Team CF is continuously discussing investment strategies, preferences and making compromises in all the final investments. Mr. CF prefers stocks combined with some crowdfunding, Mrs. CF favours real estate. It should then also be unsurprising that we have a very diverse portfolio, and we own real estate as part of it. But how did we get started? What did we do to get where we are today? And what is the return on our real estate? This is what today’s post is all about: Real Estate Investments – History, Yields, Risks and Strategies.
Real Estate Investments – History, Yields, Risks and Strategies
We got started in 2014 with our first properties after Mrs CF walked by an duplex and got excited. She pulled out the good old excel spreadsheet and started to make various calculations. We got quotes from contractors for renovations and found that the property could make an, for us reasonable, return on investment. Next the bidding and negotiation began. To our surprise we actually agreed upon the sales price that ended up at about 75% of the asking price (yes, the properly needed a lot of renovations!). Next, we renovated the place extensively (with the use of a local contractor) and about 4 months after purchase, we had both units rented to solid tenants (one through a property management firm, one to family whom had helped with the financing and renovations).
The financing of the properties was done utilizing the value in our existing home at the time, supplemented with family loans (yes, with proper contracts in place and interest rates according to market conditions).
Our Initial Financing
How did we got all this money? Well, before we found the path to FIRE, we were not sure what to do with our money (we had bad experiences with investing and were not properly informed about index funds or dividend stocks), so we aggressively paid off our own house. This came in very handy once we realized that we were better off investing than paying down the house. We had a HELOC (Home Equity Line Of Credit) at that time, which allowed every euro (dollar, actually) to be pulled out against the governing variable market interest rate. In short, we were able to purchase the house in cash and used remaining cash and loans for the renovations.
Fast forward to 2016, with the investment strategy to become FI firmly in mind, we searched for a property that could be split in multiple units or already consisted of multiple properties (e.g. duplex, triplex or more) to live in ourselves but also rent out the other unit or units (we had sold our previous home and were renting at this time).
We ended up finding a former B&B that suited our criteria. This property provides us with a sizable upper unit (~125m2) for ourselves and two smaller units (~40-45m2) that could be rented out. It also has a large workshop (~65m2) which could be rented out commercially (with an option to transform into an additional living unit after renovations/modifications). We financed this property with a regular mortgage, which we would be able to pay for on one salary (albeit that would have been a bit of a struggle).
What to Expect Financially?
To make a long story short, we currently own 5 rentable units, and one unit for our own use, in just about two years’ time. Two units are almost paid for (just a personal loan remaining), three are financed using a regular mortgage. An overview of their value, rental income, yield (gross and net), etc. is provided below.
To explain the various columns in a bit more detail, let’s review each one:
- Property Market Value – the value of the property if it would be sold on the current market, for units 3-5 it is the value of what we paid for it in mid-2016;
- Mortgage/Loan – value of the mortgage or (private) loan on the property/unit;
- Asset Value – the Market Value minus Mortgage/loan value;
- Gross Rental Income – Income based on 12 months’ income per year at the gross rental price (i.e. before management fees/expenses);
- Yearly expenses – all reoccurring expenses such as property management fees, insurance, property tax, sewage/waste disposal fees, etc.;
- Yield (Gross) – Gross Rental Income minus Yearly Expenses (value and percentage based on Asset Value);
- Reservations and Maintenance – All units are well maintained (or newly renovated) and reservations for the coming years are primarily for paint works, replacements for fridges, dish washers, heating units, etc. The reservations also include a risk allowances for unexpected expenses (damage), temporary vacancies (i.e. no tenants) and other unforeseen scenarios (e.g. water damage). We use percentages of between 2-3% of the Property value for combined maintenance and reservations; and,
- Yield (Net) – Yield (Gross) minus Reservations and Maintenance (Absolute Value and the percentage based on Asset Value).
As you can see the net yields are pretty healthy, even if the reservations/maintenance is under estimated we should likely still get yields in the order of 5-6% before taxes. The Gross yields are actually really good, which is what is helping us a lot. The main reason for that is that the reservations will likely not be required until a couple of years from now. This allows this cash-flow to be reinvested in other assets, thereby allowing the financial snowball to keep going faster and grow (read: “compounding interest”). However, we do need to increase our financial buffer to accomodate unexpected costs associated with issues in our Real Estate.
Where to Start?
Some recommendations/ideas to consider when you want to invest into Real Estate:
- Start small, smaller units generally have higher yields than larger/more expensive properties and are easier to finance;
- Look for areas that have good rental markets (e.g. in or near larger cities, or smaller towns that provide a good social environment where younger folks want to stay) and do your homework;
- Make sure you are cash-flow positive as soon as possible after you purchase the property;
- Using mortgages or loans as leverage allows you to need fewer of your own assets, thereby increasing the yield on your invested assets (but this does coincide with higher risks!);
- Look for properties that are, or can be, split into multiply units. For these properties, you generally pay less per unit and thereby increase your yield on your investments; and,
- Put effort (or funds) into tenant selection. This is one of the best risk management tools you have in Real Estate investing (plus added benefits of Box 3 Taxes). Also treat your selected tenant well and with respect, in return they tend to also take care of your property for you (this is also our personal experience).
Happy House Hunting!