INTRODUCTION
We will be exploring the obvious basics such as Cap Rates, rate of returns, why investors are motivated to buy, current market conditions, financing, and more subjective areas such as how to keep clients at the table during negotiations and due diligence periods.
The apartment building industry is a specific niche within the Commercial Real Estate industry and has become considered to be one of the most conservative types of real estate investments in Canada.
Financing for prospective buyers is easy to achieve, even during down markets with very flexible and attractive financing solutions that are available through the Canadian Mortgage Housing Corporation. These mortgages are considered commercial mortgages in many ways but still have a little flair for residential mortgages in the sense that they can be insured and have Loan to loan-to-value ratios as high as 85%.
The supply and demand of buildings for buyers has become very lope-sided in the past ten years with many more buyers for good apartments than what is available. This is partially because, in the past few years, many small and large investors have recognized these investments as being very secure. This along with the rate of emigration into Canada and the comfort level for many of these investors. Brick-and-mortar type of investments offer a level of comfort the fact that they are easy to manage and are only a short drive away has created a frenzy for suitable properties.
Because of this and many more reasons the challenge for investors has become finding suitable properties available for sale.
Any good investor or real estate representative/broker knows that these properties need to meet a certain objective for both the buyer and the financing institutions. You, the seller, should also understand the parameters of these objectives for a successful transaction to take place. This will also help you distinguish between a qualified buyer and one who is not. This will result in the lowest amount of resistance during the sales cycle, due diligence, and financing period.
Your objective is to wade through and reject buyers who do not meet the financing criteria and press on with persistence to find the right buyer who is motivated and qualified.
INCOME PROPERTY VALUATION
Income evaluation is by far the most important key to this business. By understanding the criteria of the different lending institutions and CMHC you will have a good understanding of the process the buyer will be subject to and if he will qualify for the purchase of your building. Knowing this process and what makes a buyer a good candidate for CMHC will reduce the risk of having a deal fall apart. You need to know and recognize the different signs that indicate whether a building is a good fit for any buyer and can be financed with the anticipated down payment available to the buyer. This, along with relying on the experience of those around you who may have more of a subjective feel for the business, will create a powerful asking price. This is where the rubber meets the road and a solid understanding of how the financial institutions look at the income & expenses will assist you in the evaluation of the property you are interested in selling. At the end of the day, the value of real estate in most markets is determined by the ability of the buyers to achieve reasonable financing and return on investment. Without a reasonable return on investment, even the large institutional buyers will pass. This is another reason why your proforma must be correct. I have seen income on a building underreported and when presented to a large institutional buyer, they passed not realizing the seller and representative undervalued the income. It doesn’t always take a large amount of additional income to turn a red light into a green light in the eyes of a buyer.
Property values based on capitalization rates are calculated on a formula based on rental income generated from current tenancy agreements minus a set of expenses. The capitalization rate of any building is in constant fluctuation based on market conditions and ongoing evaluation of the building based on several factors. The capitalization rate is the return on investment if the purchaser pays cash without any financing. In addition, a person providing a value may determine an Estimated Value based on potential upside due to many factors resulting from existing and past management. Potential upside has real value to the bottom line, but it is important to know this potential upside doesn’t have one hundred percent value to you, the seller. Someone must do the work and take the time and risk to achieve this upside. However, as a seller, it is important to recognize this potential upside value to you. You don’t want to leave this potential upside on the table for the buyer, it should be shared between you.
There is an advantage to pricing your building accurately and as close to the final selling price as possible as this will bring you the greatest number of offers which will always demonstrate true value. Many listings on the market will be priced incorrectly due to a lack of knowledge and investigative exploration of the asset. Putting a one-dollar value on the listing has become extremely popular in some markets, which leaves you open to buyers and their agents incorrectly valuing your building resulting in offers that are incorrect and requiring intense negotiations. The experienced investor is going to base his/her value on a Cap Rate, Price Per Door, condition, unit mix, gross rent multiplier, and upside Finding out what your buying needs and goals are. Getting you qualified for loans and getting proof of funds arranged. Finding the right property on or off the market Negotiation the purchase of the property Closing.
Working the numbers to make the deal look better so you can justify the asking price, this means you adjust your expense numbers within an honest parameter to make the evaluating number look better. Meaning, if you are overspending in areas such as property management or insurance you can adjust these numbers knowing that any purchaser can adjust these numbers as a prudent buyer and new owner to reflect a better outcome. You may also be spending more on insurance just because insurance companies are known to increase their price over time. Insurance can’t be transferred to the new owner so when they get quotes for new insurance, they will achieve a better price than what you are paying. Adjusting this number in your sales proforma is an honest adjustment that can and will change the numbers in your favour. Inexperienced sales representatives seldom utilize this representation of the numbers, I even suggest your representative gets up-to-date quotes and uses these new quotes in their sales package as proof of representation.
You should now have the information required to offer an informed price for your property by knowing the NOI and the appropriate cap rate based on the location, type of building and its condition. Using this information, you will determine quickly if any offers are accurate for the marketplace and base any decisions on an informed mindset. Be prepared to supply two years of expenses and a current rent roll during due diligence to verify the numbers represented in the proforma.