Some time ago Mike and his wife exchanged comments about having tenants pay off your mortgage.  My mother takes the same position as Mrs. Pillars does:  tenants paying off your mortgage is a good thing.  With respect to both frighteningly intelligent women, I’m suspicious this is a poor way to think about the investment.

Say you buy a rental property in Pleasantville.  This is a delightful small town, where few people move to but few people leave (’cause it’s so pleasant).  Because of this property prices are very stable, increasing at the rate of inflation.  Say you buy a property for $100K with a 100% interest-only mortgage and you manage to rent it out for exactly the same rental fee as your mortgage payment (so every month you take the rent check, hand it to the bank and you’re even with them).  Is this a good investment?

I don’t think so.  First off, you aren’t making much (in cash flow or appreciation, beyond the increases due to inflation).  While your mortgage is being covered, you’ll still have to pay the maintenance, vacancies (maybe), utilities and taxes yourself. You’ll also have to put in time dealing with tenant complaints or problems. If appreciation equals inflation, this may (or may not) exceed your costs, making this a pretty volatile investment.

Say as an alternative, I invest in ultra-safe GICs and get the 3% rate being offered by PC Financial. This will probably work out to be a little bit above inflation. Is this better or worse than investing in Pleasantville? With an unknown future (and all my made up numbers), it’s impossible to say, but I find it pretty tough to view the real estate investment as the clear winner. There’s FAR more volatility, and the returns don’t seem to compensating for this.

Some might say “Don’t invest in Pleasantville, invest in the hot markets!”. The subprime fallout in Florida, Arizona and throughout California paints a bleak portrait of one possible outcome of that choice.

Richard Thaler coined the term “Mental Accounting” in 1980.  A Washington Post article illustrated this difference with the example “Would you rather lose a $10 ticket, and have to buy another one to replace it, or lose a $10 bill on your way to the event?” Surprisingly, in spite of these being virtually identical situations (from a purely monetary perspective), most people would prefer to lose the $10 bill. Similarly, there’s something irresistibly enticing about matching up a tenant’s rent check with the mortgage payment that I don’t think is entirely rational.

My point ISN’T to debunk real estate investing. I just think that it would be very easy to have tenants paying the mortgage and it being a TERRIBLE investment. Having tenants covering the mortgage may be a small part of the reasoning about whether a deal make sense or not, but that CERTAINLY shouldn’t be the end of the consideration (if that’s all the investor is getting out of it, I think she’d do much better in an couch potato style portfolio or a even a high interest savings account or GIC).

What are your feelings about having tenants pay the mortgage?

This guest post was written by Investing Thesis: Credits Toward Financial Freedom – a personal finance and investing site from a Canadian perspective. If you like this article, I would encourage you to subscribe to our articles

With the number of homes now in foreclosure many people, home buyers and investors alike are jumping to take advantage of the surge in inventory within the housing market. Of course there are plenty of houses for sale outside of foreclosures, however buying a foreclosed property can be a very good investment if you have considered all the risks. If you looking to purchase your first home, you can save a significant amount of cash by buying a foreclosed home. Before doing so, it is important to understand the pros and cons of purchasing a property that is in foreclosure.

Understand The Process

The United States and Canada share similar foreclosure proceedings however there are slight differences from state-to-state and different provinces. In Canada, there are two different procedures that dictate how foreclosures are processed. Judicial Sale refers to the procedure where the lender must petition the court for permission to sell property that is in default. British Columbia, Alberta, Saskatchewan, Manitoba and Quebec follow this procedure. Nova Scotia follows the same procedure, however it is called Mortgage Foreclosure, despite the fact the same proceedings must take place. The provinces of Newfoundland, Ontario, New Brunswick and Prince Edward Island follow the Power of Sale procedure. In this situation, the lender can sell the property without permission from the court as dictated by the terms of the mortgage.

In any event, when you buy a foreclosed property you are almost always dealing with the bank versus the homeowner. This should be considered as banks are generally unwilling to budge on price or conditions of sale. Where a seller might negotiate price or contribute to closing costs, a lender is just looking to get their money back with the least hassle. This could prove to be a deal breaker if you do not have the asking price readily available.

