RE investing and ROI/NOI

[cdr108]

I know this has been discussed before but I can't find the posts.

For those that invest in RE for cashflow, what type of return do you look for?

Thanks.

 

[cdr108]

repost of some information from other threads that i thought woulbe be helpful to assemble here:

The intrinsic value of a house is measured by Owners Equivalent Rent, or Rent Ratio, or Income Ratio. Using the Rental Ratio, the typical norm in the US (since little data is available in Canada) is a mutliple of 15....

what would you guess would be TO's historical average 'price to annual rents' ratio?

i found the following article in cnnmoney from Fortune magazine:
http://money.cnn.com/magazines/fortune/price_rent_ratios/

what i found interesting ... the 15-year national average for the US was 16.9; however the 15-year average for New York was only 11.7 !

My best guestimate is 12 for TO average based on prices and rents pre-bubble; and currently sits @ 15 - 16.4.

The Secondary Rental Market Study found that the secondary rental market (basement apartmants and apartments over stores) accounts for the following portions of the overall rental market
35% in the City of Toronto
73% in Suburban GTA

Around the GTA second suites are legal in Toronto, Newmarket and East Gwillimbury, as well as Pickering, Ajax, Whitby and Oshawa and Oakville.
Markham is on the verge of legalizing accessory apartments
Aurora is considering legalizing them.
In Brampton, Mississauga, Richmond Hill and Vaughan they are presently illegal and are not considering them at this time although discussions are ongoing.

I'd say Toronto's would have a variance from 10 to 14 depending on your proximity to (1) the core and (2) to subway and future RT lines; by any of those ratios though, houses are still grossly overvalued (especially the ones that went insane from '02 to '08. Wait till those poor suckers have to retrofit (the historic and older ones) to cope with enormous energy bills in a few years.

As well, the mammoth tax bills. Once you use CASH FLOW you can then gain a valid and sustainable perspective on price. Wait till these homeowners (of grossly overpriced homes) come to grip with retirement income. Holy hell hole Batman!

i found the following article in cnnmoney from Fortune magazine:
http://money.cnn.com/magazines/fortu...e_rent_ratios/

One more thing...I took a look at this link, it is dated Nov 2007. The five year projections have been absoloutely demolished. In the span of a year and a half prices have been crushed almost to the tune of 40%; Meredith Whitney (google her, save me the time) is now forecasting a 50% peak to trough correction in the US.

For the five year forecast to hold, after next year prices will have to rise nort of 40% in the next two years to make the 2007 forecast hold. Ha ha ha, to quote Bart Simpson 'Eat my shorts, dude'...

That cnn/fortune piece struck me as a little odd. Why did they forecast rental price increases to go with the house price declines? I presume they wanted to lighten the blow to readers who are worried about the value of their homes. If they had reported the price drops holding rents constant, then they would have been much larger. Presuming that rents will increase when prices drops is foolish...simultaneous house price and rental price drops can just as easily happen in a severe recession.

Also, are these annual rents net of expenses? It doesn't say anywhere in the methodology. In Toronto, 10 x gross annual rents is reasonable for an investment (rental) property (espeically subdivided into multiple units), but many homeowners pay 15-25 times gross rent for places that only they occupy (no second suite).

First of all, that Fortune article was from 2007. In the midst of a bubble anyone who tried to rationally present a contra arguement was brushed off as idiotic.

Not too disismilar to the clowns on here asking 'So when are condos going to crash?' in a smug view this is not going to happen. Don't mistake timing and non-events. The freaking crash of condos WILL come here. It's going to be sudden, and of cliff diving of epic proportions.

Given that we are clearly in a debt deflaiton environment; this is a balance sheet contraction event; rents will pummel down just as fast as home prices. The unemployment number R4 in Canada and U6 in the States are both approaching unheard of territory post Great Depression.

Rents are not net of expenses, they are gross.

