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How to Avoid Killing your Net Operating Income: Apartment Buildings

The NOI (or net Operating income) is what the buyers use to determine the maximum price they would pay for an apartment building. The higher the NOI, the higher the price, as per formula (GROSS INCOME (rent and ancillary) – ALL EXPENSES = NET OPERATING INCOME). It is basically the cash in the owner’s pocket at the end of the day. NOI is “normalized” by buyers, especially the sophisticated ones, therefore private-ownership savings may not be applicable to boost NOI (i.e. an owner who takes care of its own janitorial will not have that expense removed from the calculation of NOI by any purchaser, rather this expense will be included at market rates or, at the buyers’ standard operating expense rate in the case of sophisticated buyers).

In today’s market, what are some of the expenses that could seriously hurt NOI?

Building Insurance

We have seen this go up quite a bit in the last year or so, mostly because of the replacement cost which is part of any standard insurance (should building need to be reconstructed, and founded in the reality that construction costs have risen substantially over the last 5 years). Shopping around ahead of your policy renewal is key. Here are some numbers for perspective: A client of ours was able to reduce the insurance bill from $18K to approximately $10K per annum ahead of renewal, by switching insurance companies. Total value-add: $160,000 increase in asset value! There are still insurance companies out there that will surprise with a much lower rate, and when it comes to selling or refinancing, a few thousand dollars in expenses will make a huge difference in returns/loan available.

Ancillary revenue miss

Many times an owner does not maximize the potential for additional revenues such as parking, storage, and others. We had a client who did not have parking agreements with the tenants and was charging the same amount for indoor as for outdoor parking, losing $30/spot per month in potential revenue. Based on our calculation for the NOI impact, this translated as an approximate $600,000 in building value! This was great news for the buyer, but what’s surprising is that the ownership group did not even realize the impact was going to be “significant” on what they considered a minor variance.

Retail revenue miss or not actualized

Having a retail component in an apartment building completely changes the underwriting of the asset. Key differentiator is the inability to obtain a CMHC insured loan; however, even leaving this aspect aside, not actualizing retail revenue can render the building unsellable (or sellable only at a significant discount). Even if you have “enough” revenue from the apartments, do not keep the retail empty if you are planning to sell or refinance in the next 12 months.

High expenses from old equipment

You may be on the fence regarding spending thousands of dollars on a new furnace, but how much asset-value are you losing by keeping your existing one? As the energy costs seem to approach infinity, your NOI will reflect heat loss from an inefficient furnace, old windows, and improper roof. A hard winter will have a significant impact for the asset value the following year as buyers typically review expenses for the last 6-12 months in their underwriting.

A market underwriting of your building can help identify missed revenue sources and other NOI killers.

Before Accepting an Offer

  • Ask about the buyer’s track record of closing transactions
  • Request to see Proof of Funds for down-payment (assume 30-40% of price)
  • Re-evaluate conditions and delays
  • Find out if the buyer has to raise money to make the deal happen
  • Clarify if the buyer can renege on the deal without consequence to them after your selling power was “on hold” during their conditional period
  • Know that if your offer falls-thru this will raise a question mark in the mind of other buyers and potentially impact the sell-ability of the asset.

We only work with proven buyers, who generally can put forward offers that are not conditional on financing.

Baron Realty specializes in matching buyers and sellers of apartment buildings. Ramona works in partnership with Mikael Kurkdjian and a team of real estate professionals to bring the best boutique-brokerage services to the apartment transactional space in Ontario and Quebec.

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Increase Your Net Operating Income: Apartment Buildings

Having traded apartment buildings for over a decade, we’re still surprised at how many investors misunderstand the concept of NOI and its impact on the sale or refinancing of an asset.

What does NOI mean?

An abbreviation for Net Operating Income, NOI is the Gross Income from an apartment building (including rent, parking revenue, laundry revenue, etc) minus the expenses required to run the building.

Why does a seller care about the NOI? Because, in a sale, the purchase price is going to be compared to the NOI, and a Cap Rate determined. If the ratio between income and price is substantially poorer than is being seen in other comparable transactions, the buyer may not accept the price being demanded.

Cap Rate = NOI / Purchase Price

It follows that the higher the NOI, the higher the potential Purchase Price.

Why does a buyer care about the NOI? Because the higher the NOI, the higher the loan available for the property, and hence the lower the down payment the buyer must contribute to the purchase.

We see a lot of investors and owners focusing on the “wrong” way to increase the NOI. The big caveat in calculating an asset’s NOI are: the words “required expenses”. Some owners erroneously believe that cutting expenses by either reducing the building’s services or by performing the services themselves, will automatically count toward improving the NOI. While that is true for their own bottom line profit, it is not true in a sale or refinancing scenario. The buyer (and especially the lender), normalize expenses. This means, they use industry standard expenses in their underwriting.

We know an owner of a 100+ unit portfolio who, on snowy days, would flag down a passing snow plow and offer the driver cash to quickly plow around his buildings. His expenses excluded what would otherwise be a $12,000 per annum snow plowing contract; however, this doesn’t mean the buyer, or the lender, would also leave this expense off their pro forma.

While seeing the NOI’s relationship with revenue and expenses may be easy, we encounter many owners who mis-allocate capital before a sale. How so?

Capital improvements should be performed with a strategy in mind

For example, take an apartment building where a new roof will cost $120,000. If the building owners were planning on holding the building to sell it in 10 years (or more), this $120,000 could be amortized over the lifespan of the roof but simply maintain, not improve, the value of the asset.

However, if the building owners were planning to sell within a year or two, that same capital should be deployed in some other way to improve the building’s NOI.

