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Good News For Landlords & Investors

This is an article from our regular real estate columnist Rachelle

A topic of concern for landlords has been the continued erosion of tenant quality. In the last 13 years since graduated from property management school there have been significant changes in the industry.

History Lesson

When I first began working the law did not allow for market rents. Rents were controlled. Even if people would gladly pay more for your apartments it was illegal to raise the rent higher than the percentage amount allowed by law.

Landlords Want Profit

Landlords are not a social service agency, they are in the business to make money. The only way to increase profit in those days was to reduce or eliminate maintenance. Vacancy rates in the city were less than 1%.

I’ll always remember a conversation I had at that time with the property manager about an apartment with a giant hole in the ceiling (caused by a leak). I asked him “ Are we going to fix that?” He replied in an arrogant tone “No, someone will take it” What he really meant was that someone would have to take it or live on the street. A tenant did take it a few days later and fixed it himself. In that particular building the only way to get work done was by city work order.

Down Payments

At the time, down payments on houses were 25%. It took a long time for people to save up the money to buy a home, during that time they rented. These were very good tenants, they took care of things, they paid their rent on time by postdated check. The building industry treated them as though they were trapped and had no choice.

Bad Business

My thoughts were that this way of treating people was wrong. Just because you can do something, it doesn’t mean you should! It also didn’t make sense to let your building run down to maximize profitability this quarter while accumulating deferred maintenance in the millions of dollars. Treat your customers like dirt at your own peril.

Laws Change

In 1998 the Tenant Protection Act came into effect. This law allowed for vacancy decontrol of rent. This means that once a unit became vacant the landlord could charge whatever rent the market would bear. Landlords had an incentive to provide better accommodation and charge more rent to those who could pay.

Vacancy Rates

Vacancy rates were very low and landlords could charge what they wanted as long as people would still rent their apartments. I remember showing a property and having 80 people show up.

Condominium Building

The Condominium Act became law in 1998 as well. Investors who had previously built apartment buildings began building condominiums. The property taxes on a condo building are about half what rental buildings pay. Developers could take their profits and move on to their next project. The owners of the condominiums took over liability through the condominium corporation for the building envelope and maintenance of very expensive machinery such as elevators, chillers, boilers etc. The Board of Directors were elected and knew absolutely nothing about these complex systems yet became responsible for budgets of millions of dollars.

This is just my observation, but I have worked in rental buildings that are 30 – 40 years old that don’t have half the problems that much newer condominiums have. Is it possible that the developer, knowing that they will no longer be responsible for the building 3 years later, will make choices based on economy rather than durability?

Down Payments

At the same time as landlords were charging more rent and developers were building condos by the thousands, down payments began their downward spiral from 25% to 0%.

Migration

Our core tenants, the good ones, began a migration from our rental buildings to homes and condos. Why not? If you had a good job and good credit you could buy your own place. I did this myself. I was being treated like dirt by various landlords and became desperate to have my own place. Many homeowners can relate. Slowly but surely the trend began to empty out rental buildings.

Quality of Tenant Applicants Decrease

Property managers will tell you that the quality of tenants has decreased. I look at applications every day and I can assure you it’s true. We gladly approve applications and take chances just to fill our empty space. Renters are getting poorer as a group. More of them have bad credit and more of them go from place to place without paying rent. Landlord costs may decrease slightly if the apartment is rented but as a whole the base cost for operating a building is the same if the apartment has a paying tenant in it or not. The only reduction in expenses is to water and electricity.

So What’s The Good News?

The good news is the April 19th of 2010, 0% down payments are no more. An average house price is over $400,000 in Toronto. The new buyer needs to save at least $20,000 for their down payment. That takes time. During the saving period our buyer will have to live somewhere. Some may choose to live with family, but a vast majority will rent.

This means lower vacancy rate, improved demand and better quality tenants for the industry.

Investors need to put 20% down on an investment property, this means less people getting themselves in trouble by speculating on appreciation. The trend is less demand for houses and better financial stability for the owners of these rental properties. Less people will be buying income properties as the barriers to entry increase.

This summer’s rental market has been slow since April. I see this lull decreasing and rents going up and demand for rental accommodation increasing going forward. Housing prices will also decrease as investors have to put down more cash per property and first time buyers have to save.(What a foreign concept!)

It’ll be a great day when appreciation stops being the primary motivator for investment in real estate. Warren Buffet said it best.

“The line separating investment and speculation, which is never bright and clear, becomes blurred still further when most market participants have recently enjoyed triumphs. Nothing sedates rationality like large doses of effortless money. After a heady experience of that kind, normally sensible people drift into behavior akin to that of Cinderella at the ball. They know that overstaying the festivities — that is, continuing to speculate in companies that have gigantic valuations relative to the cash they are likely to generate in the future — will eventually bring on pumpkins and mice. But they nevertheless hate to miss a single minute of what is one helluva party. Therefore, the giddy participants all plan to leave just seconds before midnight. There’s a problem, though: They are dancing in a room in which the clocks have no hands.”

Counting on appreciation to make money on income properties is foolish.

It’s worked in the past, but it’s hazardous now. The worst part of appreciation as a real estate strategy is that you can’t spend appreciation unless you refinance or sell. It’s useless for maintaining a building, paying your taxes or renovating your turn over suites. It’s all about the cash flow – you have to take the money to do these important things out of your income or your pocket. The idea that your building is worth $200,000 more than when you bought it is cold comfort when you need to pay $50,000 for a new flat roof. Having the money in the bank because you have income from the building is much cheerier.

