Investing in Real Estate in London Ontario & Valuating Income Properties
Cap Rates- The Most Misunderstood of All
Cap rate (C.R.) is arguably the most often quoted metric for expressing property value. Yet, it tells only half the story.
Why is there such emphasis on C.R.? Because it allows you to compare two widely differing rental properties financially. A poorly managed nine-plex could be less profitable than a well-managed six-plex.
C.R. expresses the relationship between a property’s current year’s net income and the property’s value. It helps but doesn’t ultimately determine the value of an investment property and its potential return on and of investment.
Cap Rate is calculated by subtracting all operational expenses (excluding financing and capital expenses), plus vacancy and bad debt from the property’s total income and dividing the result – called net operating income (N.O.I.) – by the current value or sale price of a property. It’s expressed as a percentage. There’s a mathematical inverse relationship between property value and C.R.: the higher the C.R., the lower the property value and vice versa. Buyers want a high C.R. Sellers to wish to offer a low C.R. the seller’s lower sale price reflects the buyer’s higher rate of return.
Listings may cite C.R. but often exclude or include expenses that a lender doesn’t care about or that are not an operating expense. The most common “missing” fees are repairs and maintenance, property management and vacancy and bad debt. Excluding these expenses make a C.R. look much better than it is. Because of that, lenders add in missing expense approximations, which then drive property value down. This, in turn, reduces the mortgage amount, and the deal “fails because of financing.”
For example, a property generates $100,000 in annual gross income. The listing states total operating costs are $35,000, generating $65,000 NOI. Divide NOI by five per cent CR = $1,300,000 baseline property value. You expect to receive 75 percent of the value as a mortgage, called loan-to-value (L.T.V.) = $975,000.
However, the listing didn’t include vacancy/bad debt (typically two to four percent), repairs/maintenance (typically $750 to $800/unit) and property management (average five percent). The property’s expenses are actually $45,000, generating $55,000 NOI, divided by five per cent CR = $1,100,000. Therefore, the lender’s $10,000 in added expenses reduced the property’s value by $200,000. Seventy-five per cent LTV = $825,000 mortgage, which is $150,000 less than you expected. Unless you can come up with that difference, the deal fails.
C.R. can provide reliable insights into a property’s financial performance, but because C.R. is based on N.O.I., it doesn’t factor in financing and closing costs, so it won’t tell you how much profit (cash flow) you’ll make. It doesn’t consider a property’s state of repair, so you may have to invest extra money into significant capital expenses such as windows or a boiler. It doesn’t project appreciation or geographic growth potential or considers local crime rate and types; tenant demographics; the quality, construction, size and age of a property; or the property’s proximity to amenities. C.R. doesn’t forecast increases in operating and financing costs, possible right-of-way issues or environmental concerns.
When a buyer declares in a “5.0 cap” market that they will only look at properties with a 6.0 cap, they’re saying they want a property with a high N.O.I. At a deeply discounted purchase price. Well, shucks and golly gee, don’t we all want that? Such buyers are looking for bargain-basement investment properties they’re unlikely to find, and they’ll never make a purchase.
A property’s market value generally assumes it’s in a good state of repair; the land is employed for its “highest and best use,” and its rental revenue reflects all the local positive and negative market influences. The market assumption is that the buyer won’t have to lay out any immediate cash for capital costs.
No seller should expect to receive market value for their property if any of the above isn’t true. To assume otherwise, the seller is saying they want you to pay for the property’s future potential even though the seller did nothing to deserve a share in that future potential. If a seller wants to benefit from that potential, they should invest the time and money first to realize that potential and then sell their property.
A seller might purposely offer a higher C.R. if the property is “stigmatized” and requires a buyer who doesn’t care about the stigmatism, or it may be “distressed,” expecting a notable influx of cash to fix the problem.
The above was written by Chris Seepe, a published writer and author, ‘landlording’ course instructor, president of the Landlords Association of Durham, and a commercial real estate broker of record at Aztech Realty in Toronto.
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How Much Is A Property Worth?
You would be amazed at the number of investors who do not know how to determine the value of real estate. As an investor, you must be able to determine the value for yourself and not leave it up to someone else.
The three primary yet different ways of determining value with real estate are the C.M.A., the Income Approach method and the Replacement Cost method.
The C.M.A. method (What most REALTORS use)
The C.M.A. (Comparable Market Analysis) method is based on what similar or comparable properties have sold for in the past, typically within the last three months.
The C.M.A. is the most common valuation method for residential single-family homes. However, it’s typically the least favourable valuation method for investment real estate.
