Real Estate Talk:
Income property on the rise

Seasoned investors are expanding their portfolios and new investors are starting a portfolio of their own

By Joseph Marovitch

April 13, 2022

As supply dwindles for single homes and condos, causing multiple offers and extreme rising prices, many would-be homebuyers choose to rent instead. However, the demand for rentals is so high that rental supply is low, causing increasing rents. This is the point where seasoned investors are expanding their portfolios and new investors are starting a portfolio of income property.

Each day, landlords place their income properties on the market. We define income property as six units/apartments or more. Many sellers do not understand the process of pricing income property, so many properties remain on the market for months.

… the demand for rentals is so high that rental supply is low, causing increasing rents. This is the point where seasoned investors are expanding their portfolios and new investors are starting a portfolio of income property.

The price for an income property is based on the capitalization rate or the percentage rate of return on the buyer’s investment. The capitalization rate formula is the net operating income divided by the purchase price times 100:

Net operating income (income after all expenses) / purchase price x 100 = cap rate
Ex: $50,000 / $1,000,000 x 100 = 5 cap or a 5% return on $1 million

A cap rate between 2 and 3.5 is either a duplex or triplex covering expenses or a 6 unit plus income property losing money.

A 4 cap rate with the potential to raise rents or a 5 plus cap rate is a profitable venture. For investors, the preferred purchase is a 4.5 to 5.5 cap rate, or more, on an income property of six units or more.

When searching for income property, there are criteria to follow:

• Choose good locations
• Choose properties with a cap rate of 4 or higher
• Choose property in apparently good condition

Upon finding property with these qualities, the income property cap rate must be verified, therefore conditions are placed in the offer to verify the cap rate and protect the buyer:

Condition of a first visit
Many landlords will not disturb their tenants nor reveal their expenses if the offer is not near the asking price. Therefore, visits are only possible upon acceptance of a conditional offer.

Condition of examination of leases and expenses
Should an examination reveal that the expenses are higher than indicated or the leases are less than indicated, thereby reducing the cap rate, the buyer has the option to renegotiate the price, cancel the offer, or accept the building as is.

Condition of inspection
Should an inspection reveal the building requires expensive repair, thereby reducing the cap rate, the buyer has the option to renegotiate the price, cancel the offer, or accept the building as is.

Condition of financing
If the offer is an all-cash offer, the buyer must provide proof of funds within 5 to 7 days of an accepted promise to purchase. If the offer consists of a down payment and mortgage, the type of mortgage, terms, and time to acquire the mortgage must be stated in the promise to purchase.

All the preceding conditions include a period and deadlines to fulfil the conditions that must be adhered to.

‘Qualities that investors search for are opportunities to upgrade and renovate, locations close to universities, transportation, hospitals and entertainment, and locations that are in the process of development and gentrification.’

Step 2 in the process is, after a period of ownership, to refinance existing income property and use the extra cash to purchase the next income property.

Step 3 is to sell all the small income properties and purchase larger income property. Then refinance, purchase, and repeat.

In the process of selling income property, landlords must trust the market and place the property at a fair market price with a cap rate of 4 or higher. The higher the cap rate, the more interest the property will generate. With more interest comes multiple offers. As well, investors search for income property with the potential to raise rents. Therefore, a renovated property is not always desirable to an investor.

Qualities that investors search for are opportunities to upgrade and renovate, locations close to universities, transportation, hospitals and entertainment, and locations that are in the process of development and gentrification.

Income property is one of the safest and most lucrative endeavours, and experienced investors recognize the current opportunities in this pandemic market.

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: The income property selling process in more detail

State of the market

There is plenty of interesting news in the market. The bank of Canada raised interest rates by 0.5% today in hope of curbing the high demand and overpricing. The federal government is considering barring foreigners from purchasing property for the next two years. None of these measures will address the fact that there is high demand in Canada and not enough affordable housing. Tax incentives are required to create affordable housing by offering a break to developers and contractors and reducing taxes on goods and services and imports of materials to build the homes.

According to a recent report by the Quebec Professional Association of Real Estate brokers (QPAREB), residential sales fell by 17% this past year. Single home sales fell by 18%, and condos fell by 16%. The notice that rates were to rise caused many buyers to acquire pre-approvals and purchase before rates rose, causing prices to rise higher.

‘Tax incentives are required to create affordable housing by offering a break to developers and contractors and reducing taxes on goods and services and imports of materials to build the homes.’

Interestingly, buyers were prepared to pay high prices for property within multiple offers to take advantage of a lower interest rate. Did the buyer actually save money by acquiring a 2.89% rate but paying a 30% to 40% increase in a property? What happens when the real estate tax roll comes around and the new municipal tax on the purchase property reflects both the higher value paid for the property and inflation?

Sellers, on the other hand, do not want to sell. Between the concern about the sixth wave of COVID-19 and realizing that if one sells one must enter the same boat everyone else is in and compete to purchase a new home at a higher interest rate, does not provide an incentive to add one’s property to the market.

This will all play out over time but know this – whatever the price of a property is now, it is still going to be higher as time passes due to demand, less inventory, and less space to build new unless buyers move away from the city.

Have a great week, and stay safe.

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Feature image: Tembela Bohle – Pexels

Other articles by Joseph Marovitch