Deal Analysis - Canada

3 Replies

Hi everyone,

I live in Toronto, Ontario, and I'm looking at a transaction. I was hoping I could get some help from the folks on this site. It's going to be a bit of a long-winded article, so please bear with me. Thanks in advance for everyone's help.

I've come across a potential deal in a mid-sized Ontario with about 150,000 people, and relatively stable economy/population (hasn't moved since 2000, but it's not declining). The city is not in driving distance, so I need to commute up there for the deal.

I have come across a 3-storey, walk-up apartment building that's for sale. The building is listed at $850K with 13 units (4 x 2 Bedroom @$790 per month, 7 x 1 Bedroom @ $640 per month, 2 x Bachelor @$450 per month). There are two units which are currently vacant - a 2 bedroom unit and a bachelor unit.

The basic pro-forma I've assessed is as follows:

4 x $790 x 12 = $37,920

7 x $640 x 12 = $53,760

2 x $450 x 12 = $10,800

PGI: $102,480

Less: Vacancy @ 15% = ($15,372)

Less: Management @ 10% of EGI = ($8,711)

Less: Property tax (2014) = ($15,000) - Includes trash

Less: Utilities (2013) = ($12,000) - Hydro charged back for almost all apartments; these are heating costs (it gets very cold up here in the winter, and hot in the summer)

Less: Insurance (2013) = ($3,000)

Less: Maintenance & Misc. = ($7,500)

Less: My costs to travel back & forth ($3,000)

Realistic NOI in year 1 =~ $38,000

Implied value at 7% cap = $543K

Implied cap rate @ $850K = 4.5%

What needs work in the building?

Before we jump to the conclusion that the seller is way out of whack at $850K, let me walk you through the story on this building. The property was self-managed by a local investor who has failing health and is selling off his properties. From what I understand, he didn't really take care of this building, and it's in pretty rough shape. There is a significant amount of deferred maintenance on the building, and as such, the rent are $80-$100 below market (though it's difficult to raise them because we have rent control that limit the rent on occupied apartments to inflation - unless the apartment is vacant, in which case I can raise it to whatever I want).

The seller's agent has suggested that the building needs about $80K of work to get it in good condition, and here's a list of some significant items:

-rear wall (east facing) has had bulging brick veneer removed and is ready for new siding or brick

-roof currently has a leak around the chimney - needs to be sealed and drywall repaired in one area (potentially would make more sense to remove chimney and vent boiler out exterior wall)

-one vacant unit (2br) now could use sprucing up in bathroom and paint/flooring throughout

-one unit coming up for oct 1 (1br) could use upgrade in kitchen and bath and paint/flooring throughout

-common areas could use some sprucing up - paint, maybe lighting, entrance door, perhaps flooring to improve 1st impression 

I've owned property before, but I am no handyman, so I'd need a general contractor to walk with me through the building condition. Suffice it to say that it's in pretty rough shape, but fixable (if he says $80K to fix it up, I'd budget $130K). The city ordered the seller to fix up the bulging brick veneer, and ended up fixing it themselves (and have attached the cost to the 2013 property taxes, which he would be responsible for upon closing).

Why should I buy this dump?

Now, here are the interesting parts:

1) The building is in a good location, close to downtown and along a bus route (very important in this city if you don't have a car). I'm positive that if fixed up, it would have no issues with vacancies. The city overall has a 4% apartment vacancy rate, and there's demand for decent, affordable housing in this price range.

2) The seller is not in good health at all, and wants to sell the property to settle his estate. As such, he's flexible in terms of pricing and terms, but would prefer a solid buyer who can commit to a reasonable closing date (which I am). 

I would even try to get him to carry a note for 10% of the sales price, and maybe try to offset the note against a any excess above a capped amount of renovation work (perhaps the $80K suggested by the agent).

3) Financing through Canadian Housing and Mortgage Corp. insurance (aka Canadian Freddie Mac) is very cheap - 30 years amort, 10 year term @ 4%, up to 85% LTV.

4) Replacement cost on this building is probably $90-100K per door, or at least $1M. This value is skewed by the rent controls in Ontario (which is why rental-only buildings are rarely built anymore).

The agent told me I could "have it" at $770K, but that price is absurd. If I budget $130K for repairs (which is admittedly a guess), I feel property is worth $610K in its current state (assume value upon renovation of $640K - see below), so I would offer $425K, with 60 days DD/Financing contingencies.


Value to buyer

Value if fixed up: $640K (revised $45K income at 7% cap)

Less: Renovation  ($130K)

Less: Margin of safety ($85K)

Equals: Purchase price $425K

If I buy at $425K, add in $130K for repairs (total cost $555K), with a $640K Value upon renovation, I can create $85K in value, and recoup my down-payment upon refinancing. I would initially do a 75% bank loan at current value to purchase, then hard money to renovate, following which I would refinance at whatever value the property is 6-months following closing.

I feel that fixed up, the property could show ~$45K in Operating NOI (by reducing the vacancies per above, along with modest increases in rent), and at a 7% implied cap rate, that brings the value to $640K.

Conclusion?

It's not the easiest path to making money, but what do you folks think of this? More trouble than it's worth?

Sounds like there could be created value there with rental increases post renovation.  This will be a long process though considering that only 2 units are vacant.  Maybe you can find some details about current tenants, such as how long they have been there, what sort of jobs they have, which could give you an idea of if there will be some vacancy in the near future (which is good for you).

Roof leaks + older building + disrepair could mean mold.  Definitely have a couple good inspectors run though it and check for mold.  That could add to your reno budget significantly.

I agree that his valuation is off.  If you make an offer, make it contingent on inspection and then document every little thing your inspectors find, and include that in your follow up.  Even if you don't take care of all of it right away, you can use it as leverage to get a discount.  I would think competition in your market is far less than the GTA.

What are the renters like?  Welfare, ODSP?  Jobs?  Can you change the target market of the building to a higher rent demographic?

Hi @Steve F.  

Looks like you've done your initial homework in a very detailed manner, and you are correct wrt to the overinflated asking price. Sounds like Sudbury? They definitely are in need of affordable housing, as most northern Ontario towns are.  If you could get the building for your offer price as noted above, you will get a great deal.   

I think your best bet to get Seller down in asking price is to play the CMHC card.  As you are likely aware, CMHC does their own evaluation of a property and will only allow the bank to loan up to their perceived value.  You could use this as leverage in your negotiations with seller.  You should reach out to Pierre Turgeon of Matterhorn investments, he is a former CMHC underwriter, and an expert on CMHC loans for apartment buildings in Canada.  

Keep us posted on your outcome!  

Well, I spoke to the realtor again, and he said the seller won't accept less than $700K. The seller is in too deep with a second and third mortgage on the property, so he "needs" $700K to bail him out. Best of luck to Jim - maybe I can pick up this property if it goes under power of sale in the near future.

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