Owning a rental property that provides consistent monthly cash flows can be lucrative. Period returns from a rental property, coupled with the passive price appreciation of the property itself, make owning a rental property an attractive investment opportunity.
With the rental market stability in metro areas of a city, it can seem natural to continue holding onto a property for years to come.
As consistent as returns may seem, maximizing your returns from investing in real estate may not be so simple.
After all, are you accurately measuring the rate of return you are getting year-over-year? Are those returns staying at a consistently competitive level? If you notice declining returns, it may be a sign to consider your options to boost your returns from investing.
A major factor that can contribute to declining returns is the natural aging of a condominium property.
Let’s look over the factors that can come hand-in-hand with an aging condominium.
Strata fees include coverage for both the operating budget and reserve funds assessed for a given year.
The operating budget will cover:
- Maintenance for common areas and amenities of the building
- Costs for management over the building
- The strata insurance policy to protect the physical structure of the building, and any communal areas
A portion of strata fees may also be set aside for reserve funds. These funds cover incidental expenses that exceed expected operating expenses for a given year.
Buildings will age, and significant components, including the heating system, water, electrical, and the exterior of the building, will require maintenance to maintain. Most major components will have a manufacturer proposed operating life of at most ten years. Maintenance costs can be relatively stable during the first few years. But as components age, they will require increased maintenance near the end of their working life.
Increasing period costs may mean it’s time to sell an aging property to seek better investment returns elsewhere.
Coverage of Building Operating Expenses
It is worth noting the trend of operating expenses to maintain aging amenities of a building and update common areas. The operating budget also includes the cost for strata or building insurance.
For building insurance, insurers will review the building age, how old the roof is, and the type of construction used to build it (e.g., brick veneer, concrete block). Older buildings and materials are evaluated with a higher incidence and risk factor for leaks, etc. As a result, they typically cost more to insure. An insurer will also review the type of heating at the building to assess the likelihood of a fire breaking out. More modern buildings that abide by updated fire codes and construction will carry a lower risk factor for fire incidents.
A newer building carries a lower risk score and assessed strata insurance premiums. Conversely, the older the building, the higher the risk score and insurance premiums.
Both increased building maintenance and strata insurance costs contribute to higher strata owner fees over the years.
Your homeowner insurance
As aging buildings move into a higher-risk bracket, you can expect insurance premiums to increase for your strata property. And the increasing trend might be exponential rather than straight-line as the property ages. In effect, you are hit with a double-whammy. Both strata insurance and your homeowner insurance will increase over the years.
Strata fees may not be the extent of your expenses as a strata lot owner.
As mentioned earlier, the bulk of strata fees cover operating expenses for the year. Strata can also decide to set aside reserve funds for incidental costs over and above operating expenses.
Special assessments can show up on your strata owner statement if the building requires major repairs in a given year, and there isn’t a budget for it from accumulated reserve funds.
These assessments can approach thousands of dollars if a major repair or overhaul of a central water or heating system is needed for an aging building.
Special assessments are not an everyday occurrence. But they can be expected to show up with increasing frequency when building components reach the end of their working life.
Returns over the Years from an Aging Property
As much as rent may be competitively high in Metro Vancouver, average rent levels have experienced modest growth over the years. A chief reference for regional housing data is the Rental Market Report published by the Canadian Housing Market Corporation (CHMC).
Newly-completed units have the highest rents, given renter preference for newer units. The chart below shows the average rent across the supply of rental properties.
With average rents of $ 1012 for a one-bedroom in 2010 and average rents of $ 1415 in 2020, there has been an effective 39.8% increase in the average rent over ten years.
Given the modest year-over-year increase in rents, operating expenses for your property may increase at a faster rate. The narrowing gap between your income and expenses will gradually eat away at your returns. Eventually, you may experience negative cash flows. You may decide it’s better to sell your property to cash out on its price appreciation.
Options to Maintain or Boost Your Returns from Real Estate
As operating expenses begin to diminish the returns from your investment, it is good to look at options to boost or increase your returns.
One option is to refinance your current property and invest in additional properties to generate higher period returns. The idea is to preserve the returns that you will obtain over continued appreciation in property values while increasing period returns as much as possible.
You may decide it’s time to sell your aging real estate property and re-invest. You may opt for this route if you can generate higher returns both in the short and long term by re-investing in a different property portfolio.
A big part of being a real estate investor is monitoring and managing your returns by taking on different opportunities in the market.
By staying stagnant with your property portfolio, you can marginalize your returns and forfeit returns from opportunities in the changing market.