Real Estate Talk: Criteria in
selecting an income property

Rate of return, location and condition of the building must be considered

By Joseph Marovitch

Income property can be the least risk income one can invest in, provided steps are taken to reduce the risk. Many buyers purchase a residential property with emotion. When a property is purchased with emotion, at times buyers will pay more than the property is worth. There should be no emotion when purchasing an income property. The purchase should be based on the numbers.

As discussed in a previous article, the capitalization rate should be 5 or higher for the income property to be profitable. If the property is 6 units or more and the cap rate is 4.9 or less, the purchase price should be adjusted to ensure the cap rate is 5 or higher. Less then 5 and you have paid too much if the purpose is to acquire a currently operating income property, as is.

There should be no emotion when purchasing income property. The purchase should be based on the numbers.

The second criterion is location. If you are not a developer and just intend to create a portfolio of income property, then the location is important in terms of tenants, rent and growth in the property value. Locations closer to the core of a city tend to be more valuable in terms of rent and equity growth in the building. Therefore, the closer the building is to an urban location, the higher the rents will be and the better the tenant will be in terms of maintaining the property and paying the rent on time. The downside is that you pay more money for fewer units.

If you purchase income property further from the core of a city, you will pay less for more units but possibly have more headaches. There are certain, very nice, suburbs that allow less investment for more units with fewer headaches.

The third criterion is the condition of the building. If the income property is stated to have a cap rate of 5 but the building requires a great amount of repair, the cost of the repair will reduce the cap rate. Again, the purchase price must be adjusted to maintain the stated cap rate. Items to examine are the roof, brick pointing, windows, balconies, wiring, water infiltration, cockroaches and more. To reduce the risk, ensure the due diligence in the offer includes a full inspection by a certified and experienced building inspector, which is not the same as a home inspector.

To summarize, the following criteria must be examined:
1. Rate of return
2. Location
3. Condition

‘To reduce the risk, ensure the due diligence in the offer includes a full inspection by a certified and experienced building inspector…’

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Have a great week!

Next article: Reducing risk and headache once the income property is acquired

STATE OF THE MARKET

According to a recent Canadian Mortgage and Housing Corporation (CMHC) study, buyers who purchase off the island find the savings they acquire compared to purchasing in Montreal, more than offset their transportation cost to get to work on the island. The CMHC study indicates that more and more people are buying in the suburbs and leaving the island of Montreal. The CMHC is actually warning everyone that if residential property prices continue to rise, more and more buyers will choose to purchase homes in the suburbs.

This is not exactly news and why the warning? Do they think sellers will choose to reduce their prices so people will stay on the island of Montreal? The rising prices are a natural progression when supply starts to reduce and demand remains the same or increases. Montreal is an island with a finite amount of land to build on and we are approaching the limit now. Yes, the suburbs will attract more buyers and the suburbs will also progress and become more expensive. The suburbs are the next best place to invest for those who see long term in the real estate market.

To understand the model of real estate growth and how it progresses, the CMHC should examine European cities such as Athens, Rome and Paris, which have progressed over thousands of years. Growth is inevitable. Of course, the law of supply and demand remains in effect as well.

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Read also: other articles by Joseph Marovitch