Building a real estate portfolio can mean working toward financial freedom – or it can mean taking risks that will give you more sleepless nights than days on the golf course.
The difference, according to Don Campbell, is cash flow.
“I would never buy a property that didn’t have positive cash flow,” says Mr. Campbell, president of the Real Estate Investment Network. “A lot of people, unsophisticated investors, buy properties as if they were stocks – the only way they’re going to make money is if they rise in value.”
Of course, it’s great if your properties do rise in value. But this is the “buy and pray” strategy, not the best for real estate investing, says Mr. Campbell, author of 81 Financial and Tax Tips for the Canadian Real Estate Investor, released in February.
Mr. Campbell’s advice is to look for properties in areas that have a future, not a past. And don’t make the mistake of thinking they have to be close to home. Look for places where the average income is increasing, where the population is growing faster than the provincial average, areas that are in transition and where there is spending on transportation infrastructure.
Then as you add properties, think of each as a small business in its own right and manage it until it is throwing off cash. Get your expenses where you want them to be, get your rents where you want them to be, develop a good relationship with clients, i.e. your tenants, and build loyalty.
When each property reaches that “normalized state,” you can think about adding another one. Adding properties too soon, Mr. Campbell says, is a recipe for chaos and frustration.
This is where cash flow becomes most important – because if yours isn’t positive, the bank isn’t going to lend you more money.
“If you have a positive-cash-flowing portfolio, the bank adores you,” Mr. Campbell says. “It shows that you know what you’re doing, that you have the ability to manage your investments, and that you have some business acumen.”
In fact, he adds, banks are insisting on positive cash flow now for investment properties. “You know you can expand when the bank says you can expand.”
Continually manage your portfolio with this in mind, and don’t be afraid to get rid of a property if it isn’t performing. Beginning investors often make the mistake of holding on for dear life to that one money-losing investment in an otherwise healthy portfolio because they don’t want to admit they’ve made a mistake. Mr. Campbell’s advice: Sell it, even if you take a loss, use the loss wisely from a tax perspective and move on.
Another reason cash flow is king is the show of intention when it does come time to sell. Showing that you intended to hold a property as a money-making instrument may qualify for a capital gains exemption, which means you would pay capital gains on only 50 per cent of your proceeds, instead of 100 per cent.
So-called flippers and blatant speculation do not qualify, as far as the tax man is concerned.
“If you’re lining up around the block for a box in the sky that doesn’t exist – and you hope to flip it – it’s not cash flow and it’s not a capital-gain-exempt investment,” Mr. Campbell says. “Therefore you’re going to be paying a lot more tax.”
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