Expensive market? Build to Lease to grow a portfolio

Building a rental portfolio sounds easy when listening to a podcast or reading a blog article where the investor has accumulated dozens of units all at 1% rule multiples. But what to do in a market where you want to grow a portfolio, but rents in are only a fraction of what is needed to even cover the cost of a property, and cashflow is a distant fantasy? How can a person even begin to progress toward financial independence when a fixer upper bungalow that costs a half million in cash only rents for $1500/2000 mo, likely needs continuous costly repairs and has high taxes?

This is a case study of a project in Calgary, AB, Canada's fourth most populous city, (1.25 million), where the market is based on appreciation and not cash flow, and by any metric, real estate is highly overvalued. Numerous strategies were deployed to create a workable deal.

Here is a a fairly different style of BRRR, which exchanges the rehab 'R' for a rebuild 'R'.  

1. The B, for buy is typical of any property, find a good deal.  This was a good one for various reasons, namely rental suitability and location.

2. The first R is rezone. A land use re-designation was earned after a favourable vote by mayor and council, at a public hearing, following lots of animosity and community opposition from the usual NIMBY's. The end result was a zoning change from permission to build a single or semi detached home, into the highest possible low density residential use, a rowhouse project, the RCG zone.

3. The second R is redesign - A quality architecture firm is engaged to come up with a 'build to lease' model of rowhouse. Not just a capable firm with the creative and technical skill, the design shop also has the experience to ease its way the tricky approval process, overcoming numerous hurdles along the way. Too much detail to go into here, but it was not easy to navigate.

4. The third R is rebuild. This is a challenging process involving significant engineering (civil, structural, fire safety), city obstacles typical of highly liberal and intrusive government departments, difficult site conditions, rigorous inspections and many upfront costs. By the time the project was complete, upwards of $100k is spent simply on compliance that contributes little (or no) benefit to the project. That really hurts. A large degree of experience and know-how is leveraged to get the build finished in a timely manner and on a reasonable budget. There is no way to do this on a low budget, typical of a jurisdiction where many fingers are dipping far too deeply in the construction budget to extract fees without doing any work.

5. The fourth R is Rent. After eight months of difficult grunt work, the project comes together. Units are found to be very easy to rent, and a wait list of interested parties ready to put up lease deposits is secured. By project completion, all units are leased to quality tenants. The overall project takes two years to manage, the first 16 months is spent on the political process of the zoning change and a complex development/building permit. Cost of this idle time is a real burden, and the existing home was demolished as it was not rentable in its purchased condition.

Summary - The project was successfully refinanced at about 71% of build cost, but only 57% of appraised value.  The refinance stage of the process was made more difficult by some unfortunate timing and bad luck with fluctuation in the Canadian bond market and lending rules causing a lot of difficulty.  Other investors with stronger credit and income history may have a better experience with the banks.

The success of the project is rewarding because the outcome of the building is fantastic and the long term viability of the investment appears secure. Total project cost is in the $1.45M range, monthly gross rents approximately $9k. These are very good numbers in the Calgary market, not great compared to the US midwest for cashflow, but hard to compete with in Calgary by purchasing an older building.

exterior detail

Interior decorations

This is the outcome my first major build to lease project. Many investors wonder about the cost and difficulty in building these units. In my view, armouring new units to rent is a smart way to build, especially in comparison to buying overvalued existing 50 year old buildings with costly cap ex needed. This new build has many features such as modern mechanical equipment simply not possible to achieve in a rehab.

In a high cost city such as Calgary, construction costs can balloon into a major problem. I'd estimate the cost of this build at somewhere around $200/CDN/ft or $170/US/ft. These costs include the garage, landscaping, design, and even soft costs. My advice would be for first time investors to avoid this type of project unless the local building conditions are fairly relaxed. Cold climate building costs are much higher than in many US states, plus the new utility hookup costs when building in established areas are huge. As stated before, expect to burn through $100k in non-construction related costs and fees.