Sunday, October 22, 2017

Why Investing in Second Suites Can be Bad?

I've been thinking back about my recent post on getting into real estate investing through secondary suites strategy. I'd like to share why this approach and the specific example I provided will not be good for me personally.

Numbers in the example were based on current (October 2017) home prices and rents in Barrie, Ontario.

Need More Money

You need more money. 

Typically, I invest with 20% down payment plus 10-15K capex budget for the first couple of years plus closing costs. Secondary suite addition requires an extra 50-70K to build the suite.

So, for a buy-and-hold property at 500K, I'd need to come up with 100K down + 15K CapEx + 10K closing costs = 125K. 

While for secondary suite project, I'd need 100K down + 15K CapEx + 10K closing cost + 70K build costs  = 195K. That's 1.5 times more money!

Repeating Financing

In secondary suites strategy, you have to get financing to start, then re-finance the house after the suite is done to get your build money back. Here I must say, I really don't like the idea of going through financing twice on the same deal. Financing is such a labour intensive process!  I am sure there are ways of doing this elegantly, so it would be essential to find what they are.

Negative Cash Flow 

As soon as I see negative cash flow in a deal, I personally walk away. In the example, we saw a negative cash flow of about 2K per year, or 10K during the first 5-years.

I always try to find deals that I can repeat. The idea is - If a deal is good, more of the same deal will be even better. Now, if I had 10 of these secondary suites, I'd be losing 2K x 10 = 20K per year. This will be hard to justify to my family. I'd have to get other deals just to feed money into this deal.

Appreciation Assumption

Lastly, one of the assumptions in my 5-year projection was market appreciation of 5%. 

5% seems reasonable for GTA. We are hearing a lot about a large gap between housing demand and supply; increase in demand due to immigrants inflow, etc. So, why wouldn't market appreciate?

The answer is I don't know.

But in my deals, I always ask myself - if things go bad, will I be able to hold on to the investment property and wait out until better times? So I'd re-do my projections with 0% appreciation or a slight decline and see for myself.