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Thursday
Jan072016

Top 5 Metrics to Guide Your Investment Decision

Major cities like Toronto and Vancouver are no brainers as great places to invest, BUT... investment properties have become so expensive in these cities that it is almost impossible to find one that cash flows.  This in turn makes it very difficult to achieve secure financing. 

As a result, investors need to broaden their horizons.  The next best option is to look at the smaller urban centres for prospective investments.  With so many options available, how does one know where they should be looking?  The answer is let the metrics guide you.

1. GDP Growth (Look for 1%+) - This is a VITAL metric which indicates the economic health of the city.  Look for areas that have GDP Growth of over 1%.  The Canadian Chamber of Commerce publishes an annual report forecasting GDP growth in cities throughout Canada. 

2. Unemployment (Look for less than 7%)- Another obvious metric which demonstrates the economic health of the city.   The National unemployment rate is in an around 7%.  Look for an area with less than 7% unemployment.  StatsCan releases regular monthly figures.

3. Vacancy Rate - (Look for less than 3%) You want to ensure your apartments are always full and are easy to rent on turn over.  Look for areas that have a low vacancy rate, ideally under 3%.  CMHC releases regular annual and semi-annual statistics. 

4. Rental Rate - (Look for $800+ for 2 Bedroom) To get the biggest bang for your buck look for rental rates above $800 for a 2 bedroom.  This will ensure you are bringing in enough revenue to service your debt, pay your expenses and have positive cash flow.  Again, this info can be found in CMHC reports.

5. Population Growth - (Look for positive growth) More people looking for rental accomodation means lower vacancy rates and higher rental rates.  Avoid areas with declining populations.  StatsCan releases numbers on population growth every few years.

Author: Paul Kondakos, BA. LL.B, MBA - Professional Real Estate Investor

Thursday
Dec172015

$182,000 Raised for Sick Kids Hospital!

I'm thrilled to announce that we had another incredible year fundraising for Sick Kids Hospital in Toronto.  To date the Koutroubis Charitable Foundation has donated $182,000 to the Hospital for Sick Children.  I can't think of a more worthy charity to receive this donation just in time for Christmas!

BIG THANKS to all of our Sponsors, Participants and Organizing Committee for another incredibly successful year!!! #ThankYou! #ForTheKids #SickKids #NotDoneYet

Tuesday
Dec152015

Think Outside the Box to Finance Your Next Deal

Follow up to "Financing is the Real Challenge Today"

As discussed in my previous article "Financing is the Real Challenge Today", financing investment properties has gotten tougher.  Market cap compression and tighter lender guidelines have made it much more difficult to finance deals.  As a result more deals are falling apart after their conditional period expires.  While Schedule I Banks are a great option if you can fit into their perfect box, there are many other options available to getting deals done if you think outside of the box. 

1. LOOK AT THE "B" LENDERS

The Schedule I Banks are great if you can get an approval as they tend to offer the most competitive interest rates.  The problem is that their guidelines are so tight it's almost impossible to get an income property to qualify these days (at least in any of the major cities).  A great alternative is the "B" Lender.  Their guidelines are more relaxed and they are much more investor friendly.  Another advantage is that "B" Lenders tend to use appraisals to determine loan value instead of just cash flow to service debt.  This means that the "B" Lender's valuation will typically come in higher resulting in a higher loan value. 

The downside?

"B" Lenders charge higher rates, usually 1-3% higher. 

In some circumstances it's worth paying the premium to get the deal done.  I've personally placed numerous deals with "B" Lenders and consider them a great resource for active investors.

2. "B" LENDER + VTB = MAX. LEVERAGE

For the more aggressive investor, this is one of my personal favorite techniques for achieving maximum leverage.  Another major advantage of the "B" Lender is that most allow a VTB/second mortgage to be placed on the property.  That means investors can get 75% LTV from the lender on their first mortgage and another 10% via the VTB resulting in a total LTV of 85%.  I've even done a deal that resulted in 90% LTV.  Rare but possible.

