When I made my first real estate investment a decade ago, all I wanted was to generate a couple thousand dollars a month in passive income.
Little did I know that just ten years later, I’ll make enough money in a year to buy a brand new Ferrari – and still have enough left over for a couple of nice vacations.
The best part? It was all on a single real estate investment that I closed just 18 months ago – and documented extensively on this blog.
In today’s post, I am going to unpack this case study of how we got from point A to point B – and how you can do the same.
However, if you want to make the most of it, I do recommend you read two of my earlier posts on real estate investing.
The first one covers fundamental concepts like cap rates and NOI.
The second one covers property investing more holistically and describes how people get rich with real estate:
And now, let’s dive in.
Real Estate Investment Of The Year
Let’s start with a brief recap.
The property in question is a mixed-use commercial building, with a restaurant on the ground floor and four apartments above it.
When we bought it at the height of the pandemic, it had an NOI of $49k and was valued at $855k. And if you actually read the suggested posts above, you’ll know that this implies a cap rate of 5.7%.
Fast forward 18 months and the property is generating NOI of $72k a year. Assuming the cap rates haven’t compressed (they have, but let’s be conservative here), that implies the property is now worth $1.265m.
Put another way, that’s a price increase of $410k. In the meantime, my tenants have paid off about $25k of the mortgage, which means that the value of my equity has gone up by $435k.
$435k. 20 months. And yes, it’s all tax-free – at least for the time being.
A Perfect Real Estate Investment
Here’s the thing though – I always get miffed when I read a real estate investment article that focuses on the upside but ignores all the expenses.
No, doing business isn’t free and when you come across people who tell you otherwise, you should take their advice with a pinch of salt.
On this particular deal, I’ve also incurred about $20k of expenses, mostly related to agent and lawyer fees, renos, and forgone rental income.
All in, that reduces my net gain to about $415k.
Investing Thesis vs… Reality
At the time of the acquisition, my investing thesis was quite simple.
The residential units were nicely done up and rented significantly below market prices. All in, there was about $9k of annual rent upside to go for.
About 9 months after we bought the property, two of our tenants left, and we were able to re-rent the units immediately at much higher price points.
As a result, we’ve increased residential rents by about $6k a year – and have had zero vacancy along the way.
Things were a bit more complicated with the commercial tenant.
Yes, his rent was significantly below market. Equally, if the restaurant was to go out of business, it could take me a long time to find a new tenant.
The way I got comfortable with it is by running a highly bearish “downside case” on the property, assuming I’ll lose the tenant and it will take me a whole year to find another one.
Based on that analysis, I knew that even in this worst-case scenario, I would still generate a ~5% annualized return. Armed with that knowledge, I pulled the trigger on the deal.
Well, that thesis played out almost to a tee.
In May of last year, the restaurant finally folded. We parted ways on good terms, with me holding on to a few months’ rent, last month’s deposit, and all of the restaurant equipment.
I won’t lie, it felt uncomfortable. But instead of dwelling on it, I quickly hired an excellent agent, had the place repainted, and focused on getting it rented ASAP.
Now, I’ve never negotiated a restaurant lease before. I did, however, put myself through college by working in restaurants, and so I know enough to tell a good prospective tenant from a bad one.
By the end of the summer, we had a lease signed up with a high-quality tenant looking to open his second location.
The upshot? The new rent was $19k higher to start with and will be increasing 3% per year going forward.
All in, the annual rental income has gone up by $25k while expenses have increased by $2k (primarily property taxes and a more comprehensive insurance policy).
Which is how we ended up with an NOI increase of $23k.
All About The Cash
At this point, I had two options.
One was to run the place as is, generating a much higher annual income, and paying myself a healthy dividend every year.
That, however, would imply getting taxed twice. Once on the corporate income, and yet again on the dividend payment.
Alternatively, I could do a tax-free cash refinance. The proceeds would go into the corporate bank account. If I was to pay myself a dividend, it would still be taxable – but I’m not (more on that below).
I don’t mind paying taxes, but I do believe optimizing your taxes is one of the best (albeit boring) ways to build wealth.
