By Robert Stuart Thomson, Ph. D.
Author of “Hot Tips for Real Estate Investors”.
To order my book send me an e-mail at email@example.com (Note that the main points of this article involve strategy. They work in any market. It does not matter that prices have inflated somewhat (more than doubled) since I wrote this article in 1996. This article was written with the “Generation X” in mind, but anyone can gain by following the plan.)
My daughter-in-law has been paying rent for several years. Throwing money away. A shame! She really needs to buy her own apartment and build some equity. She was skeptical when I mentioned this; she didn’t think she could afford an apartment. I crunched some numbers with her and showed her that she could afford to buy. Maybe you know someone in a similar position. If so, read on.
Here is her background. She has a good steady job (at $20. an hour) but has only $2000. in savings. She now lives in Victoria and spends $700. a month for rent on a one-bedroom apartment. She needs a game plan. Here it is.
She should decide where in the Greater Victoria area she wants to live and start looking for one-bedroom apartments. I have emphasized how important it is for her to look at a lot of units so that she has a good sense of prices. Let’s assume she can find one for $100,000. (I am predicating these prices on the 1996 market, but the method is still the same.)
With a CMHC mortgate she needs only $5000. down. The mortgage will be $95,000. She has $2000. in the bank so she should borrow $3000. from us. (If we weren’t willing she would have to find another source, but that’s not impossible.) She is willing to repay the loan in $100. per month payments as soon as she moves in; she is definitely not a risk.
I told her the rest of the plan. Find a mortgage broker in the Yellow pages and ask for help finding the best rate on a three year closed mortgage (you will have your own ideas as to the best kind of mortgage plan). Ask me and your mother to cosign for the mortgage (we will…) This should satisfy the mortgage company.
Your mortgage should be transferable in case you decide to resell the apartment before three years are up and (a) transfer the mortgage to the new owner or (b) use this same mortgage yourself on the next property you buy. Either way you will avoid heavy penalty fees. It pays to look ahead. Repay your mortgage weekly rather than monthly. This always saves you money.
Let’s look at how much money you are going to save. If you continue to pay rent, your rent money will earn nothing for you (this is called zero equity). If you buy as I have suggested, here’s what you will get.When you move in, you’ll owe $97,450., not $95,000. (CMHC will charge you 2.5% of the mortgage as a fee, plus a $75. charge.) This may sound steep but it isn’t if it gets you that apartment and starts you on the road to building equity. Besides, no other mortgage company is likely to lend you such a sum.
Let’s assume that your mortgage is calculated to be paid off (“amortized” is the technical term) in 25 years. Your weekly payments will be $136., which is much the same as the rent which you are currently throwing away. If you keep making these payments for three years you’ll owe $97,428.
This might not sound great, but listen. Over the three years your apartment has probably increased in value (after all, you did your homework well before you bought: you knew the prices and you bought it under market value. You also will have fixed it up and made it look gorgeous. In short, you will have studied my handy little book, “Hot Tips for Real Estate Investors”.) Your apartment should be worth at least $110,000., maybe even $120,000.
Now let’s look at saving even more money. This you can do by doubling up on your mortgage payments. If you can manage to pay $272. per week (trade your car for a bike? Give up smoking? Or drinking?) you will owe only $73,737.58 at the end of three years.
So if you sell the apartment for $120,000. you will be sitting pretty. Here’s the math:
$120,000. (Selling price of your apartment)
– $9,000. (Realtor’s fee, plus conveyancing)
– $4,000. (New carpets? Paint? Mirrors? Plants?)
– $73,737. (Unpaid mortgage: transfer it or pay it off)
Maybe now you want a two bedroom apartment or even a townhouse. Here’s how a partnership could work: you pay $2,000. of the down-payment and your friend pays $3,000. (Write your friend a promissory note for $500. and pay it back soon). Have a relative or friend co-sign for the mortgage, as above.
Naturally, you must take precautions. Choose your partner well. S/he should be employed, responsible, reliable, willing to make sacrifices. Also, of course, compatible! First, write out an agreement with your partner as to financing and responsibilities. What happens if one of you can’t pay or pays late? Will s/he forfeit his/her share? Will there be a fine of some sort? You might feel that you want a formal contract drawn up. Who does the cleaning? Who is in charge of repairs and maintenance? What are the consequences if one of you doesn’t pull his/her weight? Can you agree on improvements? Are you going to repaint the place? Install larage mirrors on the walls (an excellent way to make the place look bigger for when you resell.) Recarpet? Or what?
What happens if one of you wants to sell the place and the other doesn’t want to? (and you never know: a good offer might come in out of the blue and one of you will want to take advantage of it). In this case you’ll need the handy “shotgun clause” which I explain in “Hot Tips for Real Estate Investors”. It goes like this:
“Any time after 18 months from the purchase date either party can demand that the property be professionally evaluated and then demand either (a) that the property be put up for sale and the proceeds split or (b) that the partner who doesn’t want to sell , buy out the other partner for half of the appraised value.”
This clause can save you a lot of grief. It is really annoying to want to sell and yet be stuck with a partner who doesn’t want to sell. Best to iron out your plans and put them into a contract. Sign it and have the signing witnessed. This might sound mistrustful and/or over-cautious, but it’s just common sense.
The Yin of a partnership is that it makes the purchase easier. The Yang is that you get only 50% of the profit when you sell. How much money will you and your partner make on the transaction? If you each pay $136. per week (total of $272. for both of you) you’ll owe only $73,737.58 in three years. If you sell at the same profit which I’ve assumed above, you’ll each clear half of $33,263. i.e. $16,631.50.
It could get even better. If you both pinch pennies and double up on your weekly payments (each pays $272. per week), here’s what you’ll get:
$120,000. (Selling price of your apartment)
– $9,000. (Realtor’s fee and conveyancing)
-$4,000. (Carpet, paint, mirrors, plants)
-$26,376. (Unpaid mortgage: transfer it or pay it off)
Divide this by two and you get $40,312., which is what each of you is now worth.
Surprisingly, by doubling your mortgage payments you can make more with a partner than you can on your own. There are risks (what happens if one of you loses his/her job?) but if you write up a good contract, have it looked over by a lawyer or notary, then have it witnessed, there’s little, if any, risk.
If you buy low (and again, see my “Hot Tips for Real Estate Investors” to find out how to do this) you’ll do even better than I’ve outlined above and you’ll be in a good position to flip this apartment and “buy up” to a two-bedroom, a townhouse, or even a starter home.
Remember to arrange things so that your mortgage is transferable; in this way the person who buys your apartment can assume your mortgage and save money.
(Note: please respect the fact that this three page article is the intellectual property of Robert Stuart Thomson, Victoria, BC. I don’t mind if you copy it, but please tell your friends who wrote it. My book, “Hot Tips For Real Estate Investors” (120 pp. with illustrations) is full of useful ideas; overall, it’s as good as the article which you just read. You can order it by sending me a cheque for $10. (U. S. or Canadian: same price.) Cash is okay: up to you… If you send a cheque please make it out to Robert S. Thomson and send it to P.O. Box 50058, Fairfield Plaza, Fairfield Rd. Victoria, B.C. V8S 5L8 The ideas in my book are valid for any market, peak or trough. Feel free to phone me. My number: 250 414 0215