I welcome the return of fundamentals in the rental and housing markets. We’re all safer as a result.

About the Author: Rachelle specializes in renting property on behalf of landlords and is the blogger behind Landlord Rescue. She also works with investors to find good investments in Toronto and surrounding areas. Her passion is bringing multi res properties back from the brink and maximizing profitability. Check out some of her other real estate posts on MDJ

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About the author: This is a guest post. You can read more about the author in the biography above.

{ 12 comments… add one }
  • Rachelle July 28, 2010, 11:52 am

    I have the cap rate spreadsheet thanks to help from my friends. Any one who wants it can send me an email at rachelle at landlordrescue.ca. Replace the at with @.

    Have a great day!

  • jesse July 28, 2010, 1:07 pm

    Wonderful article. Tenant quality is one of the subtle but caustic ways yields have been eroding for landlords of late, not least because of the government’s allowance of a long-standing house price bubble.

  • Andy R July 28, 2010, 1:13 pm

    The government needs to get out of the the rent control business entirely and let the market take care of good and bad tenants and good and bad landlords alike.

    The economic case is crystal clear. The political side will take leadership.

  • J July 28, 2010, 4:24 pm

    Hi Rachelle,

    I think you meant to say that you need to save $80,000 for an average rental property in Toronto, or am I missing something?

    The other problem in Toronto is that there are too many flippers / contrators buying potential investment properties which make it so difficult to find a cash flow positive property here.

    Buying in other markets seems like the only way to go. I like Guelph, Ontario considering the Go Train is scheduled to provide service there within the next five to 10 years. Guelph seems to have solid properties in good condition at a reasonable price which leads me to believe it will be easier to be in a cash flow positive position. But you still need quality tenants….. are they present in Guelph? I just don’t know.

    Your articles seem to scare me away from investing in rental properties…

  • Rachelle July 28, 2010, 4:58 pm

    J,

    An investor needs $80,000 or 20%, the tenant will live there and only needs 5% down or $20,000.

    It’s not the flippers or contractors that are the problem. If investors got smart and stopped buying “investment properties” that are huge sinking black holes for their cash the madness would stop.

    Don’t be scared! Be smart! You can make money in real estate just like you can make money in the stock market. Does this mean you can buy any penny stock? No way! You need to be careful. That’s all I’m saying. Lots of people will just lie their faces off to separate you from your dough. It’s your job to stay the hell away from these liars and educate yourself before buying. It’s your money and nobody cares about it like you do.

    I wrote this post because I see brighter days ahead :)

  • Financial Cents July 28, 2010, 8:35 pm

    An enjoyable read Rachelle. You should also know that a decent home in Ottawa, downtown, is also >$400,000. I’m surprised all the time how first time buyers can afford this stuff….

    My wife and I are fortunate to have good jobs and we’re in the ‘burbs b/c we don’t want to be house-poor. I guess many people like it that way? Alas, another post.

    Agreed, I think the quality of renters should increase over time with the new mortgage rules now in effect.

  • uncle July 29, 2010, 12:42 am

    I think it makes little sense to get into the property market (condos) when apartment owners are turning their old (20+ years) apartment buildings into condos. Put in some stainless, a piece of granite and voila, 350k. If apartment owners are getting out of these properties, be very careful if considering buying one as an investment property.

    Cheers.

  • Future Money-Bags July 29, 2010, 8:19 am

    Very Insightful article Rachelle.
    When I was first considering buying a rental property I was first drawn in by the appreciation like you said ;(
    But as I continued to research, I realized that despite real estate prices usually on a gradual rise, cash flow is much more important. Noy only do I want the rent to pay my mortgage, but I want there to be extra cash flow afterwards for emergencies and for income.

    The appreciation of the property is only a bonus; Sometimes a big bonus if lucky and planned correctly. But after the new rule was put up, I slightly changed my perspective and decided to keep saving more before making D/P.

    1 question:
    I have always been looking at newer buildings, under 10-12 years old, to buy as rental properties. Is it unwise to narrow down my search to such precise criteria? I know you can still get good cashflow from older properties, even if they are 40 years old, but in the long run they will need more repairs and upkeep and can’t charge as much rent. What do you recommend, and should I keep saving for that magic $80k?
    (I also don’t wanna spend more than 75-80% of my savings on a D/P… so maybe I need 100k if I am looking at $350k pricetag.

    thanks :)

  • Andrew July 29, 2010, 8:36 am

    Great article, thanks again.

  • Rachelle July 29, 2010, 11:19 am

    Mr Money Bags,

    I am a believer in purpose built buildings. That means older that the last 10-12 years.

    Older buildings can be good too!

    The reason why building owners change to condo is pure profit. It has nothing to do with the value of the investment. The investment might be making loads of cash for the owner. Lets say they bought for $100,000 per suite if they make it a condo they can sell for $200 K per suite. Awesome! That’s why building owners decide to brave the morass of regulation and convert.

  • TinyPotato July 31, 2010, 5:23 pm

    Great article.

    This just goes to emphasize the potential problems in Vancouver’s real estate market even more. At current prices and rents the “investors” (more accurately speculators) are barely making any return at all from rent. The only potential income / gain is from price increases.

  • Aolis August 2, 2010, 9:31 pm

    Interesting and insightful article.

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