What to Expect

Whether you are searching for your first building or are a seasoned investor the systems and procedures you should follow are the same. From finding a building for sale to viewing the building to arranging all the components of inspection/due diligence and finally financing. Having a solid set of procedures will make your effort seamless and more efficient with a high probability of a satisfactory outcome. While learning the ins and outs of analyzing a building it is important to have an experienced person to reflect your calculations off, as this will save you valuable time, shorten your learning curve and prevent any pitfalls. When you start analyzing enough buildings you will be able to quickly recognize the buildings running efficiently or inefficiently. But don’t shy away from inefficient buildings too quickly as they may represent your best opportunity for creating net worth quickly. Income property valuation is simple and one of the first lessons you must learn is never to trust the numbers being supplied. So many times, the numbers are estimated, outdated or simply wrong. You must dig much deeper than the proforma statement that is being supplied and one of the easiest ways to start looking at these numbers is on a per-suite basis. Another mistake I see regularly is not including all the expense numbers or not understanding what industry standard numbers must be included in the expenses to determine a net operating income to satisfy the financial institutions and CMHC if you will be using them. When a building is under evaluation for value it is vitally important to understand the condition of the building and any capital items that may require repair or replacement. Understanding Micro and Macro markets is essential as the value of a building can change dramatically based on its location and tenant profile. In some markets, this can change as quickly as a 5-minute drive. Another area to explore is the suite mix and the percentage of units that are bachelor, one-bedroom, two-bedroom, and three-bedroom. A property that has more than two bedrooms than one bedroom will have higher rent or higher revenue per door and have higher expenses due to more people living in each unit. Plus, in any given market one or two of the above units will be easier to rent as there may be more demand for them. Simply put, this is demographics and areas like Chatham Ontario will have more retirees than most neighborhoods in Hamilton. Speaking with enough Sellers/Owners of buildings in any market and asking them which units are the quickest to rent is an easy and sure way of getting a handle on the suite mix that is most desirable for a building and its location. When analyzing numbers, you need to think with two hats on. First, you must make sure your numbers are accurate and at the same time find areas where an industry standard number acceptable to the lending institutions may allow you to achieve a higher loan-to-value ratio. Your goal is twofold, one is making sure the numbers for utilities and other expenses are accurate and you understand the effect of increased cost over time. Second, is finding areas where an industry number may represent the building better for achieving your highest amount of loan-to-value financing. Once you have and feel comfortable with all the numbers the formula is as simple as dividing the net operating income by the purchase price for determining a cap rate; however, when looking at the analyses you must take into consideration the price per door, cash on cash return, return on investment and debt service ratio. These are all components CMHC has set standards for and for financing through CMHC you must meet or exceed their benchmark. If you know that the numbers you are working with to evaluate a building are accurate, then the subsequent valuation calculation is straightforward. The value of an income property is Net Operating Income (NOI) divided by the Capitalization Rate; however, first, let’s explore what a capitalization rate is as there is a lot of confusion over this number. First, the capitalization rate is determined by the market, not the Seller, Buyer, or real estate representative individually. It is a collective number based on what Sellers & Buyers determine to be reasonable value in any given transaction that changes hands on the closing date. Speaking with enough Sellers/Owners of buildings in any market and asking them which units are the quickest to rent is an easy and sure way of getting a handle on the suite mix that is most desirable. Next, we need to look at what numbers will be included in the number-crunching process and not necessarily rely on what is being reported by the seller or representative. The obvious ones are gross revenue minus a vacancy & bad debt giving you the effective revenue, current taxes, gas, electricity, water & sewer, insurance, superintendent, management, and maintenance. For the taxes and utilities, you must have the current and accurate numbers representing the past twelve months (not last year) when you apply for financing the lending institutions and CMHC wants to see a snapshot of these expenses for the past twelve months current up to the month of the agreement of purchase and sale date and beyond if there is a long closing period. Your goal is twofold, one is making sure the numbers for utilities and other expenses are accurate and you understand the effect of increased cost over time. Second, is finding areas where an industry number may represent the building better for achieving your highest amount of loan-to-value financing. This is where the rubber meets the road and a solid understanding of how the financial institutions look at the income & expenses of any income-producing real estate is vital. Understanding how investment properties are analyzed is not only paramount but easy once you understand the foundation. Income property valuation is simple and one of the first lessons you must learn is never to trust the numbers being supplied. So many times, the numbers are estimated, outdated or simply wrong. You must dig much deeper than the proforma statement that is being supplied and one of the easiest ways to start looking at these numbers is on a per-suite basis.