The downside? 

1. "B" Lender rates

2. Too much leverage can be a risky proposition. 

I wouldn't recommend this for novice investors, but if you know your numbers and have experience managing rental properites, this technique could help you expand your portfolio wth minimal outlay.

3. MAKE THE DEAL FIT THE FINANCING

A good investment property should provide healthy cash flow.  One of the ways to achieve this is to source the cheapest cost of funds (eg. low interest rates).  We've already established that Schedule I Banks offer some of the lowest rates for commercial properties so why not look for an investment property that fits their critieria.  We know cash flow is a big deal and is usually the difference between success and failure.  Look for geographic regions that offer higher cap rates than you would find in big urban centres like Toronto or Vancouver.  As a rule of thumb look for properties with a 6%+ cap rate (its tough but not impossible) in smaller urban areas with good metrics (eg. pop. growth, GDP growth, low unemployment, low vacancy rates, healthy rental rates, infrasturcture projects, post secondary institutions, etc...).  The cash flow from a cap rate of 6%+ will likely be a good candidate for successful funding by a Schedule I Bank.

If you want to get really aggressive with your cost of funds, consider tacking on CMHC insurance.  You will get a discount of between 1 - 1.5% on your interest rate for the life of your mortgage.  Another benefit of CMHC is that they allow up to 85% LTV, however, their appraisals are so conservative you never attain anywhere near that so the real benefit here is the lower interest rate.  You are required to pay a premium up front which is added to your mortgage, but in the long run your cash flow is stronger and you will end up ahead financially.

The downside? 

To find 6%+ cap rates you have to look outside major urban centres and focus on smaller urban centres like Kitchener-Waterloo, Cambridge, Guelph, Hamilton, Barrie, Pickering, Ajax, Whitby, Oshawa, etc... and even then it can be tough to find the right property.

4. MORE MONEY DOWN

This would likely apply to very few investors, however, if you need to get a deal done and are sitting on a lot of cash, banks are much more likely to finance a deal at a lower LTV (eg. 50%) as the debt service ratios are more favorable to the bank and it leaves them with less exposure. 

The downside? 

1. Many investors don't have deep pockets.

2. A bigger downpayment is counterintuitive as leverage is likely the single biggest benefit of real estate investing.

5. GET THE SELLER TO HOLD THE FIRST

Where a property is owned free and clear, investors can try to get the seller to hold the first mortgage, thus allowing the investor to by-pass the Banks altogether.  While it may be rare to have the seller hold a first mortgage, it is not unheard of.  This is typically done in situations where the property may be a little run down and rents are under market, making it difficult to qualify for conventional financing.  With 25% down a seller may consider a short term first mortgage (eg. 2-3 years) to allow the buyer time to clean up the property and raise rents to qualify for conventional financing when the time comes.  The downside is that the rate will likely be higher than that of conventional financing.

The downside? 

1. Higher interest rate

2. Difficult to find a seller willing to hold a first mortgage 

Author: Paul Kondakos, BA, LL.B, MBA - Professional Real Estate Investor

Wednesday
Nov252015

Financing is the Real Challenge Today

Until recently, I always believed the toughest part of investing in real estate was finding the "right" income property (eg. good geographic metrics, under market rents, purpose built, good shape, good location, etc...).  In the past, my ability to find "diamonds in the rough" is what made me an effective and successful investor.  However, my opinion has now changed.  Looking back over my past few deals I realize that in today's environment, putting the right financing in place for an investment property is now more difficult than finding a good investment property and dictates your ultimate success or failure.

 

Financing

Most novice investors just assume that the bank is going to use the purchase price when determining Loan to Value.  They look at how much money they have available and work backwards.  If they have $300,000, they can use $250,000 for the downpayment and $50,000 for closing costs.  This means they can buy a property for $1 million and the bank will give them a mortgage of $750,000 based on a 75% LTV. However this couldn't be further from the truth today.

How did this situation come about?

