Rental Property Investing - Return on Investment (ROI)

Return on investment on rental properties, is a calculation which measures the profit a real estate investment will generate. It is then compared to the amount of capital initially invested, to give a percentage yield on an annual basis. As a simple example consider the following -- a fully occupied commercial plaza sells for $500,000 with a net operating income (NOI) of $50,000.  Based on an all cash purchase, the (ROI) is 10%. Not bad in today’s low interest rate environment.

But consider the effect of arranging a 1^st mortgage on the purchase of $350,000.  Again for illustration purposes - let’s assume a mortgage rate of 5.5% and an amortization of 20 years. Going back to our plaza purchase above, annual mortgage costs amount to $28,740/year, leaving a net income (after debt service) of $21,260. The yield now on the cash invested, is + 14.2% ($28740/$150,000).  Welcome to the world of LEVERAGE!

In the case of part 2 of our example (after arranging a mortgage for the purchase), we can actually increase the rate of return on our cash invested by 4.2%.  In essence, we are increasing our yield through the use of borrowed money.  With this analysis, we are only looking at the existing cashflow (rental stream), which the property provides. We’ll take a further look at ‘leverage’ in future blogs, as we factor in price appreciation/growth and other strategies. 

Just a further comment on the initial cash investment (beyond the actual downpayment) -  be sure to include closing costs, land transfer tax, immediate capital improvement expenses etc.  Essentially calculate the total estimate of your upfront cash requirement to take on the property.

Next up…sifting through the financial data and ensuring its accurancy & reliability.  Again, seek out experienced commercial realtors within your market to assist in searching out quality rental properties to invest in.

Rental Property Investing - Due Diligence on Yourself

Investing in rental properties can be a lucrative way to create wealth, by not only providing an income stream, but also by creating an opportunity for capital growth – AKA -- an increase in the property’s value during your period of ownership. Types of properties can include – residential (single unit & multi-family), retail/commercial buildings (single unit & strip centers), office buildings (single unit & multi-complex), mixed use (ground floor commercial & above ground residential), industrial buildings (single unit & multi tenant complexes), and even raw land that generates some level of income.

After assessing the various property categories, determine the type that best fits with your objectives and will best meet your criteria. It isn’t one size fits all in considering rental property investments and you need to do some necessary due diligence on yourself before moving forward – due diligence on the properties/market will follow later. Markets throughout Canada are littered with investment property ventures ‘gone bad’ and the best advice here is to ‘walk before you run’.

Some key questions to ask yourself:

Am I more interested in residential or commercial/industrial properties?

What locations/neighbourhoods are of interest?

Am I hands on, or will I require a property manager?

What are my cash flow/return on investment objectives?

What type of financing is required and what % downpayment can I put up?

What sort of financial implications can I expect due to vacancies?

What sort of maintenance & capital improvement costs am I willing to accept?

Will I incorporate?  How can I best limit any liability?

What sort of market am I comfortable buying in?

Is liquidity an issue if I need to sell (quickly)?

Any investment comes with its share of risk and rental (investment) properties are no different. Good preliminary planning, starts wth a honest self assessment of YOU, your objectives, capabilities, comfort zone and so on.  Once you’ve figured that out, it’s time to move on to the market in whatever direction best suits you.

Next up – will examine return on investment strategies and look at the mathematics of it all.  As always, seek out experienced commercial realtors within your market to assist with acquiring the best rental properties for you.

Commercial Building Sales/Acquistions - It's a Wrap!

Over the past 7-8 months, we’ve tried to overview in a ‘soup-to-nuts’ fashion the area of buying/selling commercial properties. Targeted more at the owner-occupant market, we’ve tried to provide some valuable input as you consider your purchase/sale objectives. If you are currently active on a specific deal, there may be a topic that applies directly to your situation and perhaps offers some valuable perspective on it.

                      

Within our blog archive, topics are posted weekly and titled according to the subject – which should make for quick reference. If upon reviewing the assorted topics you cannot find the subject you require, feel free to contact us and we will be more than happy to respond. Again, keeping in mind that we operate out of the Windsor-Essex, Ontario area, and our perspective is somewhat based on our market. But if we cannot help, we will try to put you in touch with someone in your market who can.

Some final thoughts on commercial property sales, whether you are looking to Sell or

Buy, “Know your market” or better yet, make sure your broker does. Real estate has always been viewed as ‘local’ and the commercial property market is no different. It’s most important to have a clear picture of  the current state of your market – and specifically - price/ft. trends, market turnover, listing/sale ratios, availability of financing, and general inventory levels of like-properties. Again, market data may be harder to find and less readily available than with the residential market – but it’s out there and you need to be up on it.

 

Again, seek out experienced brokers with strong commercial property sales backgrounds to assist in your area – do not go it alone. To see our sales history, click here.

We are moving on – next week we begin a new series on RENTAL PROPERTY INVESTING with a full slate of weekly topics to keep things interesting.

Pricing to Sell...(Sellers Only)

Once the decision’s been made to put your commercial building on the market, the Million Dollar question that arises is – what sort of asking price do we set? In early blogs we’ve discussed valuation techniques, made suggestions relative to interviewing brokers, and even covered the topic of formal appraisals. All of this should have put you in a position of understanding the value of the property.  Now the moment of truth is here and its time to establish a price to market the property at.

Before you do set the price, some final questions worth considering:

Market Turnover – what sort of commercial property turnover rate is your area exhibiting?  How long has it taken to sell similar buildings in your market – on average 2 months, 6 months, 2 years...?

Commercial Financing – is it available through conventional means and at what sort of rates/terms?  Financing a commercial property is generally necessary, and we need to understand all of the options available.

