Real Estate Talk:
Income property / 1

Income property concept and pricing – understanding the Cap Rate and other considerations

By Joseph Marovitch

Updated November 6, 2024

Some people invest in the stock market. Some invest in art. I believe in real estate as the best investment. You can invest in a single residence, condominium, duplex, triplex, multi-residential (more than five units) income property or commercial building. For the purposes of this article, I will be discussing duplexes, triplexes and multi-residential income properties.

Investing in a good piece of real estate is like purchasing a government bond. If the price is right, the condition and location are good and the capitalization rate (Cap Rate) is decent, then you have a property that grows in value and provides a constant income stream.

Some people invest in the stock market. Some invest in art. I believe in real estate as the best investment.

To price an income property of six or more units, you must understand what a Cap Rate is. A capitalization rate indicates the amount of return you receive on your investment. A Cap Rate number consists of the following:

1. NOI – The Net Operating Income or profit after expenses, on an annual basis

2. The purchase price of the property

These two factors are applied to the following formula: NOI / Purchase Price x 100 = CAP RATE

Eg: 10 Apple Rd – 10 units fully rented – NOI: $50,000 – Asking Price: $1,000,000

NOI / PRICE x 100 = CAP RATE
$50,000/ $1,000,000 x 100 = 5 or 5% return

If the Cap Rate was 3 for a ten-unit fully rented income property, you would want to reduce the asking price until the Cap Rate is acceptable at 4.5 or higher.

In Montreal, a Cap Rate can range from 1 to 12 or higher. The higher the Cap Rate, the higher the net income. Generally, the Cap Rate number indicates the following:

1 – 2: These numbers do not indicate a property that is generating a profit or even maintaining expenses.

3 – 4: These numbers would indicate a duplex or triplex that is maintaining expenses such as mortgage, taxes and/or electricity but not generating a profit except for the increased value of the property itself as time passes, called capital gain.

5 or higher: These numbers indicate a property that is maintaining expenses and generating a profit.

‘These properties [duplex and triplex] are an excellent investment in the long term as they grow in value and maintain their own expenses via the tenants.’

Duplex and triplex pricing

We do not price a single-unit condo, duplex or triplex the same way we price an income property of six units or more. If you try to price a duplex or triplex based on a cap rate, the property would be worth little. Therefore, we price these properties much the way we price a home.

The price is based on the location, condition and comparable sold and active properties in a similar location. These properties are an excellent investment in the long term as they grow in value and maintain their own expenses via the tenants.

Income property price accuracy

There are two ways to find an income property for sale. One is via the Centris system with a broker. The other is via private sale.

The vendor will indicate the income property is for sale, the asking price, gross income, expenses and net income. You will then apply this information to your Cap Rate formula. Most income property that arrives on the market each day is overpriced, with Cap Rates of 3 or 4. If these properties are six or more units, they are not worth spending time on unless the buyer requires tax losses applied to previous gains, or if there is an opportunity to raise rents via renovation.

‘An income property (six or more units) can be sold quickly in almost any area if the Cap Rate is 5 or higher and the vendor accurately indicates all the expenses.’

If the indicated Cap Rate is 4.5 or higher, you must verify the Cap Rate by examining all the leases, and expenses associated with the property, and via a building inspection. If upon examination of all these factors the Cap Rate is less than indicated, the buyer can renegotiate the purchase price, buy as-is or cancel the offer.

An income property (six or more units) can be sold quickly in almost any area if the Cap Rate is 5 or higher and the vendor accurately indicates all the expenses. I say almost any area because the more affluent a neighbourhood is, the easier the tenants will be to work with.

In future articles, I will be discussing the following:

• Income Property – Process to market
  .
• Income Property – Conditions with promise to purchase
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• Income Property – Condition: 1st visit
  .
• Income Property – Condition: Inspection
  .
• Income Property – Condition: Review of leases and expenses
  .
• Income Property – Financing
  .
• Income Property – How to increase your real estate portfolio after your first purchase
  .
• Income Property – Landlord’s obligations
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• Income Property – Tenant’s obligations
  .
• The Tribunal administratif du logement – Who are they?
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• How to deal with the Tribunal from a landlord’s perspective
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• How to deal with the Tribunal from a tenant’s perspective

Should you have questions or comments, please refer to the comments section at the bottom of the page. As well, to view past articles, click here.

Next article: Income property /2 – Process to market income property

State of the market

The real estate market has been stabilizing. Inflation has reached the 2% target as the Fed wanted. Interest rates have dropped to below 4%. All these factors have been driving the market with slowly increasing demand and supply. Currently, there is an opportunity to purchase a property with a low-interest rate mortgage. If the economy were to continue the path it is currently on, there may be further interest rate decreases and consistent low inflation which would mean low carrying costs for homeowners.

‘The real estate market has been stabilizing. Inflation has reached the 2% target as the Fed wanted. Interest rates have dropped to below 4%. All these factors have been driving the market with slowly increasing demand and supply.’

On November 6, 2024, the Republicans won the election, and the new president will be Donald Trump. The Republicans plan to implement many new policies. Some are positive, some are not. However, there are certain policies that, if implemented, will affect the Canadian economy such as:

• Increase of tariffs on goods and services entering the U.S.
• Removal of funding from Ukraine
• Removal of regulations that will affect the environment negatively
• The America First policy
• Reduction of taxes on corporations
• Eviction of all immigrants
• Exit from NATO

All these points affect our economy by slowing the supply chain and increasing inflation and interest rates. We know that, at this moment, interest rates are good for buyers. We cannot say what will occur in our economy or the real estate market in terms of carrying costs over the next few months as the new U.S. administration settles in and begins the implementation of policies that were indicated clearly during the election.

The world is in a transition, and we will just have to wait and see.

Have a great week!

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