowed in your area. Some cities, towns, homeowners associations, and communities have restrictions on renting. Make sure to research and comply with these restrictions.
Once you have carefully determined that you can and want to rent your home you will have to list it and attract tenants or room mates. In exchange for you providing a place to live they will provide you with rent, but unfortunately it is not that simple. On top of this, you will also need to manage the property unless you choose to outsource to a property manager for a fee. This includes dealing with vacancy, tenant issues, repairs, payments, screening tenants, and everything else related to keeping tenants happy and your house orderly. This can be a difficult process, but it is worth it to get your tenants to pay off your mortgage.
Here is a pro tip on attracting tenants that I have recently learned from a real estate investor that claims to never have had an issue with finding tenants: There are 3 things you can do in order to make your home appealing to potential renters. A potential tenant must clearly perceive that you have at least 1 or more of these 3 factors in order for you to sufficiently attract tenants:
1) Quality: Your home must depict high quality. This can be done by buying in a great location, having professional pictures taken to show off your home, having updated and trending renovations, etc.
2) Price: Your home must depict great pricing. This can be done by either a) allowing your home to rent at very competitive prices within the market or b) finding ways to increase the value of your home (like renovations) while keeping your original (or before renovation) rent constant.
3) Advertising: Your home must be widely advertised so that many potential tenants will consider it. This is where you have to get creative. It is most likely not enough anymore to just list your home for rent on the most common rental sites. There are hundreds of places to rent right now in Calgary alone, so what makes your place so special? Some ways to figure out how to market to tenants might be to ask industry professionals, network with real estate groups to see what they are doing, or experiment with different types of ads and see what gets the most views.
Conclusion:
Making money in real estate might seem difficult, but it is not impossible. In fact, there are many online guides and steps that you can follow. That being said, it is not easy: Real estate is a long-term game. A great way to start is to learn more about real estate through sources such as books or podcasts. You can find recommended books and podcasts on our RESA website. Check it out! If you are interested in renting, build a rental calculator to understand how renting works. We also have calculators on our website to help you analyze various real estate aspects. Understanding these calculators is also a great way to get an idea of the numbers involved in real estate. Finally and most importantly, network and make connections with your local real estate clubs and groups to meet professionals and others who can guide your next steps! RESA has many different types of events to help you take your next step in real estate. From networking opportunities to office tours to career fairs we are a community dedicated to help you succeed in the world of real estate. Have any questions or thoughts? Feel free to use our online forums to have a member reach out to you or give me an email. We cannot wait to see you or hear from you soon!
Thanks for reading!
August 4th 2020
Author: Dylan Dallaire, Director of Mentorship
Email: dylandallaire@gmail.com