Commercial property investing is seen a viable alternative by many Canadian investors. However, writes Tarun Gupta, a recent announcement from the Bank of Canada has the potential to impact commercial real estate.
No doubt, some of you read the title of this article and thought ... huh?
Well, "market cap compression" is just a fancy term for when prices for commercial real estate continue to rise. The market cap has an inverse relationship to the price/value of a commercial property. In essence, as the price/value of the property goes up, the market cap goes down or becomes "compressed." In the past few years we've seen significant market cap compression in the commercial sector, which is primarily a function of low interest rates coupled with no real alternatives to park investment dollars. The question is, what does this mean for the average investor either looking to buy their first property or their fifth?
1. Look outside of major urban centres
I've always been a major advocate of investing outside of the major urban areas such as Toronto, Calgary and Vancouver. As much as I would love to buy properties in those cities, the cap rates for multi-unit residential properties have reached historic lows and thus don't make economic sense for investors looking for cash flow. Five percent market caps have now become the norm in Toronto. I've even started to see caps as low as 3.5%. With caps that low, your investment property is unlikely to cash flow. Further, when the mortgage resets after the initial term, investors are opening themselves up to signficant risk if and when interest rates rise.
Why look to the smaller urban centres? Because cap rates in the smaller urban areas tend to be a percentage point or two higher than their more densely packed counterparts. That's not to say that all smaller areas are created equally. Investors need to focus on the key metrics to find the right place to invest which includes GDP Growth, low unemployment, low vacancy rates, population growth, etc... Smaller cities that investors should be looking in include, but is not limited to, Kitcher/Waterloo, Guelph, Cambridge, Hamilton, Durham region (Pickering, Ajax, Whitby, Oshawa) and Kingston.
2. Watch the bond markets
The bond markets are a critical metric and commercial investors need to keep an eye on them as they are used to establish the ultimate cost of funds (mortgage rate). Over the past 30 days, the Canadian bond markets have seen a significant increase in bond yields which will ultimately place upward pressure on commercial mortgage rates. In the longer term, if the movement in bond yields proves to be a trend and not just a blip, market cap compression will begin to reverse as cap rates have a close correlation to the cost of funds. Investors need to be weary in the short term that they aren't buying commercial properties today based on the recent trend of extremely low cap rates and getting financed at the new higher mortgage rates.
3. Lock into longer terms
With mortgage rates at historic lows, even with the recent run in the bond market, locking into longer term rates such as 5 and 10 year terms will make economic sense for most long term investors. This type of certainty allows for predictable cash flow and signficant mortgage paydown during your mortgage term. More importantly, it significantly mitigates the risk of rising interest rates.
4. Ensure you have a healthy spread
The key to profitable investing is to ensure that you have a healthy spread (the spread is the difference between the market cap and your cost of funds). Market cap compression in the larger cities such as Toronto have all but squeezed the spread in most cases to zero. To illustrate this point, the average 12-plex in Toronto has a cap rate of approx. 5%. The cost of funds for this type of property are typically between 4-5%. In essence, there is almost no spread, which means that the investment property is unlikely to cash flow. Even worse, the investor could be in a negative cash flow situation having to pull money out of their pocket every month. I personally like to work with spreads of 2.5% to 3% to ensure healthy cash flow and to provide a buffer should interest rates rise upon rate reset.
5. Be weary of too much leverage
Real estate investing and leverage go hand in hand. In fact, without leverage, most real estate investors wouldn't exist as they wouldn't be able to pay for their property entirely in cash. As much as I love leverage and have used it extensively to make significant gains, it must be approached with extreme caution. Basically its the old adage ... too much of a good thing. While taking on large amounts of leverage/debt may seem like a great idea now that interest rates are at historic lows, one must keep in mind that in all likelihood, when the mortgage resets in 3, 4 or 5 years from now, on a balance of probabilities, mortgage rates will be significantly higher than they are today. If you are overleveraged this can pose a significant problem with your cash flow and your ability to service your debt. As a rule of thumb 65% to 75% LTV, in a longer term (5 or 10 year) are usually a pretty safe bet.