Yes, many here over the last few years have paid multiples of 15 and 25 times gross annual rents. No different than Spain, the UK, US, Austrailia, Japan 1980's, Iceland, etc. etc., soon China included. Will soon have their asses handed to them.

the rent ratio, is a quick and easy way to determine the viability of an investment property. i generally only look at ones that are 10 or better (meaning less than 10). You'll also need to factor in cap (to account for expenses) and roi (or something similar to account for the cost of borrowing). the margins are pretty thin for the rental business. i'm not sure how people do when the rent ratios are greater than 10 or if they reach the average of 15??

 

[Observer Walt]

I'm not quite sure what cabbagetowner means by "rent ratios".

When speaking of income-producing residential real estate (not basement apartments, but things like triplexes and larger), there are two measurements that can be used.

The Gross Income Multiplier (GIM) is the relationship between sale price and gross income, expressed as a multiple of the gross income. Example: Given Gross income $60,000 / yr., and a sale price of $600,000, the GIM would be 10. This multiplier typically ranges between about 8 and 15.

The Capitalization Rate is the relationship between net (not gross) income and the sale price. Net income (often called the Net Operating Income or NOI.) is the gross income minus the operating expenses (taxes, utilities, insurance, etc.) It does not take into account the financing costs (mortgage). The Capitalization Rate (often called the "cap rate") is the ratio NOI / Sale Price. It's usually expressed as a percentage.

Example: Sale price $600,000, Net Operating Income (after operating expenses but before financing costs) $40,000, results in a cap rate of:
$40,000 / $600,000 = 6.7%. The Cap Rate for good residential properties is typically between about 5% and 9% in the current market. This rate reflects risk, and those properties which are considered to be "higher risk" will reflect a higher rate.

The capitalization rate, being a ratio, can be flipped around. Example: You are considering the purchase of the above-mentioned property, which has a Net Operating Income of $40,000. It's listed for sale at $600,000. You want a return of 8%, not 6.7%. You would be willing to pay $40,000 / .08 = $500,000 maximum.

It gets more complicated than that, but that's the basic idea.

Before considering such a purchase, do your homework!

The Gross Income Multiplier is a quick and dirty indicator. It does not take the expenses into account. The Capitalization Rate takes expenses into account, and is therefore a more accurate indicator. It's also harder to calculate, as more information is needed, preferably extending over a multi-year period to smooth out unusual fluctuations in expenses.

 

[simuls]

I believe that cabbagetowner's rent ratio and your GIM are the same thing.

 

[cabbagetowner]

yes. i think i took the term from a previous post. i usually refer to it as the p/e. (financial world).

in addition to the cap and p/e, i also like to make sure that the rents cover all of the carrying costs (including principal payment on mortgage).

there should also be a calculation of your roi. i find it useful to think of it in 2 ways. 1) what is my roi on my down payment.
2) what if i didn't need to finance, is the roi unfinanced better than the rate of financing (including all costs).

 

[cdr108]

the rent ratio, is a quick and easy way to determine the viability of an investment property. i generally only look at ones that are 10 or better (meaning less than 10). You'll also need to factor in cap (to account for expenses) and roi (or something similar to account for the cost of borrowing). the margins are pretty thin for the rental business. i'm not sure how people do when the rent ratios are greater than 10 or if they reach the average of 15??

I'm not quite sure what cabbagetowner means by "rent ratios".

When speaking of income-producing residential real estate (not basement apartments, but things like triplexes and larger), there are two measurements that can be used.

The Gross Income Multiplier (GIM) is the relationship between sale price and gross income, expressed as a multiple of the gross income. Example: Given Gross income $60,000 / yr., and a sale price of $600,000, the GIM would be 10. This multiplier typically ranges between about 8 and 15.
The Capitalization Rate is the relationship between net (not gross) income and the sale price. Net income (often called the Net Operating Income or NOI.) is the gross income minus the operating expenses (taxes, utilities, insurance, etc.) It does not take into account the financing costs (mortgage). The Capitalization Rate (often called the "cap rate") is the ratio NOI / Sale Price. It's usually expressed as a percentage.

