By Terry Harding, Senior Vice President
As read on Western Investor’s 2019 Investor’s Guide to Western Investing
Low loan-to-value ratios and cap rates keep Metro rental apartments a long-horizon strategy
The multi-family market is generally seen as one of the safest real estate investment vehicles available, often considered the bond of real estate. A multi-family investment is often viewed as a type of recession-proof pension. When the real estate market slows down, apartments traditionally resist price corrections. The main criteria are that rents remain constant or do not decrease in any significant way. Residential rental property is valued on net income.
The majority of Metro Vancouver purchasers arrange mortgages with Canada Mortgage and Housing Corp. insurance, due to the very attractive interest rates being offered. These are usually 1 per cent over bond rates, which is currently around 3 per cent.
When purchasing a building showing a 3.5 per cent capitalization rate, the positive leverage of 0.5 per cent usually entices buyers. While attractive, the low rates come with a few strings attached, one being high mortgage insurance fees, but the most significant factor is the very low mortgage amount the buildings will support.
We recently sold a building in Kitsilano, which is considered among the premium rental markets in Canada. When the purchaser arranged a mortgage on the building the largest loan he could get was for less than $3 million. With a purchase price of $10.5 million, plus closing costs and taxes of approximately $500,000, this made a loan-to-value ratio of only 27 per cent.
This is quite normal in Vancouver’s west side, while in other areas of Metro Vancouver it is unusual to get a loan-to-value of more than 50 per cent of the purchase price. This has limited the market activity as most investors need to either refinance another property or cross-collateralize with another of their buildings.
This often makes it onerous for investors, due to the low capitalization rates being offered.
With the B.C. government’s recent changes to the rental increase amounts, plus recent increases in taxation, investors are looking to purchase with longer time horizons.
Most sellers recognize that the market is slowing down.
This opens opportunities for buyers. Previously most offers needed to be made with no subjects or a very short timeline. This has all changed in the last few months with offers now being made with reasonable subject periods and, more often than not, longer closing times. This allows financing to be shopped for and secured at more favourable rates, and allows more planning on how to improve a building and its cash flow.
While B.C.’s allowable annual rent increases are very low – 2.5 per cent in 2019 – most owners expect that they will get their needed return upon a tenant moving out. Lately the term “renoviction” is making headlines. This method of improving a building and raising rents to market level is also getting a lot of government scrutiny. While it is allowed within the Residential Tenancy Act, many municipalities are trying to shut this activity down.
This creates a very good buying opportunity if the building has been improved and the rents are at market. It allows much higher loan-to-value ratios, often 65 per cent to 70 per cent. It also takes out the waiting for tenants with low rent to move out so the unit can be improved and the rent increased.
The cap rates on these types of buildings will generally be 0.5 per cent higher than on a non-upgraded building. These buildings also require lower maintenance costs in comparison with non-renovated property.
The government should be supporting the groups doing these improvements. When done properly, they can be a win for the existing tenant, who can negotiate a bonus incentive to move out, plus a free month of rent.
Bare trust option
Another opportunity to purchase a building is as a bare trust. This allows the buyer to purchase the company that owns the asset and not have to pay the property purchase tax. The savings can be significant and should always be considered. The savings to the buyers can be in the hundreds of thousands of dollars.