Apartment Buildings: Battling Rising Interest Rates | RENX

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Interest rates are the lifeline of our real estate world. Without lenders and financial leverage, all investors would have to buy investment properties in cash, completely removing the whole concept of leverage, return on investment and return from our business.

Real estate ownership is generally a long-term game, however, and a landlord will see rates go up and down over the time the asset is held. Managing the financial side of leverage (debt) can be the difference between winning and losing the returns game.

Currently, central banks have made the unfortunate decision to fight inflation by penalizing debtors and so we have seen a massive surge of rate hikes since last year.

A five-year insured mortgage would have had an interest rate of 1.80% in June 2020, 2.30% in June 2021 and 4.60% in June 2022.

Not only will these rate increases cause problems for the borrower’s cash flow, but they will also have a significant impact on the financing obtained, since the amount of the loan obtained will be reduced by 33%, which must be compensated either by a reduction of the selling price or provide a higher down payment.

The solution

How should multi-residential owners fight against this rate hike?

The only owners who can properly navigate this kind of environment will be those able to increase their net operating income to make up the difference (net operating income is the income remaining after all fixed costs like property taxes, insurance, utilities are removed from gross revenue), since one of the most important criteria lenders use when valuing a property is its net operating income in place.

The solutions that follow will seem very basic to experienced owners, but in our brokerage business, most of the properties we sell are barely optimized.

There are three main ways to increase net income:

Unit renovations

Renovating a unit beautifully and increasing its monthly rent by $200 per month seems like a small thing, but it means an increase in property value of about $50,000. Repeating this process four times results in a $200,000 increase in asset valuation.

Home Insurance

Every dollar saved monthly on the insurance bill will potentially increase the value of the property by $240. This in itself represents a return on investment of 1,900% per year, and it costs nothing more than to find the right insurer or the right insurance broker, because there are significant variations between insurers in terms of rates.

Energy costs

Energy is a whole different issue we face these days.

The high prices we all pay at the pump are a real problem, but a bigger problem is the price of natural gas year over year. The average natural gas bill has increased by around 25% in 2022 compared to 2021.

If the natural gas bill in 2021 for a given property was $20,000, that same property will now pay $25,000.

This $5,000 increase in the gas bill means a $100,000 decrease in asset valuation. This problem cannot be left uncorrected.

The homeowner should be aware of all available energy programs to perhaps replace on-site heating furnaces with more efficient ones, or learn about the various CMHC energy programs, which are always being updated and modified and may offer high benefits to owners depending on specific situations. .

In conclusion

We have seen a significant change in cap rates between 2021 and 2022. However, the cap rate is not the only factor in measuring real estate valuation. Net property income remains the most important item.

By making necessary renovations to units as they become vacant, managing property expenses including insurance and energy maintenance, the prudent homeowner will come out well ahead of those who are not proactive in our current environment. higher interest rates.

Baron Realty specializes in connecting buyers and sellers of apartment buildings. Author, Mikael Kurkdjian works in partnership with Ramona Ursu and a team of real estate professionals to bring the best boutique brokerage services to the apartment transaction space in Ontario and Quebec. [email protected]

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