Optimizing, not maximizing, returns on investments should be every real estate investor’s modus operandi. According to the founder & CEO of Sentravest Publishing, the way to do that is by diversifying revenue streams.
“Most people wonder what they can rent out their holdings for, but can you turn one year into two?” asks Ian Harper. “Can you rent out the garage separately, even to the same tenant? In multi-use buildings, is there an opportunity to put in a coin-operated laundry?”
Of course, there’s more to optimizing ROIs than that. Harper notes that people’s threshold for risk, and by extension, peace of mind, are also at play. He advises neophyte investors understand their capacity before beginning.
“At what point do you go, ‘Yes, this is going just fine, I’m getting an adequate return?’” muses Harper. “Or do you think about how you can incrementally increase your ROI, knowing it introduces other stresses in your life, whether financial and emotional stresses, or demands on your time.
“Understand your capacity. A lot of people, when starting out with investments in real estate, their only leverage is what their earnings are, what their T4 said last year, what liquidity they can borrow against. Your ability to continue buying properties diminishes greatly, so understand your capacity for risk and your financial capacity. How much can you borrow? Talk to your lenders about your ability to borrow rather than making assumptions.”
Harper is most emphatic about the importance of understanding debt. Alluding to our earliest lessons about debt—particularly the need to pay it down as quickly as possible—Harper says we don’t hear enough about how debt can be harnessed. (Just ensure you have capacity to harness it first.)
“It’s important to understand that for a given investment property, presuming you have sufficient cash flow, the higher the debt the higher the return on investment. If you buy a $400,000 property and invest $80,000, being 20% down, and that property generates $8,000 a year in combination of net revenues and appreciated values, that’s a 10% return on your investment. If, however, you had invested 25% down, or $100,000, the $8,000 a year is no longer 10%, it’s considerably less.”
To ensure one’s capacity to repay debt, Harper advises insuring cash flow and business operations, although he refers to it as the hard approach. He also says that if the monthly insurance payments eat significantly into ROIs, then more debt might not be a good idea.
“This is about optimizing returns on investments, not maximizing returns on investments,” he said. “Optimizing has to do with capacity, your financial and emotional and time available capacity to manage your investments, and your ability to carry a certain amount of debt.”
“So, to manage risk is also being prepared to say ‘no,’” Harper said of a tempting investment opportunity. “Sounds great but what is it really going to cost and is there sufficient upside? Can you make the investment, and can find the debt to give you the leverage to buy the property? Is it really an optimal place to be?”
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