Owning an apartment building or 4-plex can be an exciting prospect, but does one have what it takes to become a successful landlord? Below are 20 important considerations one should understand and discuss in detail with their REALTOR® before embarking on this new and exciting venture:
(1). Have you been recently pre-approved for financing with a commercial mortgage broker and for what amount? Since the recent economic downturn, it has proven to be more difficult for investment Buyers to obtain good levels of financing without immaculate levels of established credit, good collateral, multi-family portfolio, multi-family experience, and significant money down as part of the purchase. Find out whether a commercial appraisal is included or not because commercial appraisals can be over $1000. Ensure any offer to purchase is subject to financing to ensure your financial background is approved and a satisfactory bank appraisal has been conducted before the deal is finalized.
(2). Have you established a company GST number for your company and sought related advice on GST applicability from a certified and reputable tax accountant? Unlike the standard for residential homes, commercial buildings are sold with GST applied extra to the purchase price.
(3). How many units do you want to manage or are capable of managing? Dynamics of tenant and building issues become potentially magnified as the number of units managed increases.
(4). What neighborhoods would you consider for your building and have you obtained information from the local police department on crime statistics for the neighborhood? Buying a property in a neighborhood with low levels of crime will help prevent the risk of encountering tenants or associates of tenants who are criminals, drug addicts, etc.
(5). For any number of units beyond your capability, have you contacted or are you planning to contact a reputable and licensed property management firm to manage your complex? Note property managers in Alberta must be licensed for dealing with tasks such as handling deposit trust accounts; signing tenant leases on behalf of owners; conducting background checks and other screening for tenants; etc. [For more information on the license requirements for property managers, landlords are encouraged to consult a reputable real estate lawyer for advice.]
(6). Have you contacted a licensed commercial REALTOR® (like myself) who is a commercial member of their local Board (e.g. REALTOR’s® Association of Edmonton) and is a commercial REALTOR® with the Canadian Real Estate Association (CREA)? Commercial REALTORS® must meet additional commercial-related education, experience, and performance requirements.
(7). In the event of vacancy loss situations (i.e. tenant turnover or suite upgrades) do you have the cash to carry the mortgage payments without tenant income coming in for short periods?
(8). Do you have experience in managing tenants and tenant-related financial, social, and legal issues? Alberta landlords are advised to review the Alberta Landlord and Tenancies Act and to seek the expertise of a qualified lawyer specializing in landlord / tenant related issues.
(9). Do you have experience with repairs, maintenance, renovations, and construction on commercial buildings? These items are usually very costly and can be ongoing depending upon the age of the structure, amount of upgrades to the structure, the quality of the tenants (i.e. internal damage to suites) and the quality of the neighborhood (i.e. external damage).
(10). Is the building correctly zoned for its use and are there any active re-zoning applications or development permits for this or other nearby properties? After confirming the zoning and its allowable uses, landlords are advised to speak with a municipal planning and development officer to discuss any potential restrictions to present and future uses or modifications with the current zoning that may be related to but not restricted to the following: parking allowances; dwelling (units) congestion; grandfather clauses for older structures; past applications; extra suite permits; encroachments; etc.
(11). Is the property currently licensed for operation in the municipality and as usual part of the license, is there a fire alarm system in place that is functioning and recently certified by the municipal fire department? Fire alarm system components include smoke and heat detectors; extinguishers; fire alarm command box, sensors, lights, pull stations, and / or sirens; adequate levels of access and egress for each suite and for each part of the common area; removal of obstructive or flammable materials or objects; external fire department entry keybox; and various other specific written ordinances (with deadlines) issued by the fire department. If the appropriate licenses are not in place, are there any reasons the municipality is withholding licensing such as for outstanding land use violations, Alberta Building Code violations, fire safety violations, and / or Capital Health violations?
(12). When making a commercial offer for a multi-family building, discuss with your REALTOR® about making the offer subject to due diligence review of documents including a physical inspection of the property. Important documents include but are not limited to the following: financial statements; RPR / Compliance; tenant leases; rent rolls; equipment leases; repair / maintenance / management / janitorial agreements that may or may not be assumed; any past environmental assessment / soil / structural / inspection reports for the property; licenses; etc.
(13). It is important to note that financial costs experienced (and subsequently disclosed via statements) by the current owner may or may not have close relation to the costs experienced by a new owner (with varying levels of experience, business practices, industry contacts for quotations, etc.) For example, some Buyers may self manage (save money) while another Buyer may hire a licensed property manager (save time). Some Buyers may pay mostly or all cash for a building while another Buyer may have low cash and high monthly payments so as a result mortgage payments are not typically included as part of a building’s costs and net income. Items such as property insurance also vary based upon the company and owner volume. As a result, commercial Buyers are advised to decide for themselves how much it would cost them to run a building without placing too much emphasis on how much it costs the current Seller.
