Real Estate Talk:
Income property / 4
A look at promise to purchase conditions: Examination of documents
By Joseph Marovitch
Updated September 7, 2022
In my previous article we discussed the four conditions that must be in the promise to purchase for an income property to protect the buyer and we focused on the first condition, the first visit. Today we are going to discuss the second condition, review of all documents.
Four conditions that allow the buyer to verify the information:
- First Visit
- Review of expenses, leases, and any other financial documentation
The buyer requires protection in the offer since the buyer is providing a promise to purchase with a purchase price based on the seller’s information before the buyer has examined the property. The buyer is providing this offer because the purchase price is based on the Cap Rate, location and condition of the building.
The purchase price is not based on comparable properties or city evaluations, it is based on the income stream.
The major factor in determining whether the price the seller is asking is a fair price that will provide a feasible financial return is the balance sheet.
The buyer requires protection in the offer since the buyer is providing a promise to purchase with a purchase price based on the seller’s information before the buyer has examined the property.
In the balance sheet are the assets and liabilities. Assets, on the left side of the sheet, will list income from all possible sources, such as income from rents, common area laundry machines, parking, billboards on the side of the building, and any other source available.
On the right side of the balance sheet are liabilities such as vacant units, building repair expenses, garbage removal, superintendent salary, insurances, business taxes, school taxes, water taxes and other miscellaneous expenses.
At the bottom of the balance sheet is the total gross income, minus all expenses, to show either an annual profit or loss.
The balance sheet provides an overall picture of the financial situation of the income property but there are factors that are not indicated and make a major difference. It is very good that the Cap Rate indicated in the listing is 4.5 or 5.5 based on income and expenses, however, what if:
- Some rents expire in the next two months and they are not being renewed?
- Some tenants do not have a lease?
- Tenants are in arrears and have not paid their rent in the last three months?
- Certain expenses are missing such as garbage removal, building insurance, accounting fees, superintendent salary, etc.?
- What if electricity and/or gas fees are all rising?
‘If the buyer is not trained to examine the balance sheet and pertaining documents, it is wise to have an accountant perform the task.’
All these issues will affect the Cap Rate in a downward turn. Therefore, there is a condition where the buyer has the right to examine all the leases and expenses to their satisfaction and verify that the Cap Rate is accurate. Nobody wants to purchase a money hole and no landlord wants to remain in one. Therefore, the buyer must carefully examine all the documents. If the buyer is not trained to examine the balance sheet and pertaining documents, it is wise to have an accountant perform the task.
If in examining the documents, the buyer determines the information is accurate and the Cap Rate is correct, then the condition should be satisfied, and we move on to the next condition, inspection.
If it is determined that the expenses are higher than indicated, or that many leases are about to expire, or there are outstanding invoices to creditors, then the buyer has three choices:
- Negotiate a reduced purchase price
- Purchase “as is”
- Cancel the promise to purchase
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 /5 – Condition 3: Inspection
State of the market
The Bank of Canada has raised the overnight rate by 75 basis points to increase the key lending rate to 3.25 %. According to the Quebec Professional Association of Real Estate Brokers sales across Canada have dropped by 20%. This percentage should continue to rise for a while longer.
‘Buyers may pay higher interest rates for now, but the purchase price of a home will be more negotiable and therefore lower than in the past two years.’
While rising rates will not help consumers purchase homes, the good news is the concerted effort of these rising rates is bringing the consumer price index from 8.1% down to 7.6% and dropping. As inflation decreases, eventually we should see interest rates drop as well.
There is always opportunity in every event. Buyers may pay higher interest rates for now, but the purchase price of a home will be more negotiable and therefore lower than in the past two years. As well, the carrying cost of a new home will be less as inflation decreases.
Have a great week!
Let’s not forget that people with cancer are vulnerable too!
You are invited to keep giving to the following organizations since it’s now more important than ever to support cancer research! Click on the logos below to find out how:
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 for, 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 email@example.com