Buyer Beware

It is imperative when considering a foreclosed property to carefully inspect the house prior to submitting an offer. In order for a home to go into foreclosure, the owner must be behind in payments. In most cases this is due to some form of financial hardship which more than likely affected other financial responsibilities. The home may be in disrepair or need renovations to be habitable as a primary residence or for sale or rent to another individual. You might be getting a great deal on the purchase price, however if you have to invest a significant amount of cash to make the home livable, your investment becomes more risky. Another factor to consider is the location of the property. If the neighborhood is experiencing a downward trend, you are not likely to recoup your renovation investments. You can change out cabinets and flooring, but you can’t change location.

Know When To Seek Help

Unless you are a seasoned investor or have experience in the real estate industry, it is important to recognize when you need professional help. Buying a foreclosed property offers many benefits, however it is not the same as buying a home in the traditional manner. Foreclosure, pre-foreclosure and homes sold at auction all have different pros and cons that are readily understood by professionals. It is not simply an opportunity to buy a home at a discounted price, therefore know what you are getting into before whipping out your cheque book.

When the process of buying a foreclosed property is handles correctly, the opportunities can be endless. Many first time home buyers would otherwise not be able to afford getting their first place. In addition, savvy investors can turn a relatively quick profit if they have followed proper procedures in period of time prior to sale.

Mr. Cheap & I have published a rather large number of posts where we point out that SOMETIMES real estate agents are not your friend, associate or even on your side and they definitely can’t ALWAYS be trusted. Heck, sometimes people DO use a friend as a real estate agent and SOME agents must be foolish enough to be honest with clients.

That said, neither one of us has anything personal against agents  – most of our complaints have to do with their compensation system which is determined by the large real estate brokerage companies who control MLS (for now).

In fact, I recommend that most people should use a real estate agent for a number of reasons.

1)  Knowledge of the local market prices

Yes, your agent will undoubtedly withhold and manipulate data as they see fit for their own gain, but the fact remains that they should have more knowledge than you regarding local market conditions.  Unless you are willing to spend a ton of time learning the market yourself then it’s worth paying for someone else’s experience.

2)  Knowledge of local landscape

When I bought my first house I had a few pretty nice areas in mind where I wanted to live.  Once I figured out that I couldn’t afford to live there then my agent suggested a couple of areas that were not quite as nice (which is not to say they were bad).  If you don’t know all the areas in your city or if you are new to a city then hiring a local real estate agent can be quite helpful.

3 Access to house details and comparative sales

This is the big reason why MLS is so valuable.  If you are selling a 3-bedroom semi in Leaside then you look at all the recent sale prices and get a better sense for the market.  This info is available from other sources such as city hall but it is very difficult and inconvenient.

4)  Easier access to houses

This is one of the biggest advantages of having an agent regardless of how experienced you are with buying houses.  The fact is that people selling a house are not going to let you in without an agent.  You can contact the selling agent to book an appointment but there is no guarantee they will play ball.  Open houses are a good way to look at a house but they are quite limited.

Another problem is that sometimes buyers without agents are considered “ignorant” and might not be taken seriously.

5)  Transportation when looking at houses

The two agents I’ve dealt with on the buy side always drove me around to look at houses.  Considering I had a car this wasn’t what I would call an overly valuable service but for a house buyer that doesn’t own a car, this would come in pretty handy.

6)  Less stress to close the deal

One thing about an agent is that they will do all the administration for documents, finances etc.  This service might not be worth the money it costs, but regardless, it’s work you don’t have to do.

7)  Renovation ideas

Agents tend to have at least some knowledge of renovation and design ideas so for a client who has a problem with the layout/condition/colour of a potential house, that agent might be able to lend some insight about how to change things.  You have to remember that the agent is doing whatever they can to get you to buy the house so they will estimate potential renovation costs WAY on the low side.

On the sell side, the agent should be able to know what buyers are looking for and can make suggestions to the home owner on what parts of the house to fix up for sale.

8) You are going to pay anyway.

Even if you do the dual-agent ripoff thing you will still be paying for an agent anyway since the “dual” agent will just collect twice as much commission so you might as well get some service out of it.

So there you go – all the reasons you need to get a real estate agent, hold your nose over the fees and get going on your real estate adventure!

