March 15th 2023
Whenever I teach the Money Machine seminars, send out video updates, or council investors, I encourage them to do an annual net worth statement. Basically, it’s a yearly report card of the strength of your assets and it’s easy to do. It’s a simple matter of listing all your assets and assigning a current market value to each. Then compile a list of all your debts and liabilities. By adding the totals of each category and subtracting the totals of your debts from your asset value you arrive at your net worth. I find year-end is a great time to do a net worth statement and it’s important to do one every year. By comparing to each previous year you can get a pretty quick picture of where you are headed. The best case scenario is where you not only gain ground from one year to the next, but the amount of ground gained is increasing exponentially.
You gain ground, remember, in two ways. First and foremost, every month when you make mortgage payments you are paying off a portion of the principal. And the shorter the amortization, the more each payment goes toward retiring the debt. That’s why I encourage as short an amortization period as possible right from the origination of the loan. I find 15 years optional. And the beauty of this aspect of asset growth is that it is funded by the rent coming in from the tenants. It isn’t coming out of your pocket.
The second component contributing to asset growth is the appreciation in the value of the properties. Of course, this, unlike debt reduction, won’t happen every year. Some years, as we’ve experienced immediately post-Covid, values actively drop. But this is always short-lived and definitely will recover over time. All things being equal, properties will appreciate at a greater rate than the cost of living. This is due to relative scarcity. The country, our provinces, and our cities are all growing in population but not in land. As a growing population competes for real estate, prices invariably go up.
But here is the Achilles heel in the net worth exercise. As you do your calculations and see your wealth on paper grow, resist the temptation to tap into it by selling any of the properties off. I know, especially at moments when tenants become problematic that it’s tempting to sell and access the cash. Don’t do it! If you have to access cash for some reason, refinance the property. But don’t give up ownership and control. One day that property will be paid for, and also one day it will be worth a lot more than it is today. Resist the urge.
I’ve had people say “Well, my plan is to sell the property and with the proceeds, I’ll buy another better property.” What they are missing is that from the sale of that property, they are going to pay taxes, capital gains, and possibly recapture. They are not going to have all the proceeds to work with. Whereas if they refinance, they can use that released capital to buy another property, avoid paying any tax, and still maintain ownership of the original rental. They’ll be miles ahead in the long run.
While a net worth statement is vital in plotting your progress on your road to wealth, a better and perhaps more helpful yardstick is to do a cash flow analysis. How much surplus money is your investment properties generating on a monthly and annual basis. Here you’ll have to take a good hard look at your mortgage statements. Remember your rental cash flow is measured not just by the surplus money you have in your pocket each month but also by how much debt you have retired over that period of time. And while you may not appreciate or feel the effects today of those cash gains, one day when those properties are clear of mortgages, you will.
Would love to have a goose that lays a golden egg every day. Don’t know where I’d ever go to get one. A rental property may be as close as you’ll ever get. Don’t kill, don’t sell, don’t part with that goose. Take good care of it, and one day it’ll very much return the favour.