CategoriesAdvice

A slowdown in transactions, ‘real’ sellers and the new normal

The loan available against a property is highly affected by interest rates: the higher the rate, the lower the loan available and hence, the more down payment a buyer needs to complete a purchase.

With interest rates rising significantly and virtually overnight at the beginning of the year, we saw two significant and immediate changes in the transactions market.


Market conditions have changed rapidly

The first one has to do with the fact that any apartment building transaction requires preparation.

One must review and analyze the vendor materials; prepare the marketing; and sometimes in parallel, complete the environmental assessment (a two- to three-month delay) without which banks would not lend against the property.

These coupled due diligence items mean that for the vendor who decided to list the property in late 2021, when the interest rates were at their lowest, the spike hit during the listing and marketing process.

This caused some deals to fall through and buyers to backpedal on conditional commitments, and/or reconsider the value of the asset.

Hence, many of the properties listed for sale never traded and/or are currently still sitting on the market at reduced prices (for some, there have been multiple price reductions).

Who are the “real” sellers?

The second change in the market is the immediate identification of “real” sellers versus owners who would have otherwise sold, but do not have to.

“Real” sellers are owners who want or need the asset sold at a certain moment in time (within the calendar year). This could be due to a variety of situations:

– dissolutions of partnerships;

– lack of interest or ability to continue managing the asset;

– changing family dynamics (many rental assets are owned and managed under private family ownerships); or

– financial inability to keep up with rising mortgage payments (for the loans that came due during interest rate spike) and building maintenance costs.

The transactions we see getting done into 2022 involve sellers who understand that neither the seller nor the broker determine the price – it is determined by the market.

The market is always affected by much bigger dynamics than the buyers’ interest in owning investment properties.

The foreseeable future

We believe the current market is here to stay, with the interest rates at the same level now as they were in 2008.

The U.S. Federal Reserve has clearly indicated it plans to continue to fight inflation by keeping the interest rates at these levels or higher. Other central banks need to follow the U.S. in keeping their rates at similar levels in order to avoid currency devaluations.

What this means is the record low “pandemic-level” interest rates we had in recent years are a thing of the past and we are now in the “new normal.”

Both sellers and buyers should get used to these interest rates and focus on increasing the property values by providing more services to the tenants, increasing rents and decreasing the expenses in place.

We remain available to advise on these strategies.

Baron Realty custom-tailors each marketing process, and brings the right buyers based on the asset and vendor requirements for deal timelines. We have generated 5-12 offers on each of the listings we have taken over the last 18 months. *Ask us why; we are happy to talk to you about how to best navigate the current environment to achieve your end goal.

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 Baron Realty. Reach out today!

CategoriesAdvice

Apartment buildings: Fighting rising interest rates

Interest rates are the lifeline of our real estate world. Without the lenders and financial leverage, all investors would have to buy any investment properties in cash, completely removing the whole concept of leverage, ROI and yields from our business.

Real estate ownership is generally a long-term play, however, and an owner will see rates go up and down during the duration of asset holding. Managing the financial aspect of leverage (debt) can make the difference between winning and losing the game of returns.

Currently, the central banks have made the unfortunate decision of fighting inflation by penalizing the debtors and hence we have seen a massive push of rate hikes since last year.

A five-year insured mortgage would have had an interest rate of 1.80 per cent in June 2020, 2.30 per cent in June 2021 and 4.60 per cent as of June 2022.

Not only will these rate hikes cause problems to the cash flow of the borrower, but they will also significantly impact the financing obtained, as the loan amount obtained will be lowered by 33 per cent, which has to be made up by either lowering the sale price or providing a higher down payment.


The solution

How should multiresidential owners combat this rate hike?

The only property owners who will be able to navigate properly in this kind of environment will be those able to increase their net operating income to make up the difference (net operating income is the income left after all the fixed costs like property taxes, insurance, utilities are removed from the gross revenues), since one of the most important criteria that the lenders use when evaluating a property is its net operating income in place.

These solutions that follow will seem very basic to the experienced landlords, yet in our brokerage business most properties that we sell are hardly optimized.

There are three main ways to increase the net income:

Renovations of units

Beautifully renovating one unit and increasing its monthly rent by $200 per month seems trivial, yet this means an increase in the property valuation by approximately $50,000. Repeating this process four times gives $200,000 of increased asset valuation.