For example, if the building had an aging furnace, installing a new fuel-efficient heat plant could have a tremendous impact on NOI, and hence asset value. A $60,000 furnace could save 20% of a $45,000 annual gas bill ($9,000). If the sale occurs at a 5% cap rate, that $9,000 improvement to NOI results in a potential $180,000 increase in value ($180,000 = $9,000 / 5%).

Another way of spending the $120,000 could have been to renovate the kitchen and bathrooms in say 5 apartments. If the average unit now rents at $200 more per month, some $240,000 in building value may have been realized ($240,000 = $200 x 5 x 12 (months) / 5%).

Owners who are positioning their asset for sale should not assume that all savings on operating expenses in their buildings will necessarily equal an increase in NOI and therefore building value. Instead, the best strategy is to allocate capital such that it influences either reducing expenses permanently, or increasing revenues.

Note: the cap rate used in this article is for example and simplicity purposes. The cap rates vary across the country based on location, asset type/size and several other factors.

Baron Realty specializes in matching buyers and sellers of apartment buildings in Ontario and Quebec.

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Baron Realty - Brokers in Canada, Ontario, Quebec, Toronto, Montreal

Flushing the Highest Priced Offer: Apartment Buildings

During these uncertain times, as we are approaching the end of 2020, apartment buildings for sale in Ontario and Quebec are still few and far in between; in fact, apartments have become the most coveted asset class, because people can’t (yet!) live online.

The Bid Process

We have been successful in a few dispositions this year, and almost all of them involved a “bid process”. During a bid process, an asset is presented to the market, and a future date is set for reviewing offers. The “market” can be the market at large, or, the brokerage database of proven buyers, or, the most logical buyers for the asset – all dependent on what the building, and the vendor’s comfort level of exposure (owners of apartment buildings are often notoriously discreet). The offers can come on a template requested by the vendor (certain conditions), however, vendors must understand a buyer can still submit an offer, and the broker, under the listing agreement, is obligated to present it to ownership group, irrespective of its price and conditions. Of course, most buyers are serious about acquiring the building and will follow the instructions laid out, but some do not. Vendors are always free to reject or ignore any, or all, received offers.

Baron Realty’s Bid Process

Our bid date process involves analysis of current and potential NOI, analysis of rental upside and demographic trends for the area – all facts of the ultimate sale price, as well as projected building refinancing for the ultimate buyer. A tour of a few apartments and common areas is also agreed to by most vendors for proven buyers that have downpayment proof and/or an indisputable track record. The potential buyers often receive verbal price guidance (as per Vendor’s instructions). When offers come in, they are generally close together in price, giving the vendor the opportunity to have confirmed the market, as well as counter the offer that has the most favourable conditions. We generally present 5-10 offers during a bid process.

What if there are outlies?

Those one, or two offers that stand way above the rest in terms of price? Caution and deeper analysis are required. Sometimes the non-serious buyers are easy to identify: it’s the buyer that calls and says “I don’t have the time to see the building, put in the vendor’s price expectations, 3 months to finance, and 3 more months to close”. This is a buyer who is looking to tie up the building and raise the funds later, and/or renegotiate the price after a building tour/inspection (after all the other offers have gone away).

Things to Consider

Some other times though, it is the more subtle than that. Here are a few elements that you should consider in reviewing an outlier:

  • A long closing date – this should always be a red flag as to the funds that are available and the intention of the buyer to renegotiate the price in the future. Time is always against deals and the longer it takes for a transaction to close, the less likely it is to close.
  • No financing condition, yet the buyer refuses to agree to provide proof of funds – the gap between financing and purchase price has widened so much over the last 2 years or so, that the downpayment requirements have gone from approximately 30-35% to 50%+. This means, that for a $6M purchase price, the buyer would have to show a bank account balance of $3M.
  • A condition to visit ALL apartments aside from the inspection – there is no reason for a buyer, after doing an initial tour of 2-3 apartments, to request this as an additional inspection to the inspection clause. This probably means the buyer is looking for defects that he can point out in order to renegotiate the price, even before his certified inspector has been mandated.
  • No “time is of the essence” clause – legally, in offers without this condition, acting outside the specified delays has been sometimes proven acceptable in court. This is why, “time is of the essence” for delivery of deposit, or proof of funds becomes key to be able to move on to the next offer should the accepted one not work out.
  • Buyer’s refusal to provide a deposit – we have heard an “you know who I am, so I’m not providing a deposit” once on this one. The Vendor decided to accept this argument despite our advice. The buyer was ultimately unable to come up with financing as all of his many buildings were maxed out.

Be Aware

Be cautious of buyers who stand above the rest if you have done a proper bid process. The market decides the price based on many complex factors, not just NOI and location, but buyer confidence, banks willingness to finance, available cash, even current politics. If you have a current direct deal, look at it from more than just a legal perspective, to determine the true intention for closing. Generally, when a vendor “cleans up the offer” with proper conditions and delays in a counter-offer, the outlier simply “goes away”.

Baron Realty specializes in matching buyers and sellers of apartment buildings. Ramona works in partnership with Mikael Kurkdjian and a team of real estate professionals to bring the best boutique-brokerage services to the apartment transactional space in Ontario and Quebec.

Work with us. Contact Baron Realty Today!


Baron Realty / Immobilier Baron
400 – 6500 Transcanadienne
Pointe-Claire, Québec H9R 0A5
Telephone: 514 932 9000

Fax : 514 221 2221


Baron Realty, Brokerage
303-225 Duncan Mill Road
Toronto, Ontario M3B 3K9
Telephone: 416 301 3931

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