Attention:  There’s a wager riding on this post.  If you’ve done something like this (or know someone who has), please leave a comment with details!  Specifically we’re interested in a) how much of the persons OWN money had to be invested, b) what their construction experience was BEFORE they did this for the first time and c) whether they were able to do this part time (did they have another job).  Please do watch the comments to see how the wager plays out in the comment (I can almost taste that beer already).

Thanks, Mr. Cheap

There’s always an interest in real estate strategies that don’t require a lot of money.  Happy to fill the void, a variety of get-rich-quick-through-real-estate types offer information on bird-dogging, rent-to-own, flipping and other questionable practices.  Sadly, these strategies have major challenges (legal, ethical and business) associated with them and are unlikely to provide what the person pursuing them is looking for.  An alternative, presented today, is something I haven’t done myself but have heard being done second hand from a number of sources.  It’s possible anywhere in the world, but is particularly well suited to Canada (and our taxation laws) and to small and medium sized communities.

The basic idea is to buy a piece of land, verify zoning and get permits and build the house yourself.  Do as much of the labour as possible, and anything you can’t do, hire someone to do it for you.  Once the house is finished, move into it.  Start working on another house.  Once this second house is finished, sell the house you’re living in and move into the new house.  Repeat as needed.

When I was studying in my undergrad, a friend of mine told me his father did this (and they’d lived in 8 different houses while he was growing up).  Apparently this was his father’s preferred form of recreation (he’d finish up at work, then head over to the building site to swing a hammer for a couple of hours each night).  A friend of my father’s has just recently stopped doing this (he did it for years and has finally “retired”).  He was an electrician, so was in the enviable position that he could do the electrical work himself, and had a number of contacts in the construction industry so he knew the other work would be done properly.  He even did this for investment properties (where instead of making a private residence for himself to move into, he built apartment buildings).

I was talking to a woman about this recently, and she said her grandparents did this is Romania (however they did it because it was the only way they could have a house:  not as an investment).

Taxation

The large benefit of the Canadian tax code for this type of thing is that we can sell our primary residence and not pay taxes on the capital gains.  In contrast, Americans pay tax on this, but can deduct their mortgage interest.  Canadians can’t deduct the building materials and expenses of construction, but these should be quite a bit lower than the sale price (so it’s better to get the tax free sale than to get the tax deductions on your costs).  Living in the house is an important step in the process (if you just build it than sold it you’d be in the construction business).  Obviously you’d want to read up on CRA’s definition of a primary residence and make absolutely sure each of your “stays” qualified.

Investment

SOME money will have to be put into this strategy, since you’ll have to pay for the land, materials and labour as the house is being built.  A construction loan helps with this.  Basically you show the lender exactly what you’re going to do, they approve the plans and provide money at each step in the process.  This is completely different than the standard process of getting a mortgage, but in some cases it’s possible to convert the construction loan to a mortgage upon completion.

My understanding from people who’ve done this is that being involved in the process, EVEN if just as the general contractor, saves quite a bit of money.  Plus, if you decide to live in the house long term instead of continuing with this strategy, you’ll know that it’s a well built home.

Carrying Costs

There will be costs that will need to be paid during construction (such as property taxes and whatnot).  Part of what might makes this approach less appealing in a large city would be that these costs and the “opportunity cost” of having a construction site where work proceeds SO slowly (since at times only one person may be working) would undermine any gains.  Vandalism and whatnot might also be considerations and could stop this from being worthwhile in a hurry.

Required Knowledge and Ability

The more you know about construction (like the electrician mentioned above), the better off you’ll be.  Early on when I first met Mike and his wife, I was very impressed at the scale of renovation they’d embarked on with their house.  At the beginning, despite Mike’s engineering background, they didn’t know much about home construction, but launched into some very aggressive plans.  The place looked great when they showed me around (I met them after construction was completed).  Not everyone would have the energy and willingness to learn how to do the various tasks then actually do them for the amount of time to construct a house (but both are required if you’re going to build your own house).

Why I Wouldn’t Do This

I have pretty close to zero renovation / construction / home maintenance experience.  A buddy and I spent the better part of a day anchoring a runner for drapes in the ceiling once (think about two guys off of “The Big Bang Theory” with a drill and you get the picture).  If I was serious about doing something like this, I’d obviously work up to it by getting involved with some renovation projects (at home or with friends) first.  Hell, someone doing reno work will probably be happy to train you if you’ll do work for them, so it’s a way to benefit both people.

