Investment Properties. How to Tell if They Are a Good Opportunity.

So, the other day, I had to tell someone that he lost $100,000 of equity on the multi-unit investment property he purchased in January 2022. You might remember that back in the early spring of that year, inflation started creeping in, and the Bank of Canada began raising the prime rate. In 5 months, the rate increased 4 times for a total increase of 2.25%. Everyone who purchased recently was on a variable rate, and their mortgage payments spiked. That's right when this person bought the property. $100k is a significant loss on a $600,000 property in only 2 years.

I've been seeing a lot of investment properties lately. Precovid, before 2020, the Ottawa Real Estate Board would average about 750 multi-unit listings for sale every year. But since then, there have been about 900 a year, with a massive spike in 2021 with 1100. Why the increase? The Covid Market. People saw homes were selling for record amounts, so they put theirs up for sale, too. Knowing a good opportunity, people started converting single-family homes into duplexes and triplexes. While the number of listings jumped, the number of sales dropped drastically. About 900 new multi-unit properties were listed for sale last year, but only about 300 were sold. People aren't buying investment properties right now; the ones buying them only buy the best opportunities. 

So, how do you figure out the best investment opportunities? One of the best ways to compare investment properties is by calculating their Capitalization Rate.

  
It's pretty simple. The Cap Rate allows you to look at 2 properties and know which is the better investment or to compare a specific property to the whole marketplace. You calculate it by subtracting all your expenses from the property's rental income. Your expenses include costs like property taxes, utilities, lawn care, or snow removal; all the costs associated with the property except the mortgage payments. So, once you do the math, you divide that number (called the Net Operating Income) by the property's purchase price. That's the Cap Rate.

For example, let's say Property A has 3 units that bring in $1000 monthly rent each. That comes up to a total of $36,000 for the year. From that, subtract the property's expenses. We'll keep it simple and say there is $1000 in property taxes, $1000 for utilities, and $500 for snow removal, making the total expenses $2500 for the year. When you subtract the expenses from the rental income, you'll get $33,500, your Net Operating Income or NOI. Divide that number by the purchase price of the property. If Property A's price is $335,000, it would be $33,500 divided by $335,000, which equals a Cap Rate of 10%, a pretty good rate.

The Cap Rate is your yearly return on your investment. Property A was purchased for $335,000; the owner makes back 10% of the $335k yearly. A 10% return is better than expected from stocks or a high-interest savings account.

  
Let's create another example; Property B has 4 rental units and brings in $43,200 yearly rent. Its property taxes and other expenses add up to $2400. That means its NOI is $40,800. If Property B's purchase price is $350,000, you get a Cap Rate of ($40800 ÷ $350,000 =) 11.6%.

  

Property A's return of 10% is a good investment, but Property B's 11.6% rate is even better. 

The rate I used when talking to the person who lost $100,000 on their investment property was 8%. That's the average of the area we were looking at. When they purchased the property back in January 2022, the average rate was 6%. The higher the %, the better deal it is for the Buyer. Buyers can now be more picky with so many properties on the market, and they need to be because mortgage costs are higher, taking more money away from their profits.

    
The Cape Rate is one of the best and quickest ways of determining how good an investment is. The higher the number, the better the investment.  

Chris Smith, Broker