Thus, we chose to go with a $250k refinance, which we completed earlier this month.
Key Lessons For A Great Real Estate Investment
At this point, you may say:
“Damian, it sure is one cool real estate investment, but what’s in it for me?”
Well, here are the lessons we can all draw from my experience.
#1: It’s Possible
Now, I won’t say something silly like “Look, anyone can do it!”
Because in order to do it, you need to have $250k to play with – and many people don’t.
That being said, I also didn’t have that kind of money ten years ago. Instead, my wife and I scraped together just enough to buy our first property.
Sure, we made many other investments and earned good money in our day jobs since then.
But even if we didn’t, that first property on its own generated nearly $250k of cash since we bought it – which would have been enough to finance this particular purchase.
Alternatively, you can start with a smaller deal. Perhaps one where you put $25k down – and make $40k.
Most big things start with little baby steps.
#2: Know Your Market
Before we pulled the trigger, I spent another 18 months or so learning everything I could about our target market.
Macro data, population dynamics, vacancy rates, new developments, infrastructure investments, road works – I read through every piece of data I could get my hands on.
I also looked at pretty much every deal that was on the market. Residential rent rolls, commercial lease rates (and leases), rent growth trends, expense breakdowns, and so forth.
As a result, our rent and expense projections were pretty damn accurate.
It’s like being back at school. Do enough homework, and you are bound to ace the exam.
#3: Buy Off Market
This is probably THE most important takeaway here.
By the time a property is on the market, you are competing with multiple other buyers, which means it’s exponentially tougher to snag a great deal.
As I’ve written about here, I knew and tracked this property for about a year and bought it before the owner put it up for sale.
But you can only do it if you go through the slog of #2 above.
#4: Know Your USP (Unique Selling Proposition)
Put yourself in your tenants’ shoes. Why would they rent your place instead of going elsewhere?
Is it the area? Proximity to schools and entertainment? Short commute? Amazingly renovated apartments?
There are a lot of “meh” properties out there that end up competing on price. And if there’s one thing I remember from business school it’s that competing on price is one of the toughest business strategies to execute.
You are much better off buying properties with a specific, differentiated angle.
#5: Protect The Downside
Expect the best, plan for the worst.
Run the numbers assuming everything will go wrong. Rents collapse, vacancies go through the roof, interest rates rise, expenses balloon.
No, it won’t look pretty. But if the property you are looking at still ekes out a small return despite everything going wrong, you know that at least you won’t lose money.
And as we all know, the number one rule of making money is not losing money in the first place.
I’ve always been honest about the challenges that come with property investing. But follow the five rules above and you will be well on your way to making great real estate investments of your own.
Before we wrap up, let me go back to the cheeky comment I made at the very beginning of this post.
How To Spend It
No, I will not be buying a Ferrari. And no, we won’t be increasing our holiday budget.
Sure, the F8 Tributo looks pretty damn amazing:
Courtesy of Carscoops.com
But… we already lead the lifestyle we want – and own all the cars we need (which at the moment happens to be precisely zero).
Yes, there will be an increase in our charitable contributions budget in 2022. As it happens, there’s a pretty important cause out there my wife and I would like to support.
But beyond that, the only thing that’s missing from our lives right now is more time.
And that’s exactly what we’ll be looking to buy – by continuing to grow our real estate and stock market portfolios.
The final comment I want to make here is one around money.
I won’t lie, writing this post felt somewhat uncomfortable.
In a way, it seemed borderline inappropriate to put this whopper of a monetary gain out there for public consumption. Especially so in today’s environment.
I know many people will feel a similar way. But at the end of the day, making money is not inappropriate.
What’s inappropriate is making money unethically, or spending it in a questionable manner.
In other words, I’ll be delighted if this post helps even one person build wealth and create a richer, happier, more fulfilling life for his or her family.
Even if that means buying a supercar.
As always, thank you for reading – and happy (real estate) investing!
About Banker On Fire
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Banker On FIRE is an 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.
If you are new to investing, here is a good place to start.
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