“Ninety percent of all millionaires become so through owning real estate.” – Andrew Carnegie
Last week we discussed how Thomas Anderson, investment banker, private wealth manager and author of bestseller The Value of Debt, summarized how mortgage brokers should discuss debt when working with luxury homeowners: “Swap the good versus bad debt distinction for the notion of intelligent debt.”
High-net-worth homeowners have been using intelligent debt for decades to increase their overall net worth and to minimize taxes. This article reviews an example of the power of building net worth using real estate.
Case study: Helping Luxury Homeowners Purchase a Rental Property Near McMaster University
Most of the students attending McMaster University live in a student dormitory the first year. Beginning in their second year, many students seek other housing options. The most popular option is for five or six students to get together and rent a house within walking distance of the campus.
The clients in this case study, who are successful business owners, viewed renting as essentially flushing money down the toilet. When their daughter finished her first year at McMaster, it was time to decide about where she was going to live the following year. Five other students committed to renting a house with her, so it was just a matter of finding the right place.
When the clients reviewed the rental agreement for a home that interested their daughter, they learned that students were responsible for paying for heat, hydro-electricity, T.V., telephone, internet, and that the rental agreement would be for 12 months, even if the students lived elsewhere during the summer. When they realized the rent would be $3600 per month, they spotted an investment opportunity.
The clients owned a $4.5M home in Toronto. To purchase a $500,000 home near McMaster would mean the clients needed to increase the mortgage on their principal residence by $125,000. With a $125,000 down payment, they could get a mortgage on the new property for $375,000.
Estimated expenses added up to $3350 per month, leaving $250 per month positive cash flow. With a constant demand for housing within walking distance to McMaster, this investment had a zero-vacancy rate. Best of all, McMaster has numerous property management teams that handle everything from collecting rent to handling repairs and maintenance–making this a hands-off investment.
In summary, the clients are netting $250 per month after expenses, which translates into $3000 per year in rental income. And, they are not paying $600 per month rent, had their daughter simply rented as most students do. It is important to note that the clients did not have to use any of their own money to make this happen, they used the banks money, secured by real estate, which banks view as safe, appreciating assets, over the long term.
Lastly, we need to factor in capital creation. As the mortgage gets paid down by the tenants, lenders will re-finance, and that capital can be used to purchase another rental property. And that’s exactly what these clients did. After five years of paying down the mortgage on both their principal residence and the McMaster rental, the clients saw that both houses had appreciated an average of five percent per year.
The $500,000 McMaster home was now worth $625,000, and their $4,500,000 principal residence was now worth $5,625,000. The clients were able to free up $175,000 worth of equity that they subsequently used to purchase another rental property for $625,000.
In just over five years, their real estate investment portfolio has increased to $1, 300,000 and the clients are generating an extra $6,000 in annual net rental income, while the tenants are paying down their mortgages.
You can see why Andrew Carnegie said, “Ninety percent of all millionaires become so through owning real estate.” It’s because using other people’s money – both the banks’ and tenants’–can increase your net worth substantially over the long term.
