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Investing in real estate, especially multifamily properties, can be a rewarding venture over the long run. To make informed decisions, it’s crucial to understand essential concepts like the capitalization rate (cap rate) and the potential for rental income growth. This article aims to shed light on the relationship between cap rate and upside potential, which is often misunderstood in the real estate market as most sellers, investors talk about cap rate without mentioning the upside potential in the rents.

The cap rate a definition

The capitalization rate (cap rate) is defined as a property’s net income divided by the sale price. It’s an important metric used by investors to evaluate potential investments. However, the cap rate alone does not provide a complete picture of an investment’s potential. The potential for rental income growth, or “upside,” also plays a significant role in the decision-making process.

When a buyer or multifamily investor perceives substantial upside potential in a property’s rental income, they may be willing to accept a lower cap rate at the time of purchase. This is because the investor anticipates that the property’s net income will increase once the rental rates are raised, ultimately leading to a higher cap rate and justifying the initial purchase price. Of course, achieving this rental growth often comes with costs, such as renovations, which can be a topic for another discussion.

The cap rate and link with upside potential

On the other hand, if a property has limited upside potential, a potential buyer may require a higher cap rate. This is because the buyer anticipates that the property’s net income will not increase significantly in the future, so they need a higher initial return to justify this investment. Thus, as multifamily property owners and commercial real estate brokers, it’s essential to consider both cap rate and upside potential when evaluating investment opportunities. The cap rate alone is insufficient without understanding the potential for rental income growth.

Conclusion

In summary, the relationship between cap rate and upside potential can be described as follows: the lower the upside potential in rents, the higher the cap rate will be; conversely, the higher the upside potential in rents, the lower the cap rate can be.

Understanding the intricate relationship between cap rate and upside potential is vital for making well-informed decisions in multifamily investing.

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

The first focus for any commercial real estate broker when taking on a listing should be pricing properties correctly in order to not miss out on the serious buyers.

The right price is determined by many factors, including of course the asset itself (size, location, comparable other assets available or recently traded), but most importantly on cash flow and the available financing.

While the cash flow is more or less in the hands of the ownership group (maximizing prior to sale), the available loan is always in the hands of then-current economic factors.

In a seller’s market, based on our experience there will be three to five perfect buyers. In a buyer’s market this number drops. Mispricing a property means missing out on these top buyers – investors who should own the building based on their investment criteria and current portfolio.

The difference in pricing from the top buyers to the next group (second-tier, second-best buyers) will be over five to 10 per cent. The third tier of buyers will be even lower.

Why the correct price matters

For example, if a property is worth between $5 million to $5.1 million and is on the market asking $5.15 million, the serious offers will be submitted in the range of the asking price, plus or minus a few percentage points.

Going to market asking $5.5 million or higher means the otherwise interested buyers would not even make an offer – they believe the price discrepancy is too great to warrant the time they would spend running the numbers and going into a due diligence process.

All investors start by doing a quick calculation as to cap rate and price per unit and if this differs significantly, they will disqualify the asset and their interest for the time being.

Now the only attention the listing will get will be from opportunistic buyers waiting for the price to drop into the range of $4.5 million to $4.75 million – or even lower.

The top and logical buyers have already skipped on the listing, as it was overpriced.

The larger the gap between the asking price and the real price the market affords, the worse will be the results for the seller.

In the best-case scenario, the listing will expire.

In the worst-case scenario the seller will tie up the building with an opportunistic buyer who will “nibble” on the deal as they go along, renegotiating at every step, asking for a long due diligence process and wasting everybody’s precious time.

These buyers often have several buildings “tied up” at any given time by simply placing a refundable deposit. They will only close on the one deal they get at their target price and drop the rest.

Hence, sellers should go to market priced correctly – based on then-current market pricing – or skip going to market altogether (hold the asset and focus on increasing the NOI).

2022 multifamily investment recap for Greater Montreal

In 2022 we witnessed a major drop in transactions during the second half of the year. Both the number of transactions and volume dropped 60 per cent in Greater Montreal during the second half of 2022.

