cap rate, res and commercial

[joncnca]

from reading about it, i think cap rate is much more useful with a commercial rental property with multiple units, where you actually get a substantial rate of income. i've got two questions:

1. how is this even possible in the GTA (including burbs) area? a common hypothetical example i read about is, you bought a $100,000 and your NOI is $10,000 per year, that gives you a cap rate of 10%. i guess $10,000 is kind of reasonable, about $833 per month....so if you own a few units, might be able to scrape that together after expenses. but where can anyone find a multiple unit rental for $100,000??? such a property would have to be upwards of $1,000,000, which for the same NOI, drops your cap rate to 1%. This seems more realistic, but pretty dismal, no? is the cap rate even a good measure today with RE prices here, or is there simply no where in the area that works as a rental property.

now i'm sure i'll get a response saying how this is why property managers are selling and getting out of the rental business cause it doesn't make money...one alternative is that housing prices must fall. maybe. and furthermore, this could take many many years, who knows. does that mean people just can't make money on rental properties and will have to wait it out or give up OR* does it mean there needs to be some kinda paradigm shift, to account for the high prices, to somehow find a way to make rentals profitable again even at higher prices?

2. is the cap rate at all appropriate for residential rentals, for instance, 1 unit in a condo. now your expenses don't get shared among several renters (i.e. potential lines of income), which reduces the NOI. in fact...unless you put down a substantial down payment (and i imagine for investment properties, you want to put down as little as possible to be profitable), your NOI is going to be basically nothing.

let's take a 250,000 condo for example...kinda typical just north of GTA. put down 20% or 50,000, get a mortgage for 200,000. stuck some numbers into the mortgage calculator at canequity (5 year term, 3.29% fixed..yah it'll probably go up, 25/35 amort), and this gives you a monthly payment of about 1000 per month at 25 years, and 800 per month at 35 years.

aside: does NOI include property tax?

anyway, take 1000 mortgage, plus about 300 in condo fees, and you're basically running into the current average rental prices of about 1400 per month. this leaves you with an NOI of 1200 (25 years amort) or 3600 (35 amort). this then gives a cap rate of 1200/250,000 = 0.5% or 3600/250,000 = 1.4%. this means it could take you 200 years to get your money back!! (i'm laughing and crying at the absurdity and reality of the situation) does this even make sense, and i didn't even include for maintenance, legal fees, and vacancy...

can someone who's done this give me a real life example of a rental property (single or multi-unit) that makes money, the cap rate, and the year in which it was purchased. also, my understanding is that cap rate is calculated using the current value of the property, not the purchase price.

with these numbers, i feel like NO rental units make money at all, unless it's VERY cheap, and rent is on par with other areas that are nicer. again, a real life example is very much appreciated!

[Dmoney]

Cap rate is calculated pre-financing.

At the moment, res are going in the ~5% range in Toronto, but single family conversions can be as low as 3.5%-4% (banking on price appreciation)

The bigger the spread between interest rates and cap rates, the higher your profit potential.

Also, factor in equity paydown into your calculation of ROE and your numbers look a bit better.

[Berubeland]

Jon you are right.

A cap rate properly calculated will project how much money you are going to make if everything goes right. Cap rate also includes some things rarely seen now a days in "projections" such as vacancy, capital improvements, maintenance etc.

Every single larger landlord I have worked for has sold. EVERY SINGLE ONE. These are professional landlords and big deals. These are really smart savvy guys and they're ready to buy "When prices reflect reality"

The buildings I manage now barely break even. The owner can't buy a chocolate bar with what's left over.

There are a lot of buyers in the REIT space. There's bloated with cash from the STOCK MARKET.

Ironic isn't it?

Things are going to get worse before they get better. It makes me sad to say it.

It's kind of like watching a friend buy a 1980 ford escort for $5000. You just know it's not going to end well.

[joncnca]

who are these larger landlords selling their properties to? and are there smaller landlords (e.g. 1 unit in a condo) also doing this, and who are THEY selling to?

might sound trite, but it seems like smarter people will make money off of less informed people, sometimes irrespective of whether or not the numbers make sense...

[andrewf]

Larger landlords are selling to apartment REITs. Smaller ones are selling to clueless specuvestors.

[Just a Guy]

Any time you try to calculate a number, people will fudge them to get the number they want. You have to do your own calculations, not take someone else's.

As for selling out, I agree, the Capital gains are ridiculous, the prices are too high, it's tempting to sell out, and wait a few year then get back in. The market is in a bubble, you generally can't make money on anything in the past few years. Those who do have been in the market a long time, pre-crazy valuations.

I've seen a few speculators get burned over the past few years, it's opened up a few opportunities, but then you get the finance minister setting stupid limits, courts siding with tenants, and those tempting capital gains to lock in...tough choices.

[HaroldCrump]

then you get the finance minister setting stupid limits

What do you mean? What stupid limits?

[joncnca]

with all due respect, anyone actually have first hand experience? otherwise, we're all just speculating here, the blind leading the blind.

i also suspect that anyone who actually has found a good deal, and i'm sure they're out there, even in this climate (although i don't fully believe that ALL of the GTA is in bubble territory with low/mid-single digit annual increases), would be unwilling to share such information on a public forum...just a thought.

also, anyone have thoughts on my 'paradigm shift' comment? maybe the world of the future is one in which people are more tied to debt than ever before. just one of those realities, like declining CPP benefits, conversion of DB to DC pension plans, the probability that gas will never again be 45 cents per litre...

i'll give an example with one of my hobbies. last year when the floods in thailand wiped out a good chunk of the world's computer hard drive suppliers and the price of hard drives more than doubled within a week. everyone was complaining about how the price was too high, but one person made what i thought was an interesting comment: he said that the price wasn't too high, it was higher than prior to the flood, yes, but the higher price was the new reality, and in effect, the new 'higher' price was the new 'normal' price.

over the past year there's been some relief as some of these manufacturers have come back online and increased supply, but i think the concept is telling of this type of phenomenon, which is repeated in many different ways that affect our lives.

[canabiz]

Bumping up an older thread: We are looking at a property with cap rate of 4.5% (taking into account vacancy and maintenance) in the Ottawa area and I am just wondering if any of you here knows if this is acceptable for Ottawa or does the rate vary by neighbourhoods and type of dwelling (condo vs. town vs. multiplex)

[andrewf]

My understanding is that the Ottawa market is softening... why not wait a year and see what prices look like then? 4.5% seems pretty mediocre to me.