The Income Approach
The Income Approach method of valuation puts a value on the income generated from the property. This is the valuation method investors use most when evaluating an income property.
The Replacement Cost
This method of valuation is simply what it would cost to buy the land today and build a new building with the same square footage with similar features.
Let’s use an example to illustrate the differences between the valuation methods and assume for a moment that we are talking about a three-bedroom home with a two-bedroom basement suite.
The main level of the home is 1,000 sq ft and so is the basement for a total of 2,000 (finished) sq ft. The home is occupied by the seller and the seller collects $1,000 per month from the suite and the tenant pays for their portion of utilities in addition to their rent.
The seller is asking $400,000 since a Realtor told the seller that the C.M.A. (Comparable Market Analysis) showed that similar properties in this neighbourhood have recently sold in this price range. This is the C.M.A. value, which is again what the market is currently willing to pay.
We can determine what the income is worth from an Income Approach method of valuation. Since the seller occupies the main house and we know the market rents in the area, we can quickly estimate that the home would rent for $1,500 month plus utilities.
Including the suite income of $1,000, we would have a total of $2,500 in total gross income. We then deduct all of the expenses, not including financing.
Let’s assume that we have calculated the property taxes, insurance, vacancies, advertising, management, repairs and maintenance and a monthly miscellaneous allowance totalling $900 in monthly expenses. That leaves $1,600 ($2,500 – $900) remaining each month which is the amount left over to pay a mortgage.
By running a simple mortgage calculation based on $1,600 per month for a mortgage payment using a 25-year amortization and a 4% interest rate, the amount of mortgage that a $1,600 payment can support is $304,000. Adding a 20% down payment of $76,000 on to the mortgage amount would give a maximum Income Value of $380,000. ($304,000 + $76,000).
Pretty simple isn’t it, yet 90-95% of people who I see in my office have used the C.M.A. approach, or as an example, when I show properties, I review what the previous owner had purchased the property for and guess what?
Note: Paul Hecht, an investor, wrote most of this article, the italics are my words! No wonder they were losing money and are discouraged!
Can You Influence The Future Value Of Your London Ontario Income Property? Read More
What Sets Us Apart From Wannabes
Quite a few times, people looking for income properties in London Ontario miss the boat because by the time they have confirmed all the facts, or, ‘run their numbers’ (usually erroneously), or, gathered reliable information, the opportunity is gone because of other buyers or the property has been sold!
I see this daily, the fence-sitters, the ‘time is not right’ folks, or in 75% of the cases, their analysis of the property and income is faulty, that their illusion or perception of cash flow, appreciation and risk tolerance is inconsistent with what wise investors do!
The average real estate professional relies on what he or she hears & perceives, a great real estate professional assimilates all the available facts, sifts out the chaff, and makes the go/no-go decision on his/her ability to adhere to what I call the brutal truth.
Great investors never buy because of what the market is doing; they don’t care. It can be up, it can be down, they understand cash flow, they look at the big picture and they think long term. They buy on expectation and sell on results! Period.
As J.P. Getty said, “Investors bank on climate, while speculators bet on the weather.” In other words, the real estate market works more like a barometer than a thermometer.
Getting excellent and accurate information and then being able to act decisively on that information is what separates the wannabees and the wealthy.
What We Do When Working For Our Investor Clients:
When we work together, you’ll receive the following services that no other Realtor in the country provides, which includes:
P.S. Investing is not risk-free. You can lose money, depending on your skills as an investor. Your risk of loss is reduced dramatically because you’ll be buying a property that you can always resell. You could overpay for a property by not using a skilled Realtor; you could choose bad tenants by not using a competent Realtor and not adhering to the steps an experienced Realtor will lay out for you.
P.P.S. Yes, I hear this all the time, what about a new roof, or new windows, appliances etc. So what? Your tenant is paying down your mortgage every month.
Investing In Real Estate London Ontario Correctly
| Investing in London, Ontario, real estate rental properties can be financially rewarding if and when it’s done correctly.
However, just as with all investments, there are some risks, and not everyone who invests in real estate has had good experiences. I’ve seen more than a few landlords quit because they were either losing money or just barely breaking even.
What went wrong for the investors who didn’t succeed? They made some common mistakes.
Maximizing R.O.I. ( return on investment) isn’t just about buying a property and collecting rent. You might experience several events throughout the year that will increase or decrease your R.O.I.
For example, landlords can increase R.O.I. by keeping the premises in good shape and with modern appliances. (fewer repairs in the long run or that emergency call that the fridge is not working!)