Example: Sale price $600,000, Net Operating Income (after operating expenses but before financing costs) $40,000, results in a cap rate of:
$40,000 / $600,000 = 6.7%. The Cap Rate for good residential properties is typically between about 5% and 9% in the current market. This rate reflects risk, and those properties which are considered to be "higher risk" will reflect a higher rate.
The capitalization rate, being a ratio, can be flipped around. Example: You are considering the purchase of the above-mentioned property, which has a Net Operating Income of $40,000. It's listed for sale at $600,000. You want a return of 8%, not 6.7%. You would be willing to pay $40,000 / .08 = $500,000 maximum.

It gets more complicated than that, but that's the basic idea.

Before considering such a purchase, do your homework!

The Gross Income Multiplier is a quick and dirty indicator. It does not take the expenses into account. The Capitalization Rate takes expenses into account, and is therefore a more accurate indicator. It's also harder to calculate, as more information is needed, preferably extending over a multi-year period to smooth out unusual fluctuations in expenses.

Thanks cabbagetowner and Observer Walt ... the ratios and % was what I was curious about.

I've been looking around for a residential investment property but everything still seems overpriced.
Several places in the Annex are getting rent ratios of ~7.5% or GIM of 13.5; but the capitalization rate is ~4%.
It's also those older homes that probably hasn't been fully updated with 20+ year old mechanicals, etc so future cap expenditures are certain.

What would be considered a good capitalization rate for upper annex properties?

 

[iheartproperty]

If your property is in good condition, close to subway and has a stable rent roll of quality tenants then 6% is probably a fair return in today's market. Keep in mind that you won't really see a real 6% return on the cost anytime soon because there will always be unforeseen repairs that will crush your cash flow for months at a time. Plumbing, mechanical, electrical, roof, balcony, underground garage repairs, etc. (all if applicable obviously) are in constant need of repair and the real cash flow is rarely what it's purported to be in the broker's material.

What's your goal with this investment? Small apartment properties in today's market are really priced as stores of wealth as opposed to opportunities for profit. I would be very surprised if a property purchased today would be worth significantly more in 10 years (inflation adjusted) but I doubt you'd lose much money. The Annex, with it close proximity to the university, good transportation and all the great amenities that the area provides should at least maintain it's value, but as you realize you are paying a premium for that likely stability.

Whereas new/presale condos today are virtually guaranteed to drop in value. That's a pure sucker/speculator play. It is a bona fide Madoff scam in another package.

 

[Observer Walt]

If your property is in good condition, close to subway and has a stable rent roll of qualities tenants then 6% is probably a fair return in today's market. Keep in mind that you won't really see a real 6% return on the cost anytime soon because there will always be unforeseen repairs that will crush your cash flow for months at a time. Plumbing, mechanical, electrical, roof, balcony, underground garage repairs, etc. (all if applicable obviously) are in constant need of repair and the real cash flow in rarely what it's purported to be in the broker's material.

What's your goal with this investment? Small apartment properties in today's market are really priced as stores of wealth as opposed to opportunities for profit. I would be very surprised if a property purchased today would be worth significantly more in 10 years (inflation adjusted) but I doubt you'd lose much money. The Annex, with it close proximity to the university, good transportation and all the great amenities that the area provides should at least maintain it's value, but as you realize you are paying a premium for that likely stability.

Whereas new/presale condos today are virtually guaranteed to drop in value. That's a pure sucker/speculator play. It is a bona fide Madoff scam in another package.

I don't know if it's worth my while to respond to this. It's similar in tone to a number of other posts we have had from newbies here.

To correct the impression given in your first paragraph, the Capitalization Rate (cap rate) is intended to take into account all operating expenses, including the repair / maintenance items you mention. Anyone doing their homework knows that mechanical, electrical, roof, and the other things you mention represent expenses from time to time. I reiterate, do your homework. If you are thinking of a purchase, get the financial history of the property, preferably going back three or four years. If no recent expense shows up for these items (which is legitimately possible), you adjust accordingly. Get a qualified inspector to do an inspection of the building, to determine the current condition and the anticipated expenses for the next several years.

