Real Estate Talk:
Selling income property

An examination of the selling process for income property

By Joseph Marovitch

April 21, 2022

The price of single homes has skyrocketed, causing people to turn to rentals. Rents have risen significantly due to the highest inflation in years, increased demand, and low supply. In some cases, to maximize income, many landlords have renovated their income properties and combined the consumer price index along with the renovations to increase rents to much higher levels as permitted by the Provincial Government.

However, in some cases, landlords sell either because they are purchasing bigger, retiring, or have had enough of the landlord life.

For income properties of six units or more, buyers are usually required to submit a conditional promise to purchase that must be accepted prior to visits being permitted.

Whatever the case, selling an income property means opening the ledger books, submitting to an inspection, examining leases and expenses, arranging a phase 1 environmental test if one has not already been performed, and disturbing the tenants who pay the rent so potential buyers may see the property. As a note, permitting potential buyers to repeatedly visit tenants’ apartments can be very stressful for the tenants.

For these reasons, in income properties of six units or more, buyers are usually required to submit a conditional promise to purchase that must be accepted prior to visits being permitted. Sellers want to know the price is in their ballpark and the conditions are reasonable and not overly long before opening their books and disturbing the tenants.

The offer must consist of four conditions:

• Condition of first visit
• Condition of examination of leases and expenses and phase 1 environmental test
• Condition of inspection
• Condition of financing

The promise to purchase will also include the price, terms and deadlines.

There are three issues that must be properly managed to sell at the maximum price and avoid issues:

• Pricing
• Income and expenses
• Full disclosure of the state of the property

Pricing

Experienced investors look at the numbers first and for an income property of 6 units or more to be profitable, the property must generate at least 4% or more and/or have the potential to raise income via rents, expansion, or renovation.

Therefore, the selling price must accurately represent a capitalization rate (percentage rate of return) of 4% or higher. The capitalization rate as discussed in our last article is:

Net operating income / purchase price x 100 = cap rate

If the asking price on a 20-unit property is 3.5 or 3.5% return on investment, the price is too high and this property will remain on the market until the price comes down or the income rises. To raise the cap rate, the selling price must be reduced until the property can generate at least 4%, otherwise, the investment is a money-losing proposition unless the property has the possibility of increasing the income via renovation or upgrades that can be passed on to the tenants.

‘… for an income property of 6 units or more to be profitable, the property must generate at least 4% or more and/or have the potential to raise income via rents, expansion, or renovation.’

As a note, pricing a property fairly at a reasonable cap rate generates more offers than an overpriced property and usually creates a multiple offer scenario permitting the property to sell at the higher price possible.

Income and expenses

In the selling process, in order to verify the income and expenses, the buyer must be permitted to examine all the signed leases and all the invoices to accurately calculate the cap rate. No leases or expenses should be missing. By providing all leases and all expenses, the buyer cannot renegotiate the purchase price for the reason that the indicated cap rate is lower than stated in the listing.

Full disclosure of the state of the property

In many cases, sellers of income property do not provide a completed seller’s declaration, and they sell without warranty. Selling without warranty is understandable since the seller does not occupy all the units and can only really account for the structure, meaning roof, walls, basement, foundation, electrical and plumbing to the common areas.

However, in the description of the property that is viewed by potential buyers and/or brokers, it must be indicated if the building requires work since these issues reduce the cap rate. If it is stated, hypothetically, that the roof, balconies, railings, or windows require replacement, these items should be considered when pricing the property and disclosed. In this way, these issues cannot be used by the buyer to renegotiate the price since the offer was submitted knowing these issues were declared.

‘The seller must also examine who is the buyer. Is the buyer experienced and owns many properties? Does the buyer have financial pre-approval? Does the buyer have proof of cash? Is the buyer providing a reasonable deposit?’

Once the property is listed with professional photos and video, at the right price, the seller will receive several offers with prices, conditions, and deadlines. The seller will then peruse each of the offers to find the best price and conditions. The seller must also examine who is the buyer. Is the buyer experienced and owns many properties? Does the buyer have financial pre-approval? Does the buyer have proof of cash? Is the buyer providing a reasonable deposit?

All these questions indicate whether the buyer is financially qualified and serious or are they expecting a long negotiation process that can go nowhere, or perhaps just feeling the water, which sellers cannot afford to accommodate.

Other issues that should be verified before selling an income property that will allow the process to move quicker and more easily are title, zoning, an up-to-date certificate of location, a recent phase 1 environmental test and a recent pre-inspection.

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: Rising interest rates and their effect on the market

State of the market

Many forces are coming together to affect the market. The rate of inflation is higher than ever before, causing household purchasing power to significantly decrease. The bank of Canada has raised interest rates by 1% this year, intending to raise rates further. The Russian war on Ukraine is affecting the supply chain causing slowdowns and rising prices even further and affecting the world economies negatively.

‘… we will see property prices continue to rise as demand has not diminished, but sales to drop as the average buyer cannot afford a property. The few will be purchasing the available inventory at high prices.’

In this situation, we will see property prices continue to rise as demand has not diminished, but sales to drop as the average buyer cannot afford a property. The few will be purchasing the available inventory at high prices. There is no situation where a war and a pandemic offer a good outcome. Let us hope for better days and be proactive to create better days.

Have a great week, and stay safe.

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Feature image: Andrew Burlone

Other articles by Joseph Marovitch