Buying buildings for cash flow

Reader note: This is part three of a four-part series

Read Part 1 and Part 2

In part one, we asked a few questions to see if your clients were prepared to participate in direct ownership real estate. Presumably your answers were “yes” to all of them. Let’s look closer at why those questions were so important.

Do you have the expertise and real estate knowledge base to know you’re purchasing a good property?

Even a real estate tycoon like Joe Kennedy sought advice when he started his real estate portfolio. He actually entrusted much of it with a shrewd broker named John J. Reynolds, who was the real estate counselor for the archdiocese of New York. His mandate? Make Kennedy richer with minimum risk.

If you don’t have the expertise to know if you’re making a good purchase, leverage your network and find an associate in whose real estate knowledge, expertise and judgment you are confident.

If you don’t understand what you’re getting into, it’s not called “risk,” it’s called “gambling.”

Do you have the time available to perform research, due diligence, and ongoing maintenance?

This is probably the least considered aspect of wanting to participate in direct ownership real estate. Assuming you have knowledge and experience on your side, either personally or in a reliable associate, you still have to be a part of the evaluation and decision making processes.

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And after due diligence is complete, it isn’t just a matter of handing over money and signing papers. Once the business deal is complete (see the next question), you have officially become a landlord. You are responsible for the direct or contracted property management of your new asset.

The building won’t take care of itself and you must be prepared to ensure your investment succeeds. That’s not just the cost of keeping the water running and the lights on. It includes ensuring the property has the right tenants and a low vacancy rate, lest you risk losing your cash flow for extended periods.

Do you have sufficient capital / liquidity and access to appropriate leverage?

It’s a question so simple, it’s almost overlooked. Undoubtedly, purchasing real estate is not for the faint of wallet, but the investor must have access to that capital and maintain enough liquidity to support the ongoing maintenance of the property.

In terms of leverage, is your business acumen able to get you good rates with the right lenders under the proper deal structure?

Do you have a network of potential partners who share your investment values, philosophy and time horizon?

When we talk about “sufficient capital,” that doesn’t necessarily mean your own assets. It is highly unlikely you will purchase an asset entirely on your own and will likely be investing alongside others. Even if you have the capital to be a sole purchaser, why would you want to? As we discussed, diversification is crucial to mitigating risk, something of which even Joe Kennedy was keenly aware both in real estate and his other investments.

Have a network of potential business partners who are also seeking to participate in direct ownership, but choose them carefully. Make sure everyone is on the same page, because if any one partner decides to turn left instead of right, it can not only cause friction in the partnership, but could leave you on the hook for more than you bargained.

Are you comfortable with cash flow over capital appreciation?

The property value of real estate is often the “sexy” part of wanting to invest. But the reason most hold on to the property, is the cash flow in the form of rent. Remember, it took The Kennedys over 50 years to realize a massive gain from the Chicago Merchandise Mart, but obviously that wasn’t what made the family wealthy. Joe Kennedy bought the Merchandise Mart for $12.5-million, but a few years later he was making more than that in annual rent.

Cash flow and income in the form of rent is the true heart of building wealth through real estate. It is the payoff for conducting painstaking due diligence and meticulous deal structuring – to ensure that long-term profitability comes not only from potential price appreciation of the real estate asset, but also from the net rental income, or what’s often referred to as the capitalization rate.

Are you willing to put in the hard work instead of pay fees to have someone else do all of the above?

All of the previous questions really do boil down to this last one: are you prepared to do the work yourself?

Starting your own portfolio of hard asset real estate is not an easy task. There is a reason why those who manage real estate limited partnerships charge a fee: there’s a lot of hard work and expertise involved. You must be willing to accept that you are choosing to do this work yourself—with all the benefits and frustrations in tow—instead of paying a fee and allowing someone else to do it.

Read Part 1 and Part 2 of this series.

David Sung is President of Nicola Wealth Management, a Vancouver-based investment management and financial planning firm. With 20 years of industry experience, David leads a team of dedicated and knowledgeable advisors, serving the needs of high net worth business owners, professionals, and their families.

Wayman Crosby is CEO of Nicola-Crosby Real Estate Investments Ltd. and oversees the management of SPIRE LP. A graduate of UBC in Urban Land Economics in 1978 Wayman has an extensive real estate career spanning over 25 years.