Paul Kondakos, BA, LL.B, MBA - Professional Real Estate Investor - RealtyHub.ca
A deck is a great investment with the potential to pay off for investors looking to sell as well as those looking for tenants. In fact, those summer locales can increases a property's usable living space at a fraction of the cost of adding an inside room. Estimates are a properly maintained deck will return about 77% of its original cost. But, no one wants to buy a home where they are going to immediately incur costly deck repairs. Here are essential tips for caring for that deck from leading home inspection company Pillar To Post.
• Deep Clean: This is best done on a cloudy day before the weather gets too hot. Start by sweeping the deck and removing debris that’s trapped between the deck boards. A putty knife is great for this. You can attach it to a pipe or dowel rod so that you don’t have to bend over the entire time. Then, wash wood decks and all railings with a standard deck cleaner. You can also mix bleach and water at a ratio of one-to-one. If you have composite deck, make sure you use a cleaner specifically formulated for composite material.
• Seal the deck: This should be done 48 hours after the deep clean. You can test if your deck needs sealing by splashing some water on it. The water should bead up. If it soaks into the deck, you need to reseal it. Most decks will need to be resealed annually.
• Inspect and Repair: In the warm, dry summer months, inspect the deck for signs of rot. This is easily done by poking a flat-blade screwdriver into areas that look worn. If you can push the screwdriver more than a quarter-inch into the deck, you should repair it. Small areas, anything about an inch or smaller, can be chiseled out and treated with wood preservative. If the rot covers a larger area, you should consult a professional to evaluate the deck and recommend repairs. Also, you’ll want to tighten any screws that are loose on the railing and add galvanized lag screws to posts that need extra support.
• Preventive measures: Before winter comes, secure or replace loose and missing nails. Trimming back bushes near the deck will prevent mold, moss and rot. Moving planters, chairs, tables and other items that are on the deck will prevent the deck from becoming discolored.
Founded in 1994, Pillar To Post is now the largest home inspection company in North America with over 400 franchisees, located in 47 states and 8 Canadian provinces. The company expects to open a total of 75 new locations by the end of 2013
It`s understandable that new property investors are generally also new to property management. It's also understandable that CREW online -- courtesy of award-winning real estate professional Shannon Murree -- would provide them the ultimate tip sheet for mastering both.
Do Your Homework!
One of the top tips and advice to give a new real estate investor, or those of you starting out, is to do your research! Whether it’s a single or multi-family home, don’t cut corners when getting into the investment game. It’s important to know what the expectations are for landlords and tenants in your area and jurisdiction.
Laws vary from province to province and when you’re first starting out, even though it can be overwhelming initially, do your research because otherwise trial and error could be extremely costly.
Whether you choose to self-manage or hire a property manager – you’re going to be on the hook. Even if you hire a property manager, be involved, don’t be afraid to ask questions and ask to be bcc’d on correspondence or have status reports until you’re comfortable and gain more experience.
Afterall, you’ll need to manage your manager. Everything he/she does impacts you directly and at the end of the day, “I didn’t know” when faced with a fine for violation of a bylaw is not a plausible defence. Your name, as landlord and owner is on everything. Failing to do so, you’ll get out of the investment game quickly and not have given yourself a fair shot.
If hiring a property manager, rely on referrals and not just a company's website or a convincing Kijiji ad applauding multiple years of “combined” service in the industry. Most importantly, find out whether the principals and representatives in the management company are themselves investors.That makes a difference.
Shannon P. Murree is a sales representative and property manager with RE/MAX Chay Realty Inc. Brokerage, and Canadian Real Estate Wealth's Top Real Estate Agent of the Year, 2013.
Arrgh! Yet another rule change. New lending guidelines – and even rumours about new lending guidelines -- can really affect investors and regular consumers, alike. Let me explain.
As Centum mortgage broker and CREW columnist Dalia Barsoum points out, investors can't afford a single misstep in today's increasingly complex lending environment.
Vendor Take Backs (VTBs) may be back in vogue, but mortgage brokers and industry experts are warning buyers of the pitfalls associated with this financial arrangement.
Maybe it’s just me, but it seems like everyone is talking about real estate investments these days, especially in Toronto. It’s likely due to the unrelenting volatility of the capital markets. But, let’s leave the reasons for another time and story. Today, I want to talk about the tools that we use to measure real estate investment, and why there may be a better way than "cap rates."