Property Selection Process

The key to success in multi-unit residential investing is determined before you even close on the property.  What do I mean by that?  At any given time, there are dozens of properties on the market.  The key to success is finding the RIGHT property and then moving on it before anyone else does.  In most cases this means literally looking at hundreds of properties to find the one diamond in the rough.  To many this is a great enigma and is what scares away most prospective investors. 

I've been investing in multi-unit properties within Canada for more than a decade and have done very well following a simple formula.    Before buying any investment property I ensure that as many metrics as possible are tilted in my favor which helps to limit downside and significantly increase the potential upside.

All the metrics that I focus on are steadfast numbers which determine the profitability and cash-flow of the property and have NOTHING to do with potential appreciation (this helps to significantly limit any downside when the market turns and any appreciation is as bonus).  While most people I know would keep this information to themselves and not create potential competitors, I'm a big believer in Karma and think that the market is big enough for a few more serious investors who just need a point in the right direction.

THE RIGHT GEOGRAPHIC REGION

You can find some incredible bargains out there, but if you can't get tenants to fill your vacant units, you will be singing the blues.  You need to ensure that the area/region that you are looking to buy in has its metrics moving in the right direction.  By that I mean you have to do some research on the following which can influence your investment:

• Unemployment
• Population Growth
• GDP Growth
• Vacancy Rates
• Rental Rates
• New Projects (eg. Maple Leaf plant in Hamilton, Toyota plant in Cambridge)
• University in Town

While the big cities tend to have the most favorable metrics, don't overlook the smaller towns that can be just as competitive on these fronts.

CAP RATE

This is usually the first metric people look at to determine whether the potential investment is appealling to them.  Obviously the higher the cap rate the better, but in this period of low interest rates, cap rate compression has been taking place (Plain English: Cap rates are going down because interest rates are going down) making it much harder to find properties with high cap rates.  Cities like Toronto and Vancouver now command a 5% cap and less.  As such, I encourage investors to look to the outskirts such as Durham region (Pickering, Ajax, Whitby, Oshawa) or University towns such as Guelph or Kitchener/Waterloo where you can still find cap rates of 7% and beyond if you look hard enough.  A caveat here (and future topic) is to never assume the cap rate advertised is accurate (many times waste, maintenance, vacancy, property management, and other expenses are not included).  Although interest rates are very low right now and may allow properties to cash flow, if you buy a property with a cap that is too low (anything below 6.5% is too low in my opinion, unless you are buying all cash), you may get hurt when you mortgage is due for renewal.

RENTS

This is where I have made a significant amount of money in the past.  Many investors tend to get complacement after years of owning a property and leave their rents significantly below what the market will bare.  In this instance, if you buy the property at a good cap rate, you can score a home run if there is room to significantly increase the rents.  Here's a real life example.  I purchased a 12 plex (all 2 bedrooms) in Waterloo, ON back in 1999.  The average in the building was $650/month.  With a little work to each unit (about $4,500), within 12 months, the average rent in the building was increased to $850/month.  A $200/month increase in one unit adds approx. $35,000 in value to the building based on a 7% cap.  As such, look for properties with rental rates below market (use websites such as CMHC and viewit.ca to determine the current going rates).  On the flip side, ensure that the rental rates which you see in an income statement are either at or below market, because if they are above market, you will have a tough time keeping them rented at those inflated rates which will lead to an increase in your vacancy rates.

EXPENSES

Finding efficiencies in inflated expenses is another way to help make your investment more lucrative.  By inflated, I mean that the current owner hasn't realized, or doesn't care, that they can make their property run more efficiently and thus make more money.  This skill usually comes with time and experience in owning and operating an investment property as you get a feel of what the average water, gas, hydro, management and maintenance bills should be.  Spotting inefficiencies can be a quick way to add value to a building.  Here's another real life example.  I recently bought a property which I knew, based on size and number of residents, had a monthly water bill that was way too high.  I sent my superintendents into every unit to check for leaks.  They were able to pinpoint and fix about 1/2 a dozen leaks.  As a result the water bill was reduced immediately by 30% on a monthly basis and lead to savings of several hundred dollars per month.  The point once again is to look for opportunities to either increase income or decrease expenses.

APPLYING THE THEORY

It is rare to have all of these metrics working in your favor so what you want to do is to try to have as many of them as possible working in your favor.  It will take time and effort to find the right property, but if you do your homework and persist, you will be rewarded.  In the last few months I purchased the 2 following properties which I found using my formula above.

The first one was a 24 unit property located in Kitchener, ON.  The georgraphical metrics are bang on here as all the metrics are moving in my favor (check mark).  The cap rate was a very healthy 7% with room for improvement under the right management (check mark) Rents were on average $100/month below market.  Over 24 units, $100/month is very significant (check mark)  Expenses were high (this is the property I was refering to with the high monthly water bill) (check mark).  Other intangibles included a great VTB at 0% for 3 years, the potential to convert the units to condos and the potential to add 2 more legal units (check, check and check!).  Within 6 months the property had an offer of $800,000 over and above our purchase price.

The second one was a 12 unit property located in Oshawa, ON.  The geographical metrics again were bang on here as Oshawa has one of the fastest growing GDP's in 2012 and projected to continue into 2013.  Oshawa has been stigmatized as a one trick pony (GM Plant), but it has made great strides in becoming a multi-dimensional economy also focused on high tech and education (check mark).  The cap rate was a super healthy 8% (check mark).  Rents were pretty much at market and expenses were also pretty much right on.  While rents and expenses offered no real room for growth, the region and cap were enough to make this one a winner as well.

Needless to say, both buildings were in great shape and environmentally sound.  These were just great finds and not a case of being discounted for some major short coming.

Finding great investment properties is like any other discipline,  it take hard work and persistence, but it the end it always pays off.