Creating A Pension Plan
Michael Hallett • April 30, 2016
What's a pension? I don't have one. In today's day in age there are not many people that will have one when they retire. So it's up to us, as individuals, to create our own - build your net worth from within. There are many ways to create a pension plan, acquiring rental properties is just one of them. Many of the wealthy people these days have utilized real estate to grow their empire, whether it's through buying and selling or buying and never selling. When acquiring a portfolio of properties one is able to plan for continual growth by utilizing the potential cash flow and accrued equity to purchase a second, third, forth...property.
First step is to determine your budget, which may ultimately be decided by how much of a down payment you have as well as to figure out what your monthly comfort level is for cash flow. For all intense purposes I will be using values and amounts from my local area on a relatively new 1 bedroom/1 bathroom condo. With newer units comes less risk of future assessments. Do your homework*.
Purchase Price: $225,000
Down Payment: $45,000 (20% minimum, lender may request more)
Mortgage Amount: $180,000
Mortgage Insurance: $0 (lender may require depending on how income is reported)
Total Loan: $180,000
Variable at 2.40% (P-0.30%) 5 year term CLOSED 30 year amortization
Monthly Mtg Payment: $700.79
Est. Monthly Strata: $200
Est. Monthly Property Tax: $100 ($1,200/year)
TOTAL Monthly Payment: $1,000.79
Property Transfer Tax:
$2,500 (paid at completion, cannot be rolled into the mortgaged. It is calculated based on 1% of the 1st $200,000 and 2% on the remaining balance.) To calculate Property Transfer Tax http://www.bcrealestatelawyers.com/ptt-calculator/
Appraisal:
$300 (required to validate the purchase price because there is no mortgage insurer involved; CMHC, Genworth or Canada Guaranty).
Home Inspection:
$400 (highly recommended)
Title Insurance:
$200 (In short, title insurance is an assurance as to the state of title of a given property. In practical terms, it protects lenders and purchasers against loss or damage suffered due to survey problems, defects in title and other matters relating to title as specified in the policy.
Approx lawyer fees:
$1,500
The cost to acquire the property was $4,900.
Well that was easy, you just purchased a rental property...NOPE, you are just getting started. The obvious goal is to pay off the mortgage with the rent ($1,200/month) coming in.
Yearly Cash Flow
= Rent - Mortgage Payment - Property Tax - Heat - Strata - Renters Insurance** - 3% Vacancy
= $14,400 - $8,409.48 - $1,200 - $1,200 - $2,400 - $500 - $432
= $258.52
Positive cash flow is ultimately what you are seeking with a rental property, however this is not always attainable from the start. Just because there is positive cash flow at the beginning DOESN'T mean that you should start paying yourself (a pension), and that amount of $258.52 is yearly. So more or less this property just breaks even.
Because the real estate market is cyclical we are going to estimate the increase in market value by a modest 3%, year over year, some years more than others. Along with calculating the year over year market value increase we will look at how the mortgage balance has decreased over time. Remember the purchase price was $225,000 and the starting mortgage amount was $180,000.
Market Value Mortgage Balance Potential Equity
End Of Year 1 $231,750 $175,844 $55,906
End of Year 2 $238,702 $171,588 $67,144
End of Year 3 $245,863 $167,227 $78,636
End of Year 4
$253,238 $162,764 $90,474
End of Year 5 $260,835 $158,191 $102,644
This was the part 1 in a series of multiple posts that walk through the acquisition of rental properties in order to create a sustainable pension plan. Next up, buying property number two.
Legend
*Read everything single piece of information provided by the seller and strata; AGMs, strata minutes, property disclosure statement, Form B as well as the depreciation and engineers report if available.
**Renters insurance (purchased by the property owner) has many variables to consider for the cost; detached home, condo, townhouse, location, value of personal contents, any betterment and improvements.
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You’ve outgrown your current home. It no longer fits your life, so moving makes sense. And you’re not interested in juggling two properties. Selling first and buying something new feels like the right move. Ideally, you want possession of the new home before leaving the old one. That overlap makes moving easier, reduces stress, and gives you time to paint, renovate, or settle in before the boxes arrive. But there’s a common challenge. What if the down payment for your next home is tied up in the equity of the one you’re selling? That’s where bridge financing comes in. How bridge financing works Bridge financing temporarily unlocks equity from your current home once it has a firm sale . It bridges the gap between selling your existing property and purchasing your next one, allowing you to use that equity toward your down payment. What about competitive markets? In a hot market, a strong offer often means a larger deposit . If you don’t have that cash sitting in your account, but you do have equity, a deposit loan can help you compete with confidence. The non-negotiable requirement To qualify for bridge financing or a deposit loan, your current home must have a firm, unconditional sale . No firm sale = no bridge or deposit loan. Lenders need certainty to calculate available equity and manage risk. Bottom line A firm sale is the key that unlocks bridge financing and deposit loans. If you’re planning a move and want to understand how these options could work for you, let’s talk. I’m always happy to walk you through your options and help you plan your next step with confidence.
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