Beyond lack of ability, building a house would be A MASSIVE amount of work.  Given that I try to earn a living staring at a computer monitor (or a nice book) and not getting sweaty, this would not be for me.

That being said, maybe others aren’t as lazy as I am.  A number of people have built their own houses before, so the information and possibility is out there.  There’s also 911 hits on Amazon for “build your own house”.

We’re obviously coming off of a period of very low interest rates. When rates were low, I thought to myself “now is a great time to buy a house, since I can get a great rate on my mortgage”. Amusingly, the truth of this statement made it incorrect.

When interest rates are low, you aren’t the only one who notices. Many people decide its time to buy their first property (or upgrade to a larger property), and consequently prices get driven up: supply and demand. When interest rates are high, no one wants to buy. This causes people who HAVE to sell to either give a super deal, or to provide vendor financing at a more reasonable interest rate, which is itself a super deal.

Much as buying stocks when the market is down makes sense, often buying real estate when interest rates are high makes sense for similar reasons. With the stock market, the masses have been scared off, so you don’t have competition. Similarly with real estate. Bidding wars happen when lots of people can afford to buy.

In theory the best approach might be to buy when interest rates are high, get a variable mortgage, then when you renew if rates are lower, borrow as much as you can and get a fixed rate. If you’re renewing when rates are high, obviously get another variable rate mortage. Supposedly the long-term average interest rate in Canada is around 10%, so you can use that to decide when rates are high or low. Personally I like fixed-interest mortgages, just because it helps me plan my cash flow better. I realize I’m supposedly paying more for this, but as far as insurance goes I feel like its pretty cheap. If my mortgage was above 10%, there’s no way I would consider a fixed-rate mortgage (variable would be totally the way to go at that point).

You could also try to sell when interest rates are low, since that’s probably when there will be the most buyers available and you should get the best price.

If you can afford a big down-payment during high interest periods, not only would putting the money into your property be a good idea (since high interest periods also have high inflation and real estate is a great inflation hedge), but since you’d have a smaller mortgage, you won’t be paying as much at the super-high interest rate. Alternatively you could make the case that a big mortgage is still worthwhile, since you can benefit from the inflation (and if you have a variable mortgage, you’ll get immediate advantage when rates drop). Obviously don’t buy more house than you can afford!

You still need to be a savvy buyer and negotiate hard. Paying a higher rate due to mortgage insurance or long amortization isn’t all that helpful (this is an expensive way to purchase a house for people who don’t have any other options). If you pay top dollar for a property in a high-interest environment, the results won’t be pretty (although the seller will probably be laughing all theł way to the bank).

Quite some time ago I posted on the temperament of a landlord and how some people just aren’t cut out for it.  My focus on that post were people who walked away from disagreements or would always give in, and how real estate investing would eat them alive.  In another post, small-scale landlords, I touched on people who think “I’m just renting out a small space, I’m not REALLY a landlord” (and how wrong they are).  Another personality (briefly touched on in the previous posts) that will cause problems in real estate investing is the feudal landlord.

I’m a free market kind of guy, and I’m sympathetic when individuals invoke their rights with regard to their personal property, including land.  As Mr. Burns illustrates on The Simpsons, there are *SOME* limits to this:

Department of Labor Officer: This power plant violates every labor law in the book. We found a missing soccer team from Brazil working in the reactor core!
Mr. Burns: That plane crashed on my property!

Unfortunately, renting property seems to bring out similar feelings from some individuals.  The best parody of this I ever read was a Craigslist post for a rental in Vancouver (I love it!).  The fact that Krystal’s commenters either believed the post, or questioned whether it’s a joke or not, shows how badly some landlords are behaving (for the record: this is CLEARLY a joke).

Some real estate authors recommend abandoning the title “landlord” as inherently feudal, and calling yourself the property owner or property manager (which I find a little misleading, it seems like you’re trying to imply you’re NOT the landlord if you call yourself the manager).