Historically low interest rates in Canada have been the catalyst leading to:

  •  Cheap cost of funds
  •  Market cap compression
  •  Increased demand for real estate as alternative investments (Bonds, T-Bills, GIC's) offer poor returns
  •  Limited supply

As an investor looking to acquire an income property, you welcome low interest rates, BUT, cheap cost of funds is a double edged sword.  On the one hand you want as low an interest rate as possible to minimize expenses.  However, there is a direct correlation between cost of funds and market caps.  Both move in sync which means as interest rates go down, market caps follow suit (which means the price goes up). 

Why does this matter?

Market cap compression directly affects cash flow.  For instance, most income properties on the market in Toronto, and in surrounding areas, are being listed with cap rates of 4% to 4.5% (and in prime Toronto locations sub 3% market caps).  The problem is that there is a big disconnect between actual valuations dictated by the market and the criteria that banks use to value an income property for financing purposes. 

Just this week I approached 2 majors banks regarding an income property in a prime Toronto location and was told they use a cap rate of 6% to determine value.  A 6% cap rate on a good income property in Toronto is like a unicorn, they just don't exist.

The numbers

Most people, like myself, like to see the real math and numbers to truly understand a concept.  So here it is.

Assume a property nets $40,000.  Based on a 4% cap, a seller would list that property for $1,000,000.  Bring that same property to the bank for financing and based on a 6% cap, that same property would be valued at $667,000.  The bank will typically offer 75% LTV which would translate into a mortgage of $500,000.  The purchaser would have to come up with the balance, or $500,000 IN CASH, to complete the transaction.  One of the great benefits of investing in real estate historically has been the ability to leverage and borrow from the bank.

As if that wasn't a big enough obstacle ...

To make things even tougher, most banks have their own internal guidelines when determining a property's cash flow and they differ SIGNIFICANTLY from what you see on the property's fact sheet when it is for sale.  For example, most real estate agents will assign $400-$500 in annual repairs and maintenance per unit under expenses on the income statement.  Banks and CMHC tend to use $800-$900 per unit.  If you plan to manage the property yourself, it doesn't matter, they will assign a 4% (of gross) management expense.  Capital expenditures warrants another 1.5% to 2% of gross.  What does this mean?  It means that if you apply these guidelines the cash flow gets even weaker making it tougher to get the financing you need. 

Unless you are a REIT or have deep pockets, the erosion of leverage makes it almost impossible for the average investor to enter this market.

THE SOLUTION??

That will be my next entry - stay tuned.

Author: Paul Kondakos, BA, LL.B, MBA - Professional Real Estate Investor

Friday
Sep252015

The Investment Property Paradox

Here's the investment property paradox in a nutshell:

MORE = LESS

But how can that be???

The formula doesn't seem to make sense, but in fact, real estate investors have to deal with it all the time.

It all begins with the Municipal Property Assessment Corp., better known as "MPAC".  They are responsible for assigning a dollar value to your property based on comparables, age, structure, area, etc...  This assessed value is then used by your local municipality to determine  how much property taxes you will pay.

As an investor, one of your goals is to maximize the value of your investment.  So one would think that a high valuation by MPAC would be third party verification that you are moving in the right direction.  HOWEVER, you would be mistaken. 

A high valuation by MPAC means that your property taxes are going up.  As an expense on the income statement, property taxes affects the overall profitablity and VALUE of your investment.  So in fact, the true market value and profitablity of your investment property goes down when your property's assessed value goes up.

The prudent investor wants the lowest possible property assessment in order to pay the lowest possible amount of property taxes, thereby maximizing the profitablity and value of their investment.

The moral of the story is to do whatever you can to keep your assessed value, and thus your taxes, low.  When it comes time to reassess, make sure to build a case supporting a lower valuation and present it to MPAC.  Supporting evidence could include comparables in the area, a third party appraisal, an inspection to point out the deficiencies, etc...

Here is the formula prudent investment property owners should be working towards:

LESS = MORE (in your pocket).

Author: Paul Kondakos, LL.B, MBA, BA - Professional Real Estate Investor