The secret to successful real estate investing over the past decade has been simple: buy property, then sit back and watch it rocket up in value. With prices shooting skyward at double-digit rates in many Canadian cities, how could you not make money? Unfortunately for would-be Donald Trumps, making money over the next decade may not be quite so straightforward. A recent housing affordability report from Royal Bank proclaimed “easy money no more,” and warned that prices in both Calgary and Edmonton have “soared well above their fundamentals to unsustainable levels.” Meanwhile, the latest numbers from the Organisation for Economic Co-operation and Development say that Canadian homes are now more expensive than their U.S. counterparts, when you measure them in terms of their relationship to incomes and potential rents. Nobody is yet predicting a U.S.-style real estate collapse in Canada, but all the data suggest that the red-hot market of the past few years is likely to soon come off the boil.

If the housing market cools, the old way of real estate investing will stop working, and investors who rely on rising home prices for their profits will start losing money. Luckily, there’s another way to invest in real estate, and it works no matter what the market does.

Using this method, Dan Young made his first million by the time he was 34. He started investing in properties in his home town of Midland, Ont., when he was just 24, and made most of his money on a four-plex, a six-plex, and a 12-plex.

His secret was nothing more than a systematic method for evaluating potential investments. Rather than betting on possible gains in real estate prices, he made sure that the rent he received from a property put cash into his pocket each and every month, from the very first day he bought a property. “When things are going well, when interest rates are declining and property values are going up, then it’s really easy to look like you’re smart,” he says. “But when things go the other way, it’s really easy to lose money too. That’s why you need a long-term strategy based on some realistic expectations.”

To be honest, Young’s way of investing isn’t really all that new at all — it has just fallen out of favor over the past decade. David Southen has been using it for 24 years. He’s now 48 and he and his partners own 125 residential units in Southern Ontario worth about $7 million. He can sum up his secret in just three words: positive cash flow. “You need to be making enough from renting your property out so that after all of your expenses are paid and your contingencies are allowed for, you can pay the mortgage and still put a few shekels in your jeans,” says Southen from his London, Ont., home. “If you’re not, then it’s not a viable investment.”

If you want to generate a reliable stream of cash from your real estate investment, rather than just gamble that prices will go up in the future, Southen says you need to carefully assess each property before you buy it. Your fate as a landlord will be largely determined at the moment of purchase—pay too much and your mortgage and expenses will eat up all of your profits. Southen says there’s a simple three-step way to calculate the right price to pay for an investment property:

- First, get an honest estimate of the total income you can expect from renting it out each month

- Second, get an honest estimate of the expenses involved in running the property

- Third, figure out how much money your property will have to spin off after expenses to pay the mortgage and provide you with a profit

Once you know those three numbers, evaluating how much to pay for potential real estate investments is easy. Of course you’ll only get a trustworthy result if you use trustworthy numbers to begin with, and that’s the catch. Getting a grip on the true rental income you can expect and the true expenses associated with a property can be tough — mainly because the seller will supply you with a long list of bogus numbers. “There’s a well-known saying in real estate investing,” says Southen. “Trust — but verify. Getting a handle on the property taxes and insurance is easy. But people will lie to you about everything else.”

Sleuth out the real rents

If you want to get past the lies and figure out how much your potential investment is really worth, start by estimating the total rental income that the property can generate. Ask the seller for the “rent roll,” which tells you how much rent is being collected from each unit. Then scan the local papers to find out the typical rents being charged in your area. As a double-check, look for the rental market reports published by the Canadian Mortgage and Housing Corporation (see www.cmhc-schl.gc.ca) and find out the typical rents in your area. If the rents charged to the tenants in your building are lower than the local average, that’s good. It means there’s room to raise rents in the future.”However if the average two-bedroom is renting out for $850, and the units in your potential investment are renting out for $1,000, watch out,” says Southen. “They might be filled with the seller’s relatives, who will leave the second you close on the property. That’s an old favorite.”

Don’t forget vacancies

“The vendors will tell you the property is fully rented with a waiting list, so they don’t have any vacancy or bad debt,” says Southen. “But it’s not true. Every landlord has vacancy and tenants who skip out without paying.” When calculating your expected rental income, subtract 5% from the total income the building will generate at full occupancy to offset your expected losses from vacancy and bad debt. Then add in any additional income from laundry or parking. That will give you your “gross effective income.”