To provide a brief overview of my intended usage of feudalism, I am referring to the idea that a feudal relationship exists when someone owns land, and allows another usage of it in exchange for a set of obligations.  Historically, this existed when the monarch owned all land in the country, then gave usage of large areas to aristocratic vassals (they would be responsible to pay taxes to the monarch, fight for her in times of war, etc).  These vassals could then parcel out the land they controlled to their own vassals (who would have their own obligations in exchange for the usage of the land), all the way down to peasants who would work the land.

Interestingly, often landlords who take the feudal perspective on things, view themselves as monarchs, not as someone existing at a certain level in the hierarchy with responsibilities to those “above” them in addition to obligations due them from those “below”.  Despite “ownership” of land, such obligations do, in fact, exist.  You are typically required to pay property taxes, which is a financial responsibility imposed by the municipality the property is part of.  Owners of property are subject to the laws of the country (and province or state) they exist in, and can’t arbitrarily invent their own laws.  “A man’s home is his castle” makes a nice saying, but the law doesn’t support this.

A feudal perspective is, of course, the wrong view of the landlord / tenant relationship in the modern age.  Just because someone is renting, it doesn’t mean they have to dip their head, call the landlord “m’lord” and do whatever is demanded from them.  I also don’t think the owner is required to adopt a “the customer is always right” and give tenants whatever they want.  A landlord / tenant relationship is a legal  agreement, like any other, where each side should have their rights and responsibilities spelled out and both parties should only enter into the agreement if they’re comfortable with it.  In most places there is a default agreement (in Ontario it’s the Residential Tenancies Act) which covers both parties and which they both MUST make themselves aware of.

The consequence of adopting a feudal attitude for the landlord are all negative.  This will antagonize the tenants in a major way, and chances are they will become sticklers for the landlord to follow all relevant laws and be far less flexible or accommodating.  Turn over will increase, as tenants will be less likely to stay beyond their lease.  Both of these will probably lead to a less profitable real estate venture.

I recently came across an article I’d read and enjoyed before on anoisette. Basically it’s a horror story of what can happen if you buy into the wrong co-op in Toronto.

When I first started hunting for my first condo, I kept coming across dirt cheap properties (they’d be in great areas, look wonderful and have a low price). I’d ask my agent why she wasn’t showing me these, and she kept saying “they’re co-ops, I never recommend clients buy in co-ops”. I was suspicious about this, and the main rationale she gave me against them is that it’s hard to get a mortgage, so you need to put down 35% (it is considered a different kind of non-mortgage loan).

The reason for this, as was explained to me, is that with a condo you own a deed to that space in that building. Because of this, you can borrow against the deed and get a mortgage, much as you would with a single family home. In the case of a co-op, you own a SHARE of the corporation, which entitles you to exclusive access to one of the units. When you borrow money to buy the place, you’re using this share as equity (much as you could use a stock share to borrow money or pawn your guitar).

I’m not totally sure why banks like condos but hate co-ops, but apparently there are more legal requirements about how a condo is run, and they have more options to foreclose. My agent kept telling me that I’d need lots of money for a down payment, and becuase any buyers would have the same problem, I’d have a tough time selling it down the road.

Since I was (and am) planning to hold the properties I buy for the long-term, the selling argument didn’t bother me. The massive down payment sucked, but I reasoned that if it’s tough for me to purchase, this is a “barrier to entry” that would make it tough for other people to purchase as well (and help me get a good deal).

One strategy I also considered was to offer a vendor-take-back mortgage if I ever wanted to sell, then I’d be able to get a higher price for the property by making it easier for people to buy (I’m happy to get paid over an extended period instead of upfront as long as the interest rate is reasonable for the risk I’m assuming).

In the end, this article helped convince me that a building could go to the dogs and I could be stuck with a massive problem. Part of me still feels that this risk is reflected in the price (why co-ops are so cheap), and that by doing your due dilligence you could determine if a building was well run or not (and perhaps be willing to step in and protect your investment if you saw that the building was going down hill).

Has anyone had experience living or investing in a co-op in Canada?  How did it work out for you?

“Almost all neglect the properties they manage and take kickbacks from suppliers and subcontractors who overcharge the property manager’s client in order to pay the kickbacks.” – John T. Reed

People selling real estate advice almost always advocate using property management companies.  John T. Reed suggests they do this to overcome the objection “I don’t want to get up in the middle of the night to fix a clogged toilet.”  “Don’t want to get up in the middle of the night?  Me either!  Buy my $3,999 program and I’ll teach you how to have the best property managers begging to work for you!!!  Let THEM get up in the middle of the night.”