Sellers were holding on to outdated pricing, and buyers stopped buying in the higher-interest-rate environment.

Real estate in 2023 is still expected to be a popular choice for investors.

No one really knows where interest rates will be (judging by the behaviour of the world’s central bankers, it seems they don’t know either), yet despite this uncertainty many investors are still looking to multifamily and rental real estate to generate their passive income and build wealth.

If you are a seller in today’s environment, you will sell as long as the asking price is in line with today’s market.

If you are not yet ready, it is best to hold the asset rather than “trying” the market (i.e. listing at the price you want to achieve if this is significantly higher than market prices).

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

In today’s competitive brokerage industry, having a team of individuals with complementary skills is essential for providing high-quality service and achieving success.

However, building and retaining such a team requires careful consideration of various factors, including motivation, complementary skill sets, team dynamics, appreciation, work environment and professional development.

Motivation before skill

When adding a new member to your brokerage team, it is essential to consider their motivation before their skillset. While skills can be taught, if the person doesn’t see themselves in the role for the next five years, you may encounter retention issues.

To avoid this, take your time to determine whether the person’s goals and aspirations align with the role and the overall team.

When building a brokerage team, the end goal should be a cohesive organism that provides a full-service client experience. As such, it is essential to ensure that each team member is committed to the team’s vision and goals.

Hiring “good people”

A common mistake when building a brokerage team is hiring individuals without clearly defining their roles. This approach can result in a team with similar skillsets and missing significant elements required for long-term team cohesiveness.

You can hire “good people” with the right attitude and work ethic, but do determine up front where they fit within the team.

To ensure a balanced skillset, each team member should have a specific role that complements the skills of the other team members.

Appreciation

In a brokerage team, every role is critical to the team’s success. It is essential to remember that every team member plays an important part.

No one should feel undervalued or replaceable. When team members feel appreciated and respected, they are more likely to be engaged and motivated.

To create an environment of appreciation, acknowledge team members for their hard work and encourage them to share their ideas and insights, not only once in a while, but at the very minimum on a weekly basis.

Team dynamic check-in

A team’s dynamics are constantly evolving and regular check-ins are essential to ensure the team is functioning at its best.

Team building exercises, one-on-one meetings with team members and anonymous surveys can be effective ways to gather feedback and identify any areas for improvement.

The goal of these check-ins should be to address any conflicts that arise and resolve them as quickly as possible.

Additionally, it is important to have a motivator/moral supporter within the team to help keep morale high.

Environment

The work environment plays a crucial role in team dynamics and cohesion. In today’s digital age, remote work is becoming increasingly popular and teams can function effectively as long as communication channels are open and accountable.

To ensure a smooth and efficient work environment, encourage daily communication among team members, ideally with each member relating to one another.

Additionally, provide the necessary technological infrastructure to support remote work, such as project management tools, video conferencing and cloud-based document storage.

Sometimes schedule flexibility is a way to ensuring team retention. For example, it may not matter when during the day the marketing person is working on the marketing brochure as long as they deliver within the timeline requested.

If your team members are working remotely, trust them with their work until proven otherwise.

Professional development opportunities

Professional development is crucial for the growth and success of brokerage teams.

While hiring people that fit in their role is important, investing in ongoing training and development opportunities can help team members develop new skills, stay motivated and increase their job satisfaction.

Examples of professional development opportunities include yearly continuing education, mentorship programs or leadership training.

By investing in the professional growth of team members, you will create a team that is more skilled, motivated and engaged.

Retention is key

When you have a good brokerage team in place, it is essential to take steps to ensure their retention. Any shifts in the team can significantly affect team dynamics, morale and loyalty.

To keep your brokerage team motivated and engaged, always show your appreciating for each member; resolve any conflict quickly; be fair with the compensation; ensure all members get a “piece” of the profits when the team over-performs financially and stay competitive with schedule flexibility.

By prioritizing retention, you will ensure that you not only create a successful brokerage team but also retain it for the long term, which is essential for providing consistent and high-quality service to your clients.

Remember, your team is (and should be) your business card.

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. ramona@baronrealty.ca 

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