Tenants can decrease R.O.I. by not paying their rent, moving out prematurely, or damaging your property.
Being an investor in small real estate properties will not make you productive overnight, but over time you can build what I call slow wealth! You make money in real estate when you buy, not when you sell!
All my clients do well with this philosophy, and though this is boring as a narcissist’s fart, it works!
Again, slow wealth and walking the talk!
Below are highly acclaimed tutorials about investment properties; give me a quick call at 519-435-1600 or an email, and I see you get the three guides below and then you have made a great start as an investor!
|Are Your Cash Flow Calculations All You Need Before Buying?
So many beginning real estate investors will decide whether or not a real estate investment is good or bad based on the answer to this single question: “Will the property produce positive monthly cash flow?” Basing your entire decision on the response to a positive cash flow question is a minimal way to look at an investment. Sometimes there just isn’t a simple answer for you when you’re looking to create wealth. There are several things real estate investing beginners or even experienced investors should consider.
|No Brainer Real Estate Investor Tips
I have spent a lot of time studying and working with wealthy real estate investors. I am not talking about the flashy ones or the jet setters. I am talking about the person who looks and acts like your neighbour next door, yet has a portfolio of 5 or more properties. They could be condos, single-family houses or multifamily homes, and whatever they are comfortable with, they take the attitude of slow and long-term growth. They do not flip; they do not take excessive risks, and they are great landlords because they know the secret to be a successful landlord. Being an investor in small real estate properties will not make you rich overnight, but over time you can build what I call slow wealth! You make money in real estate when you buy, not when you sell! All my clients do well with this philosophy that I share, and as J.P. Getty said: “Investors bank on climate, while speculators bet on the weather.” Below are a few “lessons” that have been experienced the hard way by thousands of investors and a few tips on how to overcome the consequences of poor decision-making and erroneous opinions, be they yours or the so-called experts!
Using knowledge, expertise and technology to sell your property! The web is now by far the most important advertising medium for real estate, and that’s becoming truer every day. Fortunately, I’ve managed to stay ahead of this trend, and have been continuously working to increase my web presence so that I can push listings to more places very quickly, putting properties in front of online buyers very effectively.
Testimonials Thanks Ty
Hello Michael & Ty,
Roz and I would like to thank you both for the effort you put into finding us tenants on such short notice.
We realize the process may not have started off that well while the other folks were still living in the unit. We appreciated your patience and faith in us very much to bring the condo back up to standard to allow you to do your job properly.
It worked out well in the end, and we hope these new folks will spend a while in our place and treat it with respect.
Thanks again for your hard work.
Have an awesome day.
Joel & Roz
Thank you! Ty your help has been invaluable. We are returning to Toronto tonight and really appreciate all you have done to help us.
Hey Ty, thanks, great work, appreciate all your time and effort, and of course, you keeping us on track.
I could not agree more with your latest email on people paying over the asking price. The market must be accelerating even more than a month or two ago.
We very much appreciate the work you have done in helping us to achieve a portfolio of ten rental properties, and in disposing of Pond Mills. We would not have known where to start were it not for having the benefit of your expertise.
I have been busy leasing xxxxxxxxxxxxx. It took six weeks to find someone decent, and I rejected seven applicants in a row, but I finally found a great candidate. All his references describe him as reliable and his landlord says he pays rent like clockwork. The lesson in leasing is not to compromise with a weak tenant and keep marketing like crazy until the right one comes along.
Thank you for helping my client’s estate dispose of the seven properties, I and the family are quite pleased with the prices we received, we now have one more property to go, which is a private residence, see the details below and thank you again.
The place is going great!! We have an incredible tenant
that pays early every month and she’s super quiet. We
have been really pleased with the location and
neighbourhood and how everything has been with the house.
We walk right downtown in minutes and never have to worry
about parking! I would suggest this location to anyone, although
we keep looking for similar properties for ourselves in the same
neighbourhood for the future….
Nothing was really wrong with the sewer system other than large
root buildup but once we got a competent plumber in that had
a large enough root cutting machine we were back in business!
Thanks so much for all you did to get us this place and for the
wisdom and experience you had to guide us into making a very
attractive offer to get this house. Taylor and I really enjoy it.
Anna was an incredible resource for us as well. We were really happy
we went with her and look forward to working with her again in the future.
We will definitely be using your office in our future home buying process!
Thanks for the follow-up!
Derek & Taylor
Just a brief note to thank you for selling my two-income properties by Western. I know the 6 bedroom was a nightmare and thanks for taking the time with the Fire Marshall, the electrician, drywallers and getting the garbage guy out to clean up.