While it may sound great in principle, the reality can be a little less cut-and-dry.  You’re usually going to pay 5-10% of the gross rent, plus expenses to hire a property management company.  Sometimes they’ll charge extra for filling a vacant unit (for the extra work of advertising, showing and setting up the new tenant).  This is all quite reasonable, and if this was the end of the story I’d agree it’s a good way to go.

To get one case out of the way, sometimes real estate agents will offer to be property managers for the owner (or to place tenants for him).  They’ll charge a nominal fee, and will typically do a really crappy job (they won’t do their due diligence screening tenants and whatnot).  Their job is selling houses (not managing rental properties), so when they’re acting as a manager for the owner, they’re doing it to generate good will so the next time he buys or sells he’ll use them (the same reason they give you a pumpkin).  If things work out, they look like a champ for helping, if things blow up, they can just put the blame on the awful tenants (and maybe help the owner sell the place if he’s burnt out).

Genuine property management firms (where that’s what they do exclusively) are an intensively entrepreneurial enterprise.  You can be sure whoever started and runs the company loves business, and they’ll be dealing with all the typical challenges of running a business (advertising, employees, customers [owners!], etc).  As an entrepreneur, they’ll be constantly looking to maximize profit and minimize costs:  for themselves.  Property owners will assume that the property management firm will be doing this on their behalf, and in the case of a small number of HIGHLY ethical companies (that will naturally tend to go out of business, we’ll get to that later), they may be right.  The majority will sell out the owners in large or small ways.  You may think they’re your weasel, but they’re their own weasel.

Greed is one obvious motivation.  If a plumbing company offers the management company $20 every time they’re called to be the “sole supplier” for the company’s clients (or some other similar arrangement), do you think the company will refuse?  They should.  The $20 just gets added onto the cost of the job (and billed to the property owner).  If they could afford to pay a $20 kickback, they can afford to lower their price by $20.  The manager gets the kickback at the expense of the owner.

The same thing can happen in less obvious ways when a friend or relative of the manager is a plumber, and gets the business out of loyalty.  Would the owners want the job to go to the company that does the best job for the best price, or to someone the manager feels loyal to?

Apathy can kick in where greed leaves off.  If you’re not paying a bill, it becomes VERY easy to not work too hard to get the price reduced.  When I’ve had to rent a car for a business trip, I get whatever model is authorized from the first place I call.  When I’m renting for myself, I drive an economy model, use my credit card to cover the insurance, and will track down any deals or the lowest possible price in town.  If I can get a lower price to save myself some cash, I do so.  If I can save cash for a larger organization that will neither notice or appreciate it, I don’t bother.  Which case do you think the PM will be in when the owner is footing the bill?

Property management companies will argue against rent increases.  A higher rent means more money for the owner (and a tiny raise for them), but it also increases the amount of work they do (tenants will be more likely to move out after a rent increase, and may be less inclined to complain if they know they’re getting below-market rent).

If someone ethical is running a property management company, acting as a fiduciary for the owner, often customers won’t even realize or appreciate this.  They certainly don’t seem to realize how often they’re getting ripped off by property management companies, or you’d hear far more owners grumbling about them (economists call this information asymmetry).  The ethical manager will therefore be earning less money (no kickbacks) for more work (hunting for the best deals) and won’t even be getting loyalty from his customers.  How is he going to compete in this situation?  There will be constant pressure to slack off (both from an ethical and a work-ethic perspective) or give up and move into a more honourable field of work.  My reasoning here is (unabashedly) related to the lemon principle (alternative Wikipedia info).

John T. Reed’s advice is “competent real estate investors manage their properties themselves or have in-house salaried employees to do it.” I second this sentiment.

