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The Cap Rate "Bait and Switch" - Don't Fall for It

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Paul Kondakos | 08 Aug 2012, 11:56 PM Agree 0
Nothing better epitomizes the old "Bait and Switch" than the peanuts gang with poor old Charlie Brown running to punt the football being held down by Lucy. Well, we all know the outcome of that scenario. Charlie Brown always ends up on his rear.

Every week I look at dozens of investment properties and it never ceases to amaze me that I still see unbelievable Cap Rates advertised that are WAY above the market norm. Sometimes you get lucky and find great properties below market value, sometimes the high Cap Rate is inversely proportionate to the condition of the property, but more often than not it is a case of a Cap Rate that has been misrepresented.

While the Cap Rate is a metric that is used by many to determine whether an investment property provides an acceptable rate of return, the problem is that there are no real guidelines for determining a "proper" Cap Rate. Some will try to make the Cap Rate look more enticing by not including essentials such as maintenance or superintendent wages.

For instance, I recently came across an investment property with an 8% cap rate in Toronto. This is well above the going rate which is now closer to 5.5%. I had requested the rent rolls and expenses as I always do when a property peaks my interest. As a seasoned investor, it didn't take long to figure out that the Cap Rate was not a true reflection of the properties income earning potential.

When looking at the expense statement of a property, make sure that the following items are taken into consideration:

?Heat (Gas / Electric / Oil)
?Property Taxes
?Property Management
?Vacancy Allowance
?Rented Items (eg. Washer / Dryer)
?Lawn Care / Snow Removal
?Waste Removal

All too often I come across properties that do not include one or more of the aforementioned expenses. In some cases, such as with smaller properties, if you plan to manage them yourself, you can remove expenses such as superitendent and property management. Again, if it is a smaller property you can likely strike waste removal as well as the city will likely pick up the waste at no charge. However, on larger properties, you need to ensure that you have taken all of the above expenses into account. The maintenance expense is routinely left off when determining the Cap Rate, but I have yet to come across a property that has required ZERO maintenance throughout the year.

New investors need to be aware that this is a game this is played quite often. When you see a Cap Rate advertised that is too good to be true, make sure you request the rent rolls and expenses to ensure that all of the above expenses have been accounted, otherwise, it won't be just Charlie Brown that ends up on his rear.

Knowledge is Power. Happy Property Hunting!

Author: Paul Kondakos, BA, LL.B, MBA - Professional Real Estate Investor -
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