Real Estate Talk:
Income property /11
Phase 1 environmental test in an income property purchase
By Joseph Marovitch
Welcome to 2020, a new decade and a new landscape in a shrinking real estate market. Income property is a hot market in Montreal, as is indicated by increasing price per door. The price for income property use to be determined by the cap rate (net operating income / value x 100) and a 5 cap was the average for fair market value.
However, with increased prices for single homes, many people are opting to rent. More renters cause less vacancy, therefore rent prices rise. With few vacancies, there is a housing shortage, causing developers to buy property and build more apartment buildings. The problem is there is a shortage of land and income property inventory.
The income property that is for sale can demand a higher price with a lower cap rate since sellers are aware that with a shortage of inventory and space to build, rents will continue to rise. This means a buyer may purchase a property with a cap rate of 4, knowing that the cap rate will rise as the island of Montreal moves closer and closer to a resellers market.
Sellers and experienced investors/buyers see where the market is going, which is why buyers are prepared to purchase income property at lower cap rates for future gains.
A reseller market is a market where new construction ceases and old property continues to trade hands. In a reseller market, inventory remains the same as demand increases. Real estate becomes a commodity like gold. Prices rise with demand for a commodity that is not growing.
Sellers and experienced investors/buyers see where the market is going, which is why buyers are prepared to purchase income property at lower cap rates for future gains.
I work with many real estate investors. Each day I provide the income property listings that arrived on the market the day before to my clients. The properties are chosen based on three criteria:
- Cap Rates
Cap rates of 5 or higher, or property with major upside potential to raise rents or reduce the purchase price.
. - Location
Properties in a good location where decent rents can be obtained and tenants who maintain the premises and pay the rent on time live.
. - Condition
The apparent condition of the property based on the pictures in the listing.
On average there can be between 20 and 60 new properties on the market between Monday and Friday. I can usually pull out only 2 or 3 with cap rates of 5 or higher, in good condition and in good locations. I send these via email to my clients. If the numbers make sense and the location and condition are deemed okay, the client emails me back to prepare an offer. These properties can only be accessed with a conditional accepted offer.
The offer includes four conditions:
- Condition of 1st visit
.
- Condition of review of leases, building expenses and a current phase 1 environmental test
.
- Condition of inspection
.
- Condition of financing
All four conditions allow the buyer an out from the offer or a renegotiation of price, if required.
What is a point of contention for many buyers and sellers is the phase 1 environmental test. If the buyer requires financing from a financial institution, that institution will not provide a mortgage unless the buyer can produce a current phase 1 environmental test indicating the property is free and clear of contaminants.
A phase 1 test can cost between $1500 and $2500 per building. I would advise sellers to have a phase 1 test performed before placing the property on market, but this is not always the case. Many buyers feel that the seller should provide a current phase 1. Many sellers refuse to spend the money to have one performed and expect the buyer to pay for the phase 1.
‘…if the final numbers indicate the purchase will grow in value and the cap rate will continue to increase, then it is an advantage for the buyer to pay for the phase 1 just like they would pay for an inspection.’
If the buyer, for any reason, does not purchase the property, the seller can use the phase 1 for the next buyer, which is a case for the seller to pay for the phase 1. If the phase 1 test indicates an environmental issue, the buyer can cancel the offer or renegotiate the price lower to allow a clean up.
There are advantages for both parties to pay for the phase 1 however, if the final numbers indicate the purchase will grow in value and the cap rate will continue to increase, then it is an advantage for the buyer to pay for the phase 1 just like they would pay for an inspection.
In a multi-million dollar offer, it is rare for a buyer to not proceed for $1500 dollars since the future gains in income and capitol growth far outweigh the investment of $1500 to insure the property is safe. The other reason the buyer may want to cover the cost of phase 1 test is that there is a shortage and continually decreasing inventory of income property and what is left will cost more to purchase in the future.
Should you have questions or comments, please refer to the comments section at the bottom of the page. As well, to view past articles, go to the search link and type in Joseph Marovitch.
Have a great week!
Next article: The problem with home inspectors
State of the market
It is a new decade – the 2020s. We finished the last decade with tremendous gains in the Montreal housing market and it appears this trend will continue in 2020. Interest rates and inventory remains low, unemployment is low, our economy has been experiencing growth and the world around us is iffy with environmental issues and geopolitical storms everywhere. Furthermore, our island is shrinking in terms of allowing new construction. In my opinion, it is a seller’s market and prices will continue to rise.
Read also: Other articles by Joseph Marovitch
Joseph Marovitch has worked in the service industry for over 30 years. His first career was working with families from Westmount and surrounding areas, hosting children between the ages of 6 to 16 as the owner and director of Camp Maromac, a sports and arts sleep away summer camp established in 1968. Using the same strengths caring for the families, such as reliability, integrity, honesty and a deep sense of protecting the interests of those he is responsible to, Joseph applies this to his present real estate broker career. Should you have questions please feel free to contact Joseph Marovitch at 514 825-8771, or josephmarovitch@gmail.com
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