Property insurance

Each dollar saved monthly on the insurance bill will potentially increase the property value by $240. This by itself is a 1,900 per cent return on investment annually, and it does not cost anything more than shopping around for the right insurer or the right insurance broker, because there are major discrepancies between insurers in terms of rates.

Energy costs

Energy is an entire other problem we are seeing these days.

The high prices paid by all of us at the pumps are a real problem, but a bigger problem is natural gas prices year-over-year. The average natural gas bill has gone up approximately 25 per cent in 2022 versus 2021.

If the natural gas bill in 2021 for a given property was $20,000, that same property is now going to pay $25,000.

This $5,000 increase in the gas bill means a $100,000 decrease in asset valuation. This issue cannot be left uncorrected.

The owner must know all the energy programs available to perhaps change the in-place heating furnaces to more efficient ones, or learn about the various CMHC energy programs, which are always updated and changed and may provide high benefits to the landlords based on specific situations.

In conclusion

We have seen a significant change in the capitalization rates between 2021 and 2022. However, the capitalization rate is not the only measuring factor in property valuation. The net income of the property remains the most important element.

By doing the needed renovations to the units when they become vacant, by managing the property expenses including insurance and energy maintenance, the prudent property owner will come out much ahead versus those that are not pro-active in our current higher interest rate environment.

More details in an interview with STOREYS: Interview Link 

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 Baron Realty. Reach out today!

CategoriesAdvice

Apartment Buildings – Value not immune to interest rate increase

With the governments “printing” money and the inflation creeping into all aspects of our daily lives, it was only a matter of time before the federal government increased the interest rate to curb the spending. But a lot of people were surprised at just how fast this happened.

Let’s take a fictitious example of an apartment building a broker may have evaluated at $8M six months ago.

Note the down payment requirement changed by more than half a million dollars over the last 6 months, i.e., the buyer would need to have half a million dollars more in non-borrowed funds in order to be able to close this transaction.

Why does this matter? The down payment requirement is key in successful sales. The rate of down payment used to be 20-30%, further increased last few years to 40-50%, and now an almost impossible 60%+. Sure, there are all cash buyers in the market; these buyers know “their value” and will act accordingly (buying at a discount, because they know the majority of regular buyers will not be able to produce or justify the down payment required today).

Vendors need to be aware that in a fast-shifting interest rate market, deals can fall apart at financing stage just because the down payment can increase so drastically from one month to the next. Hence, if a buyer showed proof of funds with offer in October, but had to wait for the Vendor to finalize the environmental report until this April, the same buyer may not be able to close the deal.

Ways to navigate the current market (for Vendors):

  • Hold on to the asset until a significant interest rate decrease happens, to maximize the number of buyers available and willing to purchase. Of course, nobody has a crystal ball as to when this will occur; this strategy can be an issue if the building has maximized its value and is now on the decline, or for private owners who are sellers for different reasons (dissolutions of partnerships, changing life directions, no longer being able or manage the building, etc.)
  • Be prepared with all the documents needed in the sale process, most important of which being environmental reports (which can take 6 weeks to 6+ months, depending*) – without a “clean” environmental report, the buyer will not be able to obtain financing.
  • Watch for deal-delays and know that short delays are very valuable – as long as you trust the buyer has not simply committed to short-delays to tie up the deal with the intention to come and renegotiate the timelines later (buyer reputation is key*).
  • Buyers must be willing to commit in writing (offer stage) to put more down payment than required at offer-time.
  • The value of an apartment building should always be taken as the value today; in a fast-changing world, even the “safest” real estate investment asset class is not immune; if you have an evaluation from 6 months ago, it will surely not be accurate today.
  • The marketing of a property should keep in line with the changing market dynamic. Based on the asset and timing, a bid process, an asking price process or a process of no price (just a range with its respective loan potentials) and “offers anytime” may be appropriate – but the best way to market will be best determined at listing time, not based on the broker’s record from last year*.

Baron Realty custom-tailors each marketing process, and brings the right buyers based on the asset and vendor requirements for deal timelines. We have generated 5-12 offers on each of the listings we have taken over the last 18 months. *Ask us why; we are happy to talk to you about how to best navigate the current environment to achieve your end goal.

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 Baron Realty. Reach out today!

Québec

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

info@baronrealty.ca

Fax : 514 221 2221

Ontario

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

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