I'll agree with your statement that the Annex is a good neighbourhood, for reasons which you have mentioned. I'll also agree that a premium would apply accordingly, ie., a lower capitalization rate / higher sale price than a similar property in a less attractive area. But obviously you can also charge a higher rental rate.

Your final paragraph reflects the thinking of a noisy minority. Condos, and almost all other real estate, have dropped in price since early 2008. Real estate is cyclical, always has been, almost certainly always will be. If you think there is a lot more downside still to come, don't buy, that's all. But don't complain if you miss the low point of the market and are left sitting on the sidelines when values increase, as they will certainly do.

No sarcasm intended, but if the real estate market, stock market, or other cyclical markets are just not to your liking, you would indeed be wise to stay out. Your local bank will be glad to sign you up for a G.I.C. at a guaranteed rate.

 

[iheartproperty]

Thanks Walt. You sound like an appraiser? Are you one? I am a very long term investor with a significant amount of experience with investment property. The point I was trying to emphasize is that at today's prices (yes, even today, in the middle of a severe credit crisis and market contraction almost everywhere on planet earth) investors are still pricing apartment assets in Toronto to perfection with no account for the regular, re-occurring repairs and maintenance that are associated with older, depreciating buildings. You may tour and are hired to consult on these properties friend but I own them and trust me, they break down- often.

When you are contemplating a purchase Mr. Cdr, consider that reality. Talk to owners (you can pm if you are serious) and they will tell you. The brokers and appraisers that prepare the investment offering rarely give a full picture of what a true cash flow statement will look like going forward. I'm not telling you that Annex apartments aren't valuable, but I am saying that with widespread job losses, competition from desperate condo buyers and speculators looking to cover their big mortgages, escalating costs (utilities, new waste levy taxes and other negative forces), the risks are not nearly priced in. Rents have not budged really since 2001! Ask any apartment owner who has been in this game for a while and see if he or she is buying today. More than likely he is holding his cash on the sidelines (or maybe in GICs as the appraiser suggests) waiting for the predictable and eventual correction. The goal is not to not take risk with your capital but to achieve a fair risk adjusted return. They are some amazing deals to be found in America that are pricing risk appropriately and there will be many in our home market soon as well.

 

[cabbagetowner]

Thanks Walt. You sound like an appraiser? Are you one? I am a very long term investor with a significant amount of experience with investment property. The point I was trying to emphasize is that at today's prices (yes, even today, in the middle of a severe credit crisis and market contraction almost everywhere on planet earth) investors are still pricing apartment assets in Toronto to perfection with no account for the regular, re-occurring repairs and maintenance that are associated with older, depreciating buildings. You may tour and are hired to consult on these properties friend but I own them and trust me, they break down- often.

When you are contemplating a purchase Mr. Cdr, consider that reality. Talk to owners (you can pm if you are serious) and they will tell you. The brokers and appraisers that prepare the investment offering rarely give a full picture of what a true cash flow statement will look like going forward. I'm not telling you that Annex apartments aren't valuable, but I am saying that with widespread job losses, competition from desperate condo buyers and speculators looking to cover their big mortgages, escalating costs (utilities, new waste levy taxes and other negative forces), the risks are not nearly priced in. Rents have not budged really since 2001! Ask any apartment owner who has been in this game for a while and see if he or she is buying today. More than likely he is holding his cash on the sidelines (or maybe in GICs as the appraiser suggests) waiting for the predictable and eventual correction. The goal is not to not take risk with your capital but to achieve a fair risk adjusted return. They are some amazing deals to be found in America that are pricing risk appropriately and there will be many in our home market soon as well.

i'm in complete agreement wrt the stagnant rents since 2001. Those were the good days. most people aren't buying markets (unless you're buying futures in hpi) so there are still deals to be made but i think you need a pretty strong stomach to buy a property in a depreciating market.

thanks for your comments iheart, nice to hear from people with skin in the game.