$30k: real estate or stocks?

May 22, 2009 1:58 PM

I will receive $30k (canadian) as an inheritance. I'd like to invest it to start getting some revenue out of it. I have a few questions.

My first idea was to buy an apartment building. I live in a countryside region (on the border of being suburb...) that's currently going through the fastest growth of population in the province. I could get a 3 apartments building for around $300k, so I'd have a cashdown of 10% (I have a few thousand saved, but I'd keep it for eventual renovations). Revenues (before expenses and taxes) would be about $24k/year (full occupancy, which isn't a problem). I have time to invest for maintenance and all, so I won't count the hours spent. Could I get a better return just by putting my money in some sort of fund? By the way I would not live in the buidling, but would stay in the rented house I currently occupy.

Another factor to consider is that I would like to buy a house for myself in perhaps 3-4 years, and wondered if having an apartment building help to finance the house, or if I should do it the other way around (get a house, and use that to finance the building, assuming that the house would cost me $200k minus the 30k).

As you can see, this is a little vague, but then I'm really not too sure about what's the best way to make that 30k a long-term investment. Our combined family revenue is about 60k. This is in the beautiful province of Quebec.

So: (1) Assuming I have time and willingness, is buying a property to rent a better investment--ie. pays more (for long-term revenue) than a typical fund for $30k?
(1) which one should I buy first, personal house of apartment building?

I hope there are enough infos!

posted by anonymous to work & money (15 comments total)

$30k is not a lot, I would really focus on minimizing taxes and other known liabilities. Even index funds have too much volatility for a 3-4 year time period, or at least to realize growth of 6-8% that is standard return for something tracking the S&P500.

Your best bet is to put your money in some sort of tax shelter like an IRA that you can use as a down payment on a home. If you add up the broker fees and such, you'll see buying an apartment will quickly eat away at any sort of return unless you buy a highly speculative property.

I mean I have friends who speculate on real estate and are quite good at it, even in today's market. They tend to also have a lot of "vertical" experience in that they are their own broker and know to price repairs and upgrades to their benefit. In other words it really is a full time job, and they're a lot more diversified than one property.
posted by geoff. at 2:10 PM on May 22

To me, it sounds like a big risk. Your family income is below the Canadian average. You don't have your own home. You haven't noted anything about your emergency fund, retirement savings, existing debt and so on.

The mortgage on a $300k building would be at least $1400 a month at residential home ownership rates. But you probably can't get a rate of 3.69% on a first-time commercial property. You also need to include property taxes, utilities, insurance, maintenance and so on. It could quite easily put the costs up to $2,000 a month. You said the revenue was $2k a month. Now you need to look at small business tax of at least 14%, if you're incorporate, or probably 30-40% if you are a proprietor.

Not only that, the value of the property may be falling in the current economic climate.

Without knowing your total financial picture, it's tough to say what you should do. You might be better to buy a home and rent out the basement as an introduction to seeing if you like being a landlord. But it would be wrong to recommend even that without knowing your entire situation.
posted by acoutu at 2:15 PM on May 22

Assuming I have time and willingness, is buying a property to rent a better investment--ie. pays more (for long-term revenue) than a typical fund for $30k?

First of all I'm not an expert on buying rental property so I don't know a lot of the specifics on that, but I can give you some general advice. Buying the apartment building would almost certainly have more potential profit, but it would also have a lot more risk.

For example, let's say you buy the apartment building for 300k with 30k down, so you owe 270k. After a few years, property values have gone down, you've spent most of your money you made in rent on loan interest, repairs, insurance and other expenses, and now your apartment building is worth 265k and you're broke. Not only did you lose your whole investment, but you actually owe money out of the deal. If you don't think this can happen to you, just look at any of the people and companies who bought property in Las Vegas a few years ago, which was at that time the fastest growing area in the US. Those people are now bankrupt and the companies have gone out of business.

If, on the other hand, you put that money into a broad index fund, you'll only make 6-10% every year in profit on average, but even in massive crashes you won't lose the kind of money that you could by going into real estate. Really, there's no magic way to use $30k to get rich without any risk, even if you put in a lot of effort. You're usually better off just putting your hard work into a normal job, not spending much money, and investing in boring safe types of investments.
posted by burnmp3s at 2:32 PM on May 22

(full occupancy, which isn't a problem)

I would urge you not to make this assumption. Even if you live in an area where housing is so scarce that you could find new renters for an apartment within days of receiving notice that the previous tenant intends to leave, there are still many reasons an apartment could remain vacant for months at a time. What if your tenants trash the place and you have to spend significant time cleaning or remodeling before you can rent it? What if your tenants stop paying their rent and you have to evict them, a process which can take months and cost hundreds or thousands of dollars? What if the rental market tanks and you can't find renters?