Buyers Market vs. Sellers Market – what sort of market is your area experiencing?  In short, more sellers or buyers, price growth or decline, and general market activity/traffic?

Local Economy – is it expanding or contracting, is unemployment rate lower or higher (vs. national average), new housing starts up or down, and is there population growth? Call this Economics 101 – but you need to be in step with your economic (market) realities.

Competitive Positioning – do you have a competitive advantage relative to competing properties in the market?  Better location, superior building quality, discernable site advantages … giving you the ability to promote better value for your property?

Finally, ‘Serious Buyers’ tend to prefer ‘Serious Sellers’, and vice versa. Your asking price should reflect the fact that you are serious, and that you have priced your property accordingly. Give your asking price careful consideration, in order to put yourself in the best position to successfully sell your property.

As always, consult with experienced commercial brokers within your area in order to determine a ‘Pricing to Sell’ strategy.

Part 2 - VTB 2nds & Risks/Rewards

Generally 2nd mortgages have more risk than a 1st mortgage. For a Seller, the major risk is in the event of default. In a default situation, the equity position of the 2nd mortgage is behind the equity position of the 1st.  At the time of liquidation (either through a Power of Sale or Foreclosure proceeding), any equity would only be realized after the 1st lender is repaid in full (inlcuding any associated costs).  You may also be behind any unpaid property taxes, which have priority and can serve to squeeze your equity position even further.

Enough said on the negative risk side.  There may be a legitimate case to consider holding a 2nd - consider the following:

i) Adequate equity exists in the property to hold a 2nd and at the outset appears 'secure' position wise
ii) For the return it provides - often 2-3-4% higher than a 1st
iii) Property cannot be readily financed any other way - due to its condition, unavailable bank lending, poor market conditions, etc.
iv) Familiarity with the property and comfortable with its value overall
v) Confidence with the Buyer to be able to meet the total mortgaging obligations (both 1st & 2nd)
vi) Possible tax benefits on Capital Gains (see your accountant) and for the cash flow the mortgage provides

VTB 2nds are not the solution for every seller, but there may be sound reasons to consider them in certain situations. Most importantly, do your due diligence with respect to the Buyer - meaning are they a good credit risk, capable of servicing the total debt obligations of the property, have good intentions and the right plan for the property?...

As always, consult with experienced commercial brokers in your area to learn more about the opportunities for VTBs.

Vendor Take Back Financing - Good Idea on Commercial Properties?

Lots of points to discuss on this subject -- but let’s begin by saying a VTB mortgage maybe a good idea for both Buyers and Sellers. In some cases, it may infact be the only way to finance a sale, given the lack of commercial funding available through institutional lending. 

The mechanics of negotiating a VTB are basically outlined in the Agreement of Purchase and Sale.  Meaning all terms are set out – including downpayment, mortgage term/amortization, interest rate, open/closed status, prepayment rights/penalties to discharge (if any) etc.  Other items may include – personal guarantee of mortgage, provisions to renew at the expiration of the 1^st term, and any other special term(s) which may apply.

Why a VTB may benefit the Buyer:

i)                    Typically reduce the soft costs/fees associated with conventional financing

ii)                  Appraisal/Environmental expenses may be avoided

iii)                Terms (interest rate/term/downpayment) negotiated with the Seller

iv)                Ability to improve leverage or allowing to buy a higher priced property

v)                  Easier to finance ‘non-traditional’ or ‘distressed properties’

vi)                Avoid time involved in obtaining institutional approvals (several weeks to months)

vii)              If Open Mortgage (involves no penalties for early pay out)

Why a VTB may benefit the Seller:

i)         Provides a cashflow based on a set rate of return

ii)        Viewed as an investment option for your capital

iii)       Mortgage is held on a property which you have a vested interest in

iv)       May assist in achieving a higher sale price

v)        Can help in deferring capital gains tax in certain cases

vi)       Can help sell properties in a slow market, by built-in financing

vii)      Terms (interest rate/term/downpayment) negotiated with the Buyer

More on VTB mortgages in our next blog - including VTB 2^nd  mortgages , other risk factors for Buyers and Sellers, and remedies for default.

Again, seek out experienced commercial brokers within your market, to best review the prospects for VTB mortgaging options within your market.   To learn more about our experience and background, click here.

Property Survey - Why do you need one?

Seems like any requirement that adds cost to a real estate purchase, is often met with reluctance. Survey costs generally fall into this category - but there importance on the Buy-Side should never be overlooked.  Outside of the actual deed, an ‘up-to-date’ survey is probably the 2^nd most important document a Buyer needs when closing a deal.

Surveys are best described as ‘an overhead drawing of the subject lands' - in this case the property being purchased.  It should show not only the exact property boundaries, but any easements/encroachments/public right-of ways, which may affect the land. In addition, it identifies the exact location of all buildings/improvements on the property, revealing clearly the set-backs from the various lot lines. Other items which often appear include overhead lines, closed alleys, pools, fencing, porches and yard sheds.

Can we rely on an existing or original survey as provided by the Seller?  It all depends on how current the survey is today, and if no significant changes have occurred on the property. If an out-building has been built, fencing altered, building addition, etc, best practice is to order a new survey. Up to date surveys will and should reveal problem issues, which are always best rectified prior to closing any sale. 

Can we opt for Title Insurance vs. a Survey?  Best to ask your lawyer on this one – but in our view, better to have a current survey. Bear in mind that title insurance will be dealing with any problems ‘after the fact’, whereas a survey would have revealed any such problems prior to any sale.  This is only sound due diligence when buying a commercial property and should be viewed as such.

Again, seek out experienced commercial brokers commercial brokers within your market, to best represent your interests in acquiring any property.  To learn more about our experience and background, click here.