Net Earnings: (Assuming 100% financing and owner payment of property taxes and strata fees) Net Earnings = Gross Annual Rent – (Interest Charges + Property Taxes + Strata Fees)
Gross Annual Earnings = $1600 / month x 12 months = $19,200
- Interest Charges = Mortgage Interest During first 12 months of Mortgage (6% Mortgage, 40 Year Amortization) = $18,910
- Surrey Property Taxes = $2,000
- Strata / Maintenance Fees = $120 / month x 12 months = $1,440
Net Earnings = 19,200 – (18,910 + 2,000 + 1,440)
Net Earnings = -$3,150
Price to Earnings Ratio = Price / Earnings = $320,000 / -3150
Price to Earnings Ratio = -101.6 = N/A (Negative P/E ratios are not-applicable)
Now that is a bad investment. Note: Investments that lose money and have no prospect of making money are “bad investments.”
An alternative scenario: Let’s assume for a moment that our prodigious landlord had a 20% down-payment and did not factor in opportunity cost of his capital (this seems like a brain-dead idea but let’s roll with it). Interest charges now equal $15,120.
Net Earnings = 19,200 – (15,120 + 2,000 + 1,440) = $640
Our example’s Price to Earnings ratio = $320,000 / $640 = 500 (A P/E of 500 would typically be reserved for a company whose growth rate exceeds 100% per year - this is definitely not the case in our example)
$640 of profit on a down-payment of $64,000 is a ridiculously low return on investment (0.1%) and I don’t know why anyone would want to be a landlord at these rates when you can just buy a GIC which pays 4.5% very easily with no risk.
In the stock market a Price to Earning ratio in excess of 15 is considered a highly valued company. Typically companies which trade a high P/E ratio are growing quickly and earnings are expected to grow thus making the future P/E ratio smaller. This is the markets way of paying for earnings growth. Companies reduce costs and increase revenues to improve their earnings and this is why being a stock-holder can be very beneficial.
In our example of the Cloverdale townhouse, where is the earnings growth going to come from?
Will rents rise substantially? Not likely.
Will costs decrease? Even less likely.