In a recent comment, on a very old post (“5 Ways to Make (or lose) Money With Investment Properties – Part 5 – Buying at a Discount”), Awesome asks “i live in Toronto, how and where do I find the deals”.  I found this a perplexing question, as the assumption seems to be that there’s a website, or a very simple technique, which leads to low priced real estate.  The obvious follow up to this is you buy from the cheap market, sell on the regular market, then start lighting your cigars with $100 bills.  I pointed him to my posts on inefficient markets and Mike’s post on valuing real estate but never heard from him again (I guess he’s off searching for the “simple”, “easy” way).  I also told him that if someone knew where a deal was, they’d just do it themselves (and make the money themselves).  If they knew a good approach for consistently finding deals, they’ll execute that strategy themselves (and not make it harder by advertising it and drawing competition).  Between these three posts I felt like there’s still some missing information, so this post is my attempt to fill in that gap.

In “How to Buy Real Estate For At Least 20% Below Market Value” John Reed talks in the beginning about how he never saw a bargain purchase in his years as a real estate agent (not even 5% below market value).  At the time he thought they didn’t exist (and thought people who claimed they did were selling snake oil).  Once he looked into it, he found they did exist, just that they never showed up in the “official” (MLS) channels.

He summarizes the two ways to buy at a discount (for goods which are USUALLY traded on an efficient market):

• properties which no one wants and
• properties which no one knows are for sale

The impact of these principles is that you can’t buy ANY property at a discount (there’s no way to get a 20% discount on that cute little bungalow you have your heart set on), but you can buy MANY properties at a discount.  It’s like dating: if you’ve got your heart set on dating Mary Jones or Johnny Smith you’re sunk.  HOWEVER, if you just want to date someone (who meets some reasonable minimum criteria) there are ways to make it VERY LIKELY that you’ll be able to get dates.  Sadly (or happily), romance can be a numbers game.

One way to find deals is to hunt for desperate sellers (they’d fit into the “no one knows are for sale” category).  One approach to this is to make low-ball offers on many items, and try to find the person who needs to sell quickly (and can’t take the time to advertise properly and let all interested buyer know it’s available).  I detail this process in my “Shotgun Investing” post (and is also how I bought my investment condo).  I still giggle when I read Mike’s description of a “for sale by owner” sign (that might have been a big tip off that they’re desperate sellers)

Another way to find deals is to hunt for what Reed calls “leper properties”.  These are properties that have something about them that causes most buyers and agents to immediately dismiss it as a potential purchase.  Properties with foundation problems are an example of this.  I was suspicious that there might be an opportunity for buying co-ops (as opposed to condominiums) in Toronto because of this.  My agent told me not to even bother looking at co-ops, which IMMEDIATELY got my interest.  This is the “no one wants” category.

Obviously for a leper property you must have some way to fix the problem (for less that the amount of the discount), otherwise you’re just buying someone else’s problem.

In my home town (around the corner from my parents) there’s a property that at one time was the nicest in the neighbourhood.  It was on a double lot, and was far bigger than the properties around it.  The owners let it get really run down and then were trying to sell it.  It sat on the market for a LONG time, and EVERYONE in town had heard how run-down it was.  Eventually someone bought it, and immediately started a massive renovation.  I don’t know what the purchase price was, but they’re fools if they paid anything close to market (it was a property no one wanted).

Not Easy

One other factor with discount purchases is they aren’t as easy as buying on the market.  If you buy the typical way, everything is set up to make it as straightforward as possible.  As soon as you start buying in an unusual way (such as either of these approaches), the risk is going to go up and the difficulty is going to go up.  You’ll put time into a deal, then have it fall through at the last minute (or you’ll try 10 deals and have them all fall through).  Part of a reasonable approach to discount purchases is to be as efficient as possible in evaluating when a deal may occur, and dumping prospects IMMEDIATELY when it looks unlikely (so you can put your time into pursing a deal that has a higher chance of going through).  Many people don’t have the stomach for this (and will get angry if a deal doesn’t work out) and they’ll abandon their strategy because of the emotional toll.

Have you seen situations (real estate or other) where a good price has been had for one of these two reasons?

I’ve had a draft of this post sitting in the Four Pillars draft queue for over a month, and after a recent question by JN it seemed time to finish it and post it.  While I hope it gives a decent overview of finding, selecting and finalizing a tenancy for a rental property, please keep in mind that I’ve only actually gone through this process once.  The tenants have stayed for 3 years (but I can’t stand on my results), and I put quite a bit of effort into figuring out each stage in the process (reading, talking to other landlords, going through the proper procedures, etc).  A previous post on this topic was part of my “Getting Started With Investment Real Estate” series.