I thought the deal was off a few times, thanks for keeping it on track. At times I thought I was going to lose money on it but in fact, I did far better than expected.
I have included a little token of my appreciation for what you did for me and my family, and my father has asked me to offer you any of his various timeshares for a week. Let him know, its yours.
Just like you said, we are now into the 11th condo that we have bought through you and you know, as I teach this, your systematic approach was the same as our first one, the only change is we did not know what or how to do anything when we bought our first one.
Thank you for your patience and setting us straight on the numbers, you have saved us I don’t know how many headaches or thousands.
We are now preparing to buy our 12th at the end of the year, of course, with your guidance. Oh, and thanks for the name of the furnace guy, he’s great, we even had him come to our house and look at our A/C.
Thank you for your follow-up email. We are very pleased with Paul’s help in finding and buying the property. Paul was very efficient and effective on each step of the buying process. He was also very helpful to us in finding a home inspector, a mortgage agent and a lawyer for closing the deal. It was a pleasant journey for us.
I am sure we will have more opportunities to work together in the near future.
Thank you for your excellent help.
Fiona Douglas has recommended your work as Broker of Record & Owner at Envelope Real Estate Brokerage Inc.
Details of the Recommendation: “Ty has been a pleasure to work with over the past couple of years, on a least two major projects we have had on the go. He goes above and beyond and has never disappointed us, and his calm demeanour goes a long way towards keeping us focussed when dealing in our very volatile real estate market. We have no qualms about recommending Ty’s services highly, and with pleasure!”
When I was looking at places with you last year you had mentioned purchasing gift cards for your tenants at Christmas time. I took your idea and bought a couple of gift cards and the tenants seemed to love it!! Inexpensive and pretty simple, but they felt it was very thoughtful and like you said…how many landlords give tenants gifts??
All is well with the properties so far, I really appreciate the education you helped provide me in 2012…nothing beats the gift of knowledge. It’s hard to believe I went from never owning a property only 6 months ago to now have two income properties in London running!! You really emphasized the philosophy that if you keep your place proper, and treat your tenants well, then you will have success (as opposed to the slumlord philosophy lol).
Thanks and best of luck in the new year!! I will definitely be using Envelope for all my future purchases!!
ps…If any interesting properties or places pop up, I’m always interested in new ideas!! lol
We finally closed the deal yesterday with Dan. Vanty and I would like to thank you for your professional service and help; we felt confident that we were in good hands. Tenant is more than happy to sign another one-year lease agreement for the condo highrise apartment. It’s almost like happy-ending Hollywod stuff for now, but Vanty and I are aware that there will be a steep learning curve for us in real-estate investment ahead. We believe it will be challenging and rewarding for us. We’ll be in touch again after our vacation.
Jerry and Vanty
I reviewed all the statements and the invoices, everything looks clear to me, you did fantastic work, I really thank you for your effort and appreciation.
Now I am planning my booking to London Ontario, on the third or fourth week of October, please let me know which time is more suitable for you.
Subject: Re: Another Tenancy agreement
Just wanted to let you know that everything worked out with the couple I showed my place to. They provided two references, both of which said they wished all their tenants were this good. The guy is doing a fellowship at the hospital, so he has a fantastic job and they just come across as very respectful, quiet people. I used the lease you provided, and they signed on Tuesday. I asked them to bring along a rent deposit for last month’s rent, and they could pay the first month’s rent on Sept. 1. Instead, they gave me a bank draft for the entire first and last months upfront!!! I got $920/month, just like you thought would be reasonable and which covers my costs each month, and I only had the place for one week before finding tenants!!
…Things have gone so smoothly, that it looks like I may have to come in and see you again to start planning my next move!!! lol
Here is a testimonial, in case you would like to ever use it:
I am very happy with all the service you have provided. As a first-time buyer, you were extremely helpful through the researching, viewing and purchasing processes. And even after I bought my condo in Pond Mills, and you had already earned your commission, you have promptly responded to every question I sent you regarding tenants, leases and the entire rental procedure. I can’t thank you enough for everything. I will definitely be coming back to work with you again!!
On Mon, Aug 6, 2012, at 12:16 PM, Scott wrote:
Real Estate Investing Inside Scoop
If you like what you have read so far and would like the inside scoop on real estate investing in London Ontario & area, Landlord & Tenant Act, tax tips & plain, simple investor tips, let me know. These are reports, not a constant barrage of hiring me, blah blah stuff. You are never, ever under any obligation and you will never be spammed, bullsh**ted or get reality T.V. crap.