(14). Likewise, financial revenues experienced by the current owner may or may not have close relation to the revenues experienced by a new owner once tenant turnover commences. Like real estate markets, rental markets fluctuate up and down and the expertise of the landlord or property manager can have a significant influence (by sometimes $200 or more per unit per month) on how high of rents are achieved and these two factors can cause wide fluctuations. Additional factors include situations where an older landlord has kept the rent stagnant for many years just to keep the tenants happy even though the market would generate significantly more. As a result, commercial Buyers are again advised to decide for themselves the revenue they expect to realize without placing too much emphasis on current revenues generated.
(15). Do the tenants pay their own utilities and is the building separately metered? This is very important when comparing one complex to the next and usually it is much preferred by investors to have separate metering and leases whereby the tenants are responsible for all utilities.
(16). What is the average number of bedrooms and washrooms per unit? On average, with all else equal, two and three bedroom units with multiple washrooms fetch much higher rents and subsequent higher cost per suite than small one bedroom or bachelor units. Other considerations include separate laundry, separate entrances, living area above ground, quality of upgrades, etc.
(17). For a commercial multi-family building inspection, it is very important to hire a certified commercial property inspector who can demonstrate good experience with inspecting multi-family buildings as opposed to hiring an inspector with only residential or acreage experience. Issues related to roofing; HVAC; plumbing; electrical; foundation; exterior; and shared walls between suites are some of the major differences between multi-family and residential and pose different levels of challenges for correct inspection, analysis, repair, and / or maintenance.
(18). Do you have terms (provisions) in your contract that allow you to show the property to prospective tenants and contractors with REALTOR® escort prior to turnover; and provide total control over how any upcoming vacancies must be handled by the Seller prior to turnover? Also, have you ensured that any new tenant damage; tenant damage deposits; assumed leases; move-in inspection reports, etc. will be transferred to you by the Seller upon completion?
(19). Do you understand all common area components including the attic or roof access; utility room; meter room; and / or laundry room? If not, do you need a term that the Seller to provide any instructions and demonstrations as to how any building equipment is operated? Will keys to all suites and common areas be provided to you in an organized, labeled set upon completion?
(20). An important measure to evaluate when comparing multi-family properties is the cap rate which is a function of the net income and inverse function of the total value. As the net income increases, the cap rate increases. At the same net income, as the cap rate decreases, the value of the property decreases. This is a measure of a property’s value regardless of how big or how many suites are in the complex and allow properties with different suite mixes and different types of commercial properties to be compared with each other purely from an investment perspective. Cap rates in the Greater Edmonton Area can typically vary from 3% or less in strong markets and / or for properties that are under-rented (i.e. lots of potential to increase rents) to 5 to 6% for most decent neighborhood properties and good condition properties in a stable market to upwards of 7 to 8% in bad reputation neighborhoods although there is no limit for really bad neighborhoods that can see cap rates on occasion over 10% in slower markets. Note the net income by definition does not include mortgage payments (and for some properties does not include management or other owner expenses) that can vary as Buyers take out different levels of mortgages, obtain different interest rate and amortization quotations, etc. that vary based upon a Buyer’s financial strength and current Bank of Canada interest rates. As a result, each Buyer should figure out their own the level of cash flow based upon how they intend to manage the complex. Note that negative cash flow in the early years of an investment can be made up in later years of ownership if the market improves and if there is potential to increase the rents as time progresses to compensate for any cash flow losses. Other measures include cost per suite but the problem with this measure is that it does not compensate for building improvements; size of the suite; number of washrooms; in-suite laundry; metering; and level of rents (i.e. revenues) whereas the cap rate measure takes into account these factors since cost, revenue, and value are part of the cap rate equation. As a result the cost per suite measurement is for many reasons not as good of a measure of building value as the cap rate. Also ask your REALTOR® about recent past sales and how those cap rates compare with the cap rate being considered for purchase.
In summary, buying a commercial multi-family property is not easy, and nor should it be due to the complexity of risks and considerations involved. However with strong due diligence, attention to detail, and assistance of a good commercial REALTOR®, mortgage broker, commercial inspector, and real estate lawyer, your next apartment buying experience can be a positive and rewarding one.
[Article written and ©2009 by Kelly Grant, M.Eng., ABR, NCSO, P.Eng. - REALTOR® at Maxwell Devonshire Realty in Edmonton, AB]
Disclaimer: for those readers not currently represented by another licensed REALTOR®, to obtain more information on this topic and / or if you are serious about selling or buying in the Greater Edmonton Area, call Kelly at 780-414-6100 (pager) or send Kelly an email to SOLD@KellyGrant.ca to schedule a confidential appointment.