Philosophy on Renting

Before you even start trying to rent out your property you must know yourself and what you’re looking for.  Do you need to get a tenant (any tenant) in the property as soon as possible?  Do you want to focus on finding the best tenant possible, even if it takes longer to fill the unit or leads to a lower rent?  Do you want to maximize the income from the unit?  Do you want to minimize the bother your tenant causes?  Your answers to these questions will affect how you go about the process of finding a tenant.

For the record, my belief (which underlies my suggestions in this post) is that no tenant is better than a bad tenant (and I’d rather minimize bother than maximize income).

Advertising

The first step in getting tenants into an empty unit is to let people know that it’s available.  If you have the time and inclination, I would first try to advertise through every available free channel (e.g. Craigslist, Kijiji, posters in the neighbourhood).  If you aren’t getting a large number of responses (at least 10+) you need to crank up your advertising immediately and maybe consider paying to post in the local newspapers or paid internet postings (such as ViewIt in Toronto).

I provide as much information as possible in the advertisement to help people make their decisions.  I put together a website for the unit (which I referenced in each ad), which had pictures, maps of the area, and lists of local amenities.

Rent

Determining what is market rate for a unit is tough.  If more than half of the people showing up to view the apartment choose not to fill out your application then your rent is too high.  Lower it.  Keep lowering it until you get half the people to fill out your application.  If someone takes an application to fill out at home or says they’ll contact you later, they’re just being polite, they aren’t interested. If everyone is filling out an application than your rent is too low.  I’m not 100% sure the best course of action in that situation (I’d probably pick the best person, and be upfront with them that I know they’re getting a good deal and warn them that the rent will be increased at the end of the lease).

Showings

A large number of people won’t show up for appointments.  If they find another place or something comes up, for whatever reason they don’t bother to let a potential landlord know.  I suspect tenants view it as one situation they’re in control and can safely stick it to a landlord.  When I was renting my unit I’d rush over to show it whenever was convenient for the people who called.  Next time I’m doing it I’m going to plan all the showings at one time (maybe on a Saturday afternoon) and make them 20 minutes apart.  I’ll take the name of anyone who can’t make the showing and offer to contact them if it doesn’t rent.

I walk around and point out the nice features of the apartment and answer questions.  If there’s something that’s a negative about the unit I don’t point it out, but I certainly acknowledge it if the tenant inquires (such as no security guard, no air conditioner, or no dishwasher).

Application

If you do a Google search for rental application or ask any friends who invest in real estate for a copy of their rental application you should be fine.  First and foremost you don’t want any illegal questions on your form.  The purpose of the form isn’t really to get the answers (although they might rule out some applicants).

If someone has a convoluted explanation for why they can’t tell you their current landlord or why they don’t have a current employer I’d probably drop them as an applicant.  There may be good reasons why they are in the situation they’re in, but don’t spend your time trying to assess their unique challenges.

Check out anything they’ve listed and see if you can verify it (I was able to tie a woman’s “current landlord’s” phone number to her father’s consulting firm with Google).  If they’ve lied on the application, reject them.

Contact current and previous landlords.  If they’ve ever had problems collecting rent reject that applicant.

Keep the form.  Sometimes if you run into problems later their “personal references” will be a way to track down a tenant or may help you with other problems.

Credit Check

In Ontario you can do this with Rent Check Credit Bureau.  They’re expensive for only one unit though ($20 per check and a $100 annual membership fee or something like that). You can avoid the membership fee if you join the landlord self-help center for $25.

You want to look for delinquent payments (if they aren’t paying other people on time, why will they pay you in a timely manner?).

If there’s problems with the credit check, reject them and move on to the next applicant.  If you run out of applicants, advertise again and show it to some more people (perhaps lowering the rent if you’re having trouble getting enough applicants to find a good one).

Lease & Keys

At this point you have a tenant, fill out a lease (you can sometimes buy one at a bookstore, get one from a landlord’s association, or ask for one from a friend who rents properties), get first and last months rent (and damage deposit if local laws allow).

Let the other applicants know that you’ve rented to someone else.

I don’t claim this is gospel, and if anyone with more experience disagrees with anything I’ve written, please comment below.  Also comment on any alternative approaches you’ve had success or failure with.