$2.8 million investment property

Two weeks ago I received an excited phone call from James, a forty something family doctor living in Richmond Hill with his wife, an ER nurse at a local hospital.  They had discovered a beautiful 7,900 square foot house in Vaughan, not long reduced in price from $3.5 million to $2.8 million. James and Rachel wanted to buy the house as an investment property.

The house was being sold under power of sale by the Korea Exchange Bank. Turns out it has an interesting history. It was bought for two million dollars some years ago by the Chung family, who operated a convenience store in Burlington, and collected a $12.5 million winning ticket back in 2003. Although there were suspicions, the prize was released one year later, and immediately the money was channeled through dozens of accounts in Canada, New York, and South Korea.

On September 30, 2010 the Toronto Star reported

“Back on Callaway Crt., the gated community in Vaughan where Kenneth Chung lives with his parents, neighbours were shocked….

Ironically, neighbours said, their house was at one time a prize for the Princess Margaret Hospital lottery.”

The Chungs were charged with fraud and money laundering, and their dream home is now on the auction block.

Anyway, what about the house itself? It is a magnificent specimen. At the end of a cul-de-sac in an exclusive gated community, backing onto a ravine and golf course. The finishings are top of the line; in fact the Chungs had apparently invested $300,000+ in the basement alone – setting up a home theatre for the ages. The mansion boasts seven bedrooms and eight bathrooms, and a huge, undeveloped back yard. The lot is 22,000 square feet, and has a four car garage and sufficient parking for fourteen cars in the driveway.

I sat down with James and Rachel to review their finances. They had done their homework. Homes in the area are routinely selling for $3.5 million and up. If one prefers to build from scratch, there are still a few lots available – running between $1.7 million and $2 million.

They had consulted a couple of luxury home builders, who had told them they could expect to spend roughly $300 per square foot to build a home of comparable quality. This means anyone buying one of the vacant lots with a view to custom build a 5,000 square foot home could be looking at a price tag of around $3.5 million. But THIS home is 7,900 square feet, and “only” $2.8 million.

Down the street there is a 7,000 square foot beauty, listed at $4.3 million. James was positively salivating. ‘Ross, we can make an easy half million in a year – maybe more. It’s the deal of a lifetime!’

Their realtor was naturally enthusiastic – even at a 2% sales commission, he had a $56,000 paycheck waiting in the wings. As their mortgage broker, I’d make a few shekels too. But they were looking for my professional opinion, not just for a mortgage.

Let’s look at the numbers. Their present home is worth $1.1 million, and they only have a small $135,000 mortgage. Their thinking was to take a home equity line of credit on their home, and apply $600,000 towards a down payment.  They would still have around $145,000 to play with – but with land transfer taxes of over $50,000, and a desire to build a swimming pool, and rebuild the deck, that money would easily be spent.

So if they could buy the mansion for say $2.7 million, they would need me to arrange a $2.1 million mortgage!

Now this was happening just as stormy waters hit the mortgage industry. In early February, it came to light CMHC had come close to their $600 billion lending cap, and as a result, lending guidelines were tightening daily.  Investment properties, equity deals, and mortgages for the self-employed were the first and biggest casualties. We wrote about this here on February 2. And the media are constantly warning us of an imminent pullback in Canadian real estate prices – could they be right?

If, I mean IF, I could pull this off, James and Rachel would be taking on a monthly mortgage payment of roughly $9,000 per month, plus an additional $1,900 per month for property taxes, and maybe as much as $1,000 for utilities and maintenance. And don’t forget their intention was to use borrowed money for the down payment – $600,000 at 3.5%. Another $1,750 per month in interest costs.

So the monthly nut would be close to $14,000.

James was not deterred. “Ross you know my practice is cash flow positive – we can handle this. Look at the area, we can flip this thing next year for maybe $4 million – easily $3.5 million.”

I’ll let you form your own opinion, but here are some of my thoughts:

It’s one thing to buy this home to live in, especially if you are as successful as this couple. Presumably they could weather out the ups and downs of the real estate market – home is home, and your home should be comfortably affordable. But James only wanted to buy it as an investment.