Those readers who’ve been around this blog for a while know that I rarely take a break from regularly scheduled programming.
In other words, I happen to be one of those (boring?) folks who like to stick to a schedule.
Thus, when I do take a hiatus, there’s a good reason for it.
Over the past 10 days, that reason was adding another property to our real estate portfolio.
It’s been more than a decade since we first got into the real estate game, buying a property with infinite returns.
Since then, we’ve been gradually increasing the cadence of our real estate purchases.
About a year ago, we gulped hard and bought a multi-unit, mixed-use commercial / residential property right at the outset of the pandemic.
But as soon as that deal closed, we knew another one is on the cards.
Our investment portfolio still had too much cash – and not enough real estate.
This time around, however, we weren’t looking for a commercial property.
Instead, we wanted to add a single-family, detached home in the metropolis where I grew up.
Moving The Goalposts
Over the years, I’ve avoided buying single-family homes.
Prices have been going up consistently across the board, with rental yields coming down as a result.
Even at today’s mortgage rates, finding a cash-flowing property is nigh impossible.
In that context, you are really relying on just two drivers of investment returns:
- Deleveraging, which can be quite predictable, and
- Price appreciation, which can be anything but predictable
Now, the strategy of avoiding single-family homes may have been very sensible.
However, the result of that strategy is that we don’t have any detached houses in our portfolio.
The other complication is that my wife and I would like to move back across the pond at some point. When the time comes, we would like to buy our dream family home there.
A single-family property would give us a near-perfect hedge from further price increases in the local market.
Cue in the change in strategy.
I’ll spare you the details of bidding for a house in an overheated market. You can forget about things like home inspections or conditional offers.
Being overseas made it even more challenging, what with remote viewings and late-night bidding wars.
On multiple occasions, I stayed up until 4 am just to find out we’ve been outbid yet again. Suffice it to say that the mornings after weren’t joyful.
What saved the day here was having a fantastic agent. Our guy also has quite a bit of building experience and doubled up as an on-the-spot inspection agent.
It also didn’t hurt having family around who could do viewings and extra due diligence on the houses we liked.
I know a lot of folks who talk a good game about remote real estate investing.
My take on it is that it might work under “normal” market conditions, but certainly not the ones we’ve seen over the past six months.
The real pitfall, however, lay elsewhere.
The Cost Of Being Disciplined
If there was one misstep along the way, it was failing to anticipate the sheer velocity of housing market recovery post-Covid.
We screened our properties, did our research, and bid “market” prices.
However, those “market” prices were informed by sales over the precedent few months.
In the meantime, buyers flush with cash and buoyed by all-time-low mortgage rates kept raising the bar.
As a result, we’ve missed out on a fantastic property in October 2020.
Then another one in January 2021.
And one more a few weeks later (which really hurt).
In the meantime, prices just kept ticking up – and the properties we missed out on looked more and more of a bargain.
Worried about a traditional spring “melt-up” in the market, we finally decided to bully our way into the game in late March.
The Juicy Details
Here’s the lowdown on the latest addition to our (real estate) family.
It’s a four-bedroom bungalow on a nice 60 x 120 lot.
Renovated just nicely and recently enough to attract good tenants – but not nicely enough to make it cost-prohibitive.
We picked it up for $1.6m and will finance it with an 80% LTV mortgage.
It will likely rent for about $4.5k a month, and with a conservative set of financial assumptions, will likely be cash negative to the tune of $25k a year.
Yep, you read that right.
In essence, it means I will need to set aside another $125k to cover the running costs over the next 5 years.
All in, my cash outflows will total about $500k (there’s also a meaningful chunk of fees and taxes involved).
However, it will also de-lever rapidly.
Assuming a price increase of about 4% a year, I’ll be able to take about $390k off the table when I refinance in 5 years.
Set aside another $125k (to cover running costs for the next 5 years) will leave about $265k in net capital release, equivalent to about $53k/year.
All in, that adds up to an IRR of about 9%.
But now, let’s consider the most important question:
What Could Possibly Go Wrong?
A number of things.
To start with the most critical one, the anticipated price growth might not materialize. For all I know, prices might actually come down.
I’ve got a reasonable conviction they won’t, based on local macro prospects and demographic outlook.
However, hope is not a strategy.
What gives me ultimate comfort is the fact that I have a natural “offset” in the reduction of the price of our dream home.
Then there’s the risk that interest rates might go up, but I’m hedging that risk by taking out a fixed-rate mortgage.
Are we about to buck the trend?
Some of the more customary risks include rental rates coming in below expectations, dealing with horrible tenants, or not being able to rent the home out in the first place.
All valid concerns.
Then again, the beauty of real estate investing is that it’s a skill that accrues over time.
By now, I’ve got enough experience to have confidence around both my projections, as well as my ability to handle any curveballs.
More importantly, I’ve got enough experience to know that things can and will go wrong. After all, there’s a reason they call them risk assets.
And the only way to mitigate this risk is to hold enough liquidity to prevent me from becoming a forced seller.
Time and market will be the ultimate judges of our latest investment. I will make sure to provide regular updates along the way.
But in the meantime, I hope today’s post is a helpful reference point for anyone considering making a real estate investment of their own.
In the meantime, I’m about to go downstairs, open up a cold beer, and cross one more item off my 2021 to-do list:
Buy another investment property
Thank you for reading – and have a great weekend!
About Banker On Fire
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Banker On FIRE is a London-based M&A (mergers and acquisitions) investment banker. I am passionate about capital markets, behavioural economics, financial independence, and living the best life possible.
Find out more about me and this blog here.
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