Michael Dominguez, investor and realtor, outlines the key calculating methods that buyers should undertake when assessing the value of a property.
The first is the comparison method. If I own a three-bedroom home with two baths in a subdivision, the first thing I should know is what other similar properties are selling or sold for in that area. From there, add or subtract based on key features in the home.If the last three homes all sold for in the $240,000 to $255,000 mark, there is a good chance your property is also valued the same.
The second method of determining value is based on the revenue it delivers. The most common method of calculating that is by CAP Rates. The CAP, or capitalization rate, is defined as the ratio between the net operating income (NOI) produced by an asset and its capital cost or alternatively, its current market value. The CAP rate is calculated annual net operating income divided by cost (or value).
For example, if a building is purchased for a $500,000 sales price and produces $30,000 in positive net operating income (the amount left over after the fixed and variable costs) during one year, then the cap rate is 6 per cent ($30k/$500k).
In 2014, investors in the Greater Toronto Area (GTA) are willing to purchase a property that has a much lower CAP rate then they would have been willing to do in 2010. Specifically, in Toronto, where once 6 per cent was the low number, now I’m seeing deals transpire at rates under 4 per cent. Even in Oshawa, where once 8 per cent was acceptable. Capitalization rates are an indirect measure of how fast an investment will pay for itself. A property with a CAP rate of 10 per cent, the payback is 10 years. At 6 per cent, it is 16.6 years.
Debt repayment, however, is not factored in when determining the NOI. If it were included, the CAP rate would be much worse on a building that had a mortgage versus another that is owned free and clear. The owner’s property financing must have nothing to do with a property’s worth.
Now, let me share with you the importance of consistently raising your rental amounts. For example, if you had a property that can be resold with a 6 per cent CAP rate. If you find a way to increase your rent just $10 a month, that works out to $120 a year. That works out to a value increase of $2,000. Therefore, increasing the rent by $10 a month raises the value of the property by $2,000.
An increase of $100 a month means a property value increase of $20,000. If you have the option of doing a repair to a unit and it would cost you $10,000, you can increase the rent by $100 a month, should you do it? My answer is that not only will you receive the extra rental money, but you have built double the equity in your building.
While some believe these figures only matter when you sell your property, this is not always true. Once you have built enough equity in the building, you can do a bank refinance and get much of your initial investment and/or renovation costs out of the property, while still maintaining a debt to equity ratio that our very conservative banks will accept.
Be careful when you see CAP rates. The listing real estate agent or seller may not be including all of the actual expenses or be using projected rental revenues rather than actual numbers. I can show a 10 per cent CAP in all of my properties if I exclude yard maintenance, property management, basic repairs and waste removal. I can also show a zero percent vacancy rate and tell the buyer it is always rented. However, the fact is that these things exist. Get the numbers they provide, and as you are doing the walk through of the property, look for the renovations and services that are not includes in the operating expenses provided.
Investor and Realtor focused on cash flow generating properties in southern Ontario. Besides adding properties for his own portfolio within Oshawa, Cobourg and Orillia, Michael is building a joint venture team for these markets. As a realtor, with ReMax Jazz Brokerage, he uses those investor mindset skills to make a valued member of his clients' power teams. You can reach Michael at firstname.lastname@example.org and follow him on twitter @durhamhome or on his website http://www.durhamhome.ca/.
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