Any real estate investor will agree that purchasing property is exhilarating. The process of evaluating properties and brokering a deal an make you look ahead to potential income. However, it's important to consider all financial aspects of the sale because neglecting to do so could negatively impact your bottom line.
The blog post will outline some of the important things you should consider before purchasing an investment property.
The Property Value
This may seem like an obvious consideration when purchasing an investment property but its value doesn't always equal its market value. I've heard many stories of investors overpaying for a property as a result of sellers asking for a price much higher than its actual market value.
1. Do your research. Head to online real estate listing sites to see what similar properties in the neighbourhood are selling for, and what they've sold for in the past. Some sites require a subscription that provides more information, while many free sites will give you a general idea of what's on the market now.
Keep in mind that recent sales will provide a more up-to-date picture of you property's market value. Evaluating a handful of nearby sales should give you a good idea of whether your property is a good deal or overprices.
2. What's the price per square metre? Comparing this figure to similar properties in the area is another way to evaluate the property's value. Keep in mind that apartments or condos often don't include outdoor spaces in this calculation. Houses, however, may take include total land area.
3. Ask a professional. Paying a professional to assess the property's value can save you time and money. While they will likely use the above two methods to calculate the value, they will likely be able to do so much more efficiently than an average investor.
If you're acquiring traditional financing to purchase the property, the bank may use its own valuers to access the value of the property. While this may negate the need for you to value the property your own, it's important to consider that the valuer may assess a lover value to side with the bank.
Additionally, unless the property's value is vastly inflated, the bank's valuer will likely accept the property's value on the contract. This is based on the logic that an average buyer and seller would have time to negotiate and wouldn't buy or sell the property for an unreasonable amount. For these reasons, it might be a wise to also consider hiring an independent valuer.
4. What about commercial properties? There are many factors that affect the value of a commercial property, which makes assessing this figure more complex. This includes:
- The length of any existing leases
- How profitable similar properties are
- The property's potential yield compared to its current yield. The current figure might be much lower than what you could bring in after redeveloping the property.
Because commercial properties have more valuation complexities than residential properties, it may be wise to consult a professional. This will put you in a better position to evaluate the asking price and confirm the property's other details, like existing leases.
While banks will consider your debt service ratio (GDSR) and loan-to-value (LTV) ratio when you apply for financing, they may consider other factors that could affect your application.
- LTV: The bank evaluates the LTV to ensure that they can recoup their investment if you default on the loan. This amount will take into consideration the bank's potential need to sell a property quickly by discounting it.
Banks will typically lend up to 80% of the value of a residential property without mortgage insurance, but may lend more if you add mortgage insurance to the loan. Commercial properties are riskier, so banks typically lend only 60%-70% of their value. This amount often depends on economic conditions, where favourable conditions mean less risk and a potentially higher LTV.
- GDSR: The bank will evaluate your ability to service the debt based on your existing financial situation. Banks calculate the GDSR by dividing your loan payments by your gross income over the same period. A higher GDSR means more risk to the bank because it could mean that you're stretching your finances in order to service existing debt. Typically, banks will lend on a residential property when your GDSR is under 30%-35%.
- Debt coverage ratio (DCR), also known as interest cover: Banks may consider DCR instead of GDSR for commercial properties. To determine your DCR, banks will divide your net operating income by annual mortgage payments. Banks will typically lend on a DCR of 1.5 or more.
I recommend considering a mortgage broker for commercial property financing because they may be able to get you a better deal or present options beyond what banks will offer.
- Budget and emergency funds: It's important to consider your budget, including both your personal and rental income and expenses. For example, you should take into account your loan repayment as an expense and lost income from potential rental vacancies.
it's also wise to consider the loan repayment amount by calculating it on principal and interest basis (even on an interest-only loan), and to consider a scenario in which the interest is doubled. This will give you a better idea of how your ability to pay the loan could change in different situations.
Ultimately, how much risk you are willing to take on is your decision but analyzing the investment sensitivity will help you understand how much risk is really involved.
It's also useful to consider the following when purchasing an investment property:
- Include a "subject to finance" condition in your offer so you can take the time to find the best financing for your needs.
- Decide on the property's ownership structure before signing the contract. Do you want the property in your name on in your trust?
- Consider negotiation a lower deposit than the typical 1% to free up cash flow.
- Insure your property to give yourself peace of mind.
- If you are using a property sale to purchase another property, do not commit to a purchase until the sale is complete and the cooling off period has passed.
Whether investing in a residential or a commercial property, it's critical to consider all aspects of the sale in order to maximize profit and prepare for unforeseen expenses.
Want to learn more? Contact me to discuss your investment property financing needs.
Ofir Varsulker, B.A.
Specializing in alternative lending solutions