The point is, don't become a landlord unless you know what you're getting yourself into and have cash reserves enough to cover your mortgage in case something happens.
posted by decathecting at 2:35 PM on May 22

Shoert answer to (1): No.

Short answer to the other (1): No.


Talk to a financial advisor. This sort of thinking is how people end up bankrupt.
posted by smitt at 2:51 PM on May 22 [2 favorites]

Revenues (before expenses and taxes) would be about $24k/year (full occupancy, which isn't a problem).

Uh, what about your mortgage payments? A $270,000 mortgage with 25-year amortization at 5.25% (the current rate for a 5-year fixed-rate mortgage from the major banks) has a mortgage payment of $1600/month, which is $19,200/year. Considering taxes and other expenses, the time and hassle (it's basically a second job), and the risks, this doesn't seem like such a great idea.

I'd suggest starting by reading a basic personal finance book. My personal favorites are Andrew Tobias, The Only Investment Guide You'll Ever Need, and Gordon Pape, Sleep-Easy Investing. Pape also has a book out on the new tax-free savings account (TFSA), which is a pretty major change.

Next, a question: do you want security, long-term growth, or cash flow?

If you want security, stick the money into a 4- or 5-year GIC, inside an RRSP. It won't give you much of a return (less than 2%), but it'll stay safe.

What about if you're willing to take risks? (As Tobias puts it: meanwhile, down at the track....)

If you want cash flow, an alternative to buying your own apartment building would be to buy shares in a real estate investment trust (REIT). A REIT holds real estate properties (e.g. strip malls) and pays out regular dividends to its shareholders. Part of the cash is considered a return of capital, so it's not taxed (but you'll have to pay more capital gains tax when you sell it). Right now the yield on RioCan (REI.UN) is just under 10%. The risk is that if the economy declines further and retailers give up their leases, RioCan will be forced to cut its dividend, driving its share price down.

If you want long-term growth, on the other hand, you could put the money into an index fund like the iShares S&P/TSX 60 exchange-traded fund (XIU). It only pays 3% in dividends, but over the long term (20 years or so), you'd expect the return on stocks to be greater than for GICs or bonds, simply because they're riskier. Over the long term, the historical average equity premium for US stocks has been 6%.

Taking a step back, there's a tradeoff between risk and return. If you want higher return, you need to take higher risks.

Some possible options:

1. Keep the money as a cash reserve. Put as much into your TFSA accounts as possible (you can contribute $5000 each year).

2. If you already have a cash reserve, covering three to six months of living expenses, but you don't want to take any risks with the money, the simplest thing to do is put it in a GIC, inside an RRSP account.

3. If you're willing to take risks, and you want the money to generate cash flow, you can buy REIT shares. Use a TFSA account (so you won't need to pay tax), and don't put all the money in at once; consider putting in $5000 each year. I'd also recommend keeping at least half the money in cash or GICs: you can't predict the future.

4. If you're willing to take risks, and you want long-term growth (you won't need to use the money for the next 20 years or so), you can buy an index fund. Again, use a TFSA account; don't put all the money in at once; and keep half the money in cash or GICs.

Disclaimer: I am not a financial advisor.
posted by russilwvong at 3:54 PM on May 22

Let's throw in some more numbers to help you do an apples-to-apples comparison.

Assume, as you said, you pull in revenue of $24K / year.

Assume, as russilwvong said, your mortgage payments are $19,200 / year.

Assume, for the sake of being conservative, that the $5000 difference is eaten up by maintenance, taxes and other expenses.

Assume, for the sake of being optimistic, that the town doesn't depopulate when its main industry goes bust or something.

i.e. so your input at Year 0 is $30K, and your output at year 25 is $300K. This translates to a consistent annual return of 9.65%.

This is a bit better than the return provided by the Dow Jones Index or the S&P 500 -- typically 7% to 10% averaged over the long term (depending who's numbers you believe).

I'd say the risk is also about the same -- i.e. entering/exiting the market at the wrong time can significantly reduce your returns. All markets go through bull and bear markets, you just gotta know how to read them (learning to read them takes a lifetime of experience).

So really, what is the difference? I think it boils down to the fact that managing rental property is A LOT OF WORK. Dealing with tenants. Dealing with maintenance and repairs. Dealing with all the paperwork. If you hire a property manager, then you gotta pay the guy and you still have to manage him, to a certain extent.
posted by randomstriker at 5:52 PM on May 22

Assume, as you said, you pull in revenue of $24K / year.

Assume, as russilwvong said, your mortgage payments are $19,200 / year.

he must be already taking mortgage payments into account when providing the revenue - if he has three apt buildings with full occupancy, he'd have to get more than $2000/month from them, right? I mean, maybe i'm just confused by canadian dollars / rent in some areas, but I'm having a hard time seeing how he wouldn't be getting some kind of profit here, IF occupancy, upkeep, taxes, etc work out as simply as he hopes (time to do real research, not internet-board research, for that)
posted by mdn at 6:07 PM on May 22

I appreciate your interest in turning your money into more money. It's one of my hobbies that I am absolutely terrible at, but 30k isn't enough money invested to get involved. You have to look at it as risk versus reward and what's your return on investment here.

