Real Estate Talk:
Income property /10

The selling process for an income property

By Joseph Marovitch

March 13, 2019

The best investors of income properties, meaning residential apartment buildings of six units or more, rarely sell. An income property with a cap rate of 5 or higher is like a fixed income bond – it just keeps steadily providing income in the form of rent.

Instead, they hold the property, refinance the property, meaning borrow against the property, and purchase more income properties to increase a growing portfolio.

If an investor decides to sell an income property, there are usually two main reasons to do so:

1. The owner is retiring, needs the equity and has no one to pass the property to.
2. The owner wants to sell a smaller property to purchase a larger property: as an example, selling an eight-unit building to purchase a fifty unit building.

An income property with a cap rate of 5 or higher is like a fixed income bond – it just keeps steadily providing income in the form of rent.

To determine the price of an income property, the seller must consider the capitalization rate, location and state of the market.

The cap rate, as discussed in the article Income property, is the return on the investment which is determined by dividing the income after expenses into the purchase price and multiplying the number by one hundred:

Net income/purchase price x 100 = Cap Rate
or
$50,000 net income / $1,000,000 purchase price x 100 = 5 Cap Rate

A number of 5 or higher would indicate a property that can generate income after expenses.

If the seller is indicating a cap rate of 5 or higher, the expenses must be accurate and the asking price should reflect the condition of the property, should the buyer have to do repairs to the roof, balconies, windows or other areas.

The price can be higher and the cap rate lower than 5 if there is a possibility to increase the rents, if supply of vacant apartments is low, or the property can be expanded such as building an additional floor.

The marketing process includes insisting potential buyers provide a promise to purchase that is accepted by the seller prior to a first visit. This ensures the buyer is within the price range the seller is asking. There is no reason to disturb tenants with a visit, show the entire building and provide expense invoices and copies of leases if the buyer and seller are far apart in price.

Buyers are protected by conditions they place in the promise to purchase as indicated in the article Income Property Purchase Promise.

‘The marketing process includes insisting potential buyers provide a promise to purchase that is accepted by the seller prior to a first visit. This ensures the buyer is within the price range the seller is asking.’

In Montreal, cap rates of 5 or higher of property that is new to the market tend to generate multiple offers, therefore the seller would examine the offers for the best price and conditions and then choose the offer to accept that has the most chance of coming to fruition.

Following acceptance, the seller would allow a first visit followed by a review of leases and expenses, followed by an inspection. If there is a finance condition, once the mortgage is approved, both buyer and seller go to the notary and finalize the sale.

Should you have questions or comments, please refer to the comments section at the bottom of the page. As well, to view past articles, click here.

Next article: Certificate of location

REVISION OF THE ARTICLE DATED NOVEMBER 8, 2018 ENTITLED THE INSPECTION PROCESS:

The inspector should be trained, experienced and certified by the Canadian Association of Home and Property Inspectors (CAHPI), the Association internationale des inspecteurs immobiliers certifiés du Québec (InterNACHI Québec), the Association des inspecteurs en bâtiments du Québec (AIBQ), or the National Home Inspector Certification Council (NHICC).

STATE OF THE MARKET

According to the CMHC (Canadian Mortgage and Housing Corporation), new construction of single homes decreased over the past year. Income property construction, on the other hand, has increased as more and more people are deciding to rent. Rising single home prices combined with stringent mortgage lending rules have been a deciding factor in opting to rent. For the young or retiree individual or couples who rent, this means more liquid cash available.

For income property investors this means full occupancy and increased rents for new tenants as demand increases. An increase in demand to rent as new construction single homes decrease also means income investors who wish to sell can sell with lower cap rates.

Image: Andrew Burlone

Read other articles by Joseph Marovitch