A franchise coffee shop near my neighbourhood got listed for sale a few days ago. It operates in a leased space approximately 2100 square feet. The listing claims that it earns about $12,000 in sales per week. And it’s listed at $219,000.
If you live in the area, chances are you’ve been in this coffee shop before. I’ve certainly visited it once.
Owing a business is a dream for many who want to escape the rat race and take control of their lifestyle and destiny — for people who want to be independent of the 9 to 5 grind.
A franchise makes starting, owning and operating a business somewhat more attainable. Despite the initial investment required to get things started, a franchise provides a proven system you can replicate. The marketing systems are done for you. The look and feel of the venue is taken care of. The flow of products and supplies are handled for you.
All you have to do is show up, turn the key, turn the lights and equipment on, and serve your customers. If you operate it correctly, you should earn a profit.
This is where the demands of running a franchise are eventually discovered by their owner operators.
You have to operate the prescribed hours dictated by your franchise agreement. You must purchase products and supplies only from them or their approved suppliers. You have to follow their systems in order to replicate their success. You have to do what they tell you to do and operate within their guidelines.
Wait a minute… doesn’t that sound like going to work, and doing your job? Except in this case, you have to invest money in order for you to ‘earn’ the right to own a job within your business.
Many small business owners and franchise owners eventually discover how demanding it is to own and operate a business. The hours you need to put into a business are significantly greater than the usual 9 to 5, especially if you want your business to succeed. The income is not always guaranteed, and any shift in market dynamics could cause your sales to fluctuate.
In this example, a coffee shop earning $12,000 a week would realize gross revenue of $624,000 per year. And that’s assuming their weekly sales are stable and verifiable.
Let’s say rent costs about $4,000 a month, or $48,000 per year which is about 8% of your gross revenue.
The cost of the goods you sell cost about 35% of gross revenue, so let’s say $218,400.
Payroll costs about 30% of gross revenue so $187,200.
Let’s say administrative expenses costs about 15% of gross revenue or $93,600
And don’t forget about paying yourself, with your salary (included in payroll) plus your profit, which you get from the remaining 12% of gross revenue you have to work with — $74,880.
When you combine the costs of running a franchise business, the hours it takes to run it successfully, and the small amount of profit relative to the effort you put in, running one franchise doesn’t seem as desirable. To be successful in the franchise business and to really earn income at great scale, it would make sense to buy several franchises. This requires even more time, money and resources.
And that’s what causes franchise owners to eventually sell what they thought would be a financially beneficial venture.
Let’s look at an alternative.
How about investing in a condo?
Let’s say you had $200,000 in cash to buy a business, and you invested it into a condo instead. You used it as a downpayment to buy one or perhaps two condos.
As a 20% down for investment property, you could use the entire $200,000 to buy a $1,000,000 condo, or split it into two payments of $100,000 each to buy two $500,000 condos. What you do depends on your mortgage loan qualification, of course, so I am generalizing here but you should understand the level of income you need, your credit score, and the rentability of the investment properties you purchase (amongst other things).
Let’s use the example of buying two $500,000 condos.
Remember this is a hypothetical and simplified scenario, and you should consult with your real estate agent, mortgage broker and accountant to work on this investment plan.
The downpayment on each $500,000 condo at 20% is $100,000.
This would require you to have a $400,000 mortgage.
Amortized over 25 years and assuming a rate of 3.20%, your monthly payment is $1,938.72.
We can assume property tax to be $200 per month or $2,400 per year.
These days, a $500,000 condo in Scarborough (for example) is a one plus den, maybe a two bedroom depending on the area.
In downtown Toronto, it’s barely a one bedroom. You might find a studio at this price point.
In Markham, you’re also looking at a one plus den or just a one bedroom.
Across the board, depending on the actual condo you get, you’ll earn rent of approximately $1,900 to $2,100 for this price point.
That means you will cash flow negative after maintenance fees, but let’s look at a specific condo available today and what the numbers look like.
In my favourite condo investment area of Scarborough Town Centre, a one bedroom plus den condo sold in late February for $485,000.
The maintenance fee is $417.
Taxes amount to $1,625.
It has both parking and locker.
A one bedroom plus den condo in this particular building (contact me to find out which one it is) leased for $1,950 to $2,050 in February.
Let’s be conservative and use a rent of $2,000.
Now let’s crunch the numbers.
Purchase price: $485,000
Mortgage: $1,880.55 (3.20% at 25 years amortization)
Property tax: $135.00
Your cash flow will be negative $432.55 per month, or $5,190.60 per year.
Okay, okay, wait a minute… if you run a coffee shop, you don’t get negative cashflow right… assuming your sales are ‘okay’ and you’re not spending more in expenses than what you’re earning in income — so what makes this a ‘better’ investment option?
Let’s look further.
In your first year, even with negative cashflow, your tenant has paid down your mortgage and your principal amount earned in total is $10,301. Subtract $5,190.60 from that and your net principal earned in your first year is $5,110.40. All passively.
Multiply that by two (if you purchased two condos) and you’ve earned about $10k in wealth through passive real estate investing.
Now let’s look at something else — appreciation.
Typically, condos have appreciated 7% per year in this area (some years a lot more, some years less).
Based on a purchase price of $485,000, a 7% appreciation would result in a $33,950 increase in your wealth. Multiply that by two if you purchased two condos and you’ve increased your wealth by $67,900.
I know this is an overly simplified example, and it’s hypothetical, but cumulatively, you would have earned almost $80,000 in wealth accumulation by investing in two condos, where tenants are paying down your mortgage, and when paid off (in 25 years or less if you add lump sum payments) you’ll be generating cash flow from two rental properties.
Now here’s an important point to consider in this overly simplified example.
When you buy a coffee shop business, you are earning income through salary (what you pay yourself to run your shop) and profits.
When you invest in condo, and if it’s a negative cash flow each month, the benefits you should look for relate to wealth accumulation by means of mortgage pay down by your tenant (principal value earned) and appreciation (what your condo goes up in value for each year). You’re not getting cash or income in your hand this way — and that’s one big distinguishing factor you should consider before deciding what you should do.
If you have no other means of income and you need a salary and profit, you should look at buying a business, whether it’s a coffee shop or whatever kind of business you feel you can operate profitably and earn an income with.
If you currently earn a salary from your career, or if you already own a business and earn salary and profits, you should consider investing in real estate and earning additional wealth passively (and by passive I mean hiring a property manager to take care of active tenant issues that may arise).
I’ll end this blog post with a real life example.
Over a decade ago, my wife and I owned an investment condo (in addition to our primary residence) and a cupcake bakery. (It’s the cupcake bakery pictured above.)
We sold the investment condo. We ran the bakery…. for five years, before closing it down.
We failed at the business side of things. But we look back and wondered what would have happened if we kept the condo?
#1 — the condo went up significantly in value and we’d probably be sitting on an additional $300k of equity as a result of appreciation.
#2– rents have gone up significantly and we would be generating even more positive cashflow each month.
We should’ve kept the condo. And found another job or business to earn salary/income and profit from. 😉