You're not going to see a passive income out of this place for 10 years and that's if everything absolutely goes your way. And in homeownership? Nothing ever goes your way all the time. Ever.

If you had maybe 3x that amount, I'd say use 60k as a down payment and 40k as reserves, but even then I'd say you wouldn't be turning an actual profit for a few years.

Managing property (as a landlord or a management company) is a huge amount of work. It will become at least a part-time job for you between tenant management and actually property management.

Unless you are extensively handy and a jack of all trades, you're going to be spending a lot of money on contractors. Someone's always going to be plugging up a toilet, putting something ill-advised down the garbage disposal, water heaters will go, as will heating systems. Windows will break, roofs will leak and eventually both will need replacing. Apartments will need painting and cleaning in between tenants. Carpets will need cleaning or replacing. The few thousand you have saved for this isn't going to cut it.

Oh, and don't forget insuring the place. The mortgage company (and you) will want you to insure your mutual investment for loss, but above and beyond that, you'll need to insure it for liability in case people are injured on your property.

And the mortgage company? I don't know how it is in Canada right now, but the mortgage company might want to see more than a few thousand in reserves, especially where this is a multi-unit dwelling that will not be your primary residence.

And don't presume 100% tenant occupancy will be no problem. Because even if they are in there, they might not be paying. Then you'll expend lawyer fees/court costs to have them evicted.

I could see if you had the lifelong goal to be a landlord and outright owned or had significant equity in an existing property...
posted by jerseygirl at 6:25 PM on May 22 [1 favorite]

mdn, it seems like this is in small-town quebec, I'm guessing low-rise buildings with only a few apartments in each -- rent of a few hundred dollars per unit per month is pretty normal. especially if you can buy all three buildings outright for only $300K (that would barely get you a one-bedroom condo in Toronto or Vancouver).
posted by randomstriker at 6:27 PM on May 22

I think the OP means a 3-unit apartment building. "3 apartments building" is a potential translation/transcription error.
posted by acoutu at 9:40 PM on May 22 [1 favorite]

I think knowing your age would have been helpful.
posted by Taurid at 10:02 PM on May 22

I think I would check with a tax professional first and make sure your won't pay tax on the $30k.

I don't think it's a good idea to buy a property when you will still be paying rent on your primary residence. I don't always agree when people say that renting is throwing money away, but by buying you basically stabilize your future housing costs. Your income (not considering the incoming rent) is relatively low to be paying a large mortgage AND your own rent, if for some reason you can't rent the units at some stage.

Four years ago our area was so saturated with population growth that the apartment complexes had 4-6 month wait lists. Companies built so many new complexes since then that even though the population is growing, there are so many new apartments that the older ones have to drop the rent and at least one new complex stopped during mid-construction.

I think a safer bet for you would be to buy a duplex or a house with an basement or attached apartment, which would also be your primary residence. This would guarantee occupancy on one unit (yours), limit your liability, and with you living on site would help prevent small problems from becoming big problems. Although this arrangement may not provide a large return on paper, the remainder of the mortgage payment should be dramatically less than your current rent, allowing you to save more money for your eventual goal of your own private house in a few years. At that stage, you will have two units to rent and presumably more equity in the rental property.
posted by Yorrick at 11:40 AM on May 23

Buy your own home first, when the time is right. I think the duplex idea is good, then you still get rental income.

Talk to a financial advisor - 30 K is not a huge amount of money, frankly. Do you already have a TFSA maxed out? If not, that's where I put 5K for sure, you don't get a tax deduction like with RRSPs, but the gains you make in a TFSA, whether interest income or capital gain, are tax-free. I think you should put 5K in a TFSA savings account (Cdn Tire currently has the highest interest rate), pay off any debt you may hold, and then see where you are.

If you have no experience with stocks or mutual funds, don't jump in with all the remaining cash. No respectable broker will be interested in a 30K account (I know. I phoned around myself, and was told by stockbrokers: Until you have 50K you can afford to lose, don't invest in the stock market.)
posted by Penelope at 1:57 PM on May 24

No respectable broker will be interested in a 30K account (I know. I phoned around myself, and was told by stockbrokers: Until you have 50K you can afford to lose, don't invest in the stock market.)

That's a bit strange. I would put it differently: until you have your debts paid off, a three- to six-month cash reserve, and some money in GICs, don't invest in the stock market. But once you're in that position, I don't think you need to start with 50K that you can afford to lose--5K seems like a more reasonable number. With a discount brokerage like BMO InvestorLine, you can purchase index funds (like XIU) for $30 a trade.
posted by russilwvong at 9:53 PM on May 24