Frequently, we receive calls or e-mail from people looking for “Investment Properties” and i thought I would share with you how many of these situations seem to play out.
Some individuals have a specific property type in mind. It could be a small residential property, duplex, triplex etc., or a large multi-residential building. Alternately, it could be a mixed use commercial/residential situation, or possibly a plaza, industrial building or industrial multiple. Others may not have any focus, and just a sense that a real estate investment property may be a better long term in investment that financial based products.
Normally, the ones that have a focus tend to be more experienced and understand the non-financial aspects involved, such as property management, dealing with tenant relationships, assessing property conditions, etc. Typically, they are active in searching the market, and have specific criteria which they are looking for, such as location, undervalued properties, established income streams, anchor tenants, to name a few. Properties that meet these criteria are usually very hard to find in today’s market, where it is very much more balanced in terms of buyer or seller advantage. Although in some case such as multi-residential properties, the demand is so high that per unit values have been driven sky high. Similarly, in the case of good retail plazas or shopping centers, because they enjoying better rates and occupancy levels in resent years, they have been targeted by institutional investors, and thus opportunities are slim. What is left, is pretty well picked over, and usually is overpriced, poorly located or needs major capital improvements.
It is the second group of callers that I would like to concentrate on, which tend to be less experienced in real estate investment and hence, more at risk in terms of getting into difficult or undesirable situations.
There is a great deal of difference between property types and what will be required of the investor over and above the financial commitment. The investor must understand what these management obligations might be and decide how prepared or capable they are to deal with them, in order to secure their financial investment.
For example, small residential properties, often require intervention with tenants in terms of lease turnover (expiry, eviction, screening, etc..) with related Landlord and Tenant protection legislation which governs these relationships, collection of rents, property care, etc. It can be very stressful and to a large degree if often out of the owner’s control. It is not just a question of investing your money and collecting your rent.
Also, investors also need to be able to assess property conditions before such a purchase to make sure that the current net revenue stream or reasonable expectations to adjust this, does not just support the purchase price, but also, the repairs and capital improvements that need to be done in the near future (i.e., roof, heating systems, windows, etc…) And remember it is the net revenue, after all expenses, including taxes, is what the return on investment shot be based, not gross rents.
In summary, residential properties require a tolerance for aggravation, an ability to intervene and maintain the asset, along with liberal dose of luck in terms of getting good tenants. Yes, some of these things can be contracted out, but it would only be practical in situations where the economics would justify it.
Commercial and industrial investment properties, are a little different, but still require property management abilities, and usually the cost and risks are bigger. Tenant turnover can still be an issue, but at least the landlord has more over the relationship, which is governed by the Lease Agreement and not by government legislation. Also, the leases for the most part tend to be “Net”, which essentially means the Landlord gets to keep the net rent, and the tenants are responsible on a proportionate share basis, for the other operating costs of the property, including fealty taxes, as Additional Rent. However, as with properties set out above, net income at the time of the purchase, must take into consideration of the property, future conditions affecting the site, etc., to know much additional capital may be required to sustain revenue, or how existing net revenue may be eroded.
The bottom line is that most real estate investments are not passive, and can have a relatively high element of risk, particularly for those who are challenged in the aspects of the management required. Also, given the nature of market, they may not offer huge returns, which would normally tend to offset the risk factor, and in fact, many investment properties in the last few years have been trading at lower Cap rates (relates to lower expectation of return) relatively speaking, than other more stable investment.
What I have found is that experienced real estate investors, who understand the risk and management requirements, can with some effort, identify properties with upside potential, whereby they can add value by their to improve the property with their own resources and sweat- equity, and may not have to contract out the work to others. Again, this is not a usual attribute of someone who wants a passive investment.
In closing, real estate investment is not for amateurs of those who do not want to get in the management of the asset on a day to day basis. Otherwise, if they want some real estate component in their portfolio, they should invest in things like real estate backed funds of Real Estate Investment Trusts (REIT).
I.C.& I. Tip: Somebody once told me that the ideal investment is one that works while you’re asleep. With respect to real estate a situation that has that element and is less risky than what is described above, would be a freestanding single-use property, leased to a Triple A covenant tenant for a long term, totally net and carefree basis. consider owning a property leased to Tim Horton’s, McDonald’s or the lime, under this scenario. This has pension plan written all over it. The bad news is that they are extremely hard to find and unless you are the original developer, the return might not be as desirable.
Robert J. Lyons, CMA, is an Associate Broker with Royal LePage Real Estate Services Ltd., 200-3060 Mainway, Burlington.
