Six is the Sweetspot for New Investors

On an almost daily basis I have a conversation with someone who wants to try their hand at real estate investing and become a landlord. There are always alot of different questions that come up, but one of the more frequent ones is; "where do I begin?".  It is a very open-ended question which can garner any number of responses.  However, given the current Canadian economic and institutional landscape, my response is to "Start with Six".  Six-plex that is.

I think that the purpose built six-plex offers new investors their best opportunity to become a real estate investor as it sits in the sweet spot of a venn diagram consisting of 3 circles representing 1. Manageability  2. Cap Rate and 3. Low Interest Rate.

Manageability

Most new investors want to be involved with their real estate investment as they see it being a new adventure (and rightfully so), they want to gain valueable knowledge and experience and they want to save the costs associated with hiring a superintedent and/or property manager.  Managing six units may seem like a daunting task at first, but once you dive in you will realize that it is not all that difficult as long as you are a well organized individual that has a few hours to spare every week.  While managing one unit (eg. condo) is an easier task, the superior return from a six-plex more than off-sets the extra effort.  Tips to help with efficient management of the property include:

• Ensure close proximity to property
• Try to get post-dated cheques from tenants
• Prepare a list of contractors (plumber, electrician, handyman)

Cap Rate

The cap rate for a multi-unit residential property typically has a directly proportionate relationship between the number of units and cap rate (until it reaches a plateau and levels off).  For example, the cap rate for a six-plex is higher than a tri-plex which is higher than a single unit.   While georgraphy and location play a critical part in determining the cap rate for a typical six-plex, it is safe to say that the cap rate range is somewhere between 5% to 6%, which is significantly better than most condos and tri-plexes.  The six-plex lets real estate investors start to take advantage of economies of scale and thus provide a better return.  Tips for those looking to maximize the return on a six-plex:

• Look outside the big urban centers and look to smaller towns university towns such as Kitchener-Waterloo, Guelph, Hamilton, etc...
• Look for purpose built six-plexes as they have better re-sale value and typically require less maintenance

Low Interest Rate

A low interest rate is the linchpin to making the six-plex the best place to start for new investors.  The math is simple, the cheaper your mortgage interest rate, the bigger the potential spread (difference between interest rate and cap rate) and bottom line profit.   Mortgage rates vary based on whether a property is classified as "residential" or "commercial".  They are handled by different departments and have different rates.  Commercial rates tend to be higher by a percentage point or two than those offered on residential properties.  This is where the secret lies in maximizing your ROI on a six-plex.  While just about every financial institution in Canada offers commercial rates for six-plexes, the Royal Bank of Canada ("RBC") offers financing on six-plex multi-unit residential properties at residential rates.  This means getting mortgage rates in and around 3% for a six-plex (at the time of publishing this article the rate of approx. 3% was accurate, however, rates can change without notice).  Tips on where to get started with RBC mortgages:

• Luciano Guarino - Mortgage Specialist (416.575.5994)
• Mario Mancini - Mortgage Specialist (647.405.2518)

In Summary

When you put these three components together (manageability, cap rate and low interest rate), the six-plex is the ideal starting point for new investors as it provides an investment that is relatively easy to manage, yet at the same time delivers a great spread of between 2% to 3% based on the economies of scale offered and financing available at residential rates.

Author: Paul Kondakos, BA, LL.B, MBA - Professional Real Estate Investor