Appriciation rate of commercial properties

[nepoez]

Hi Investors it`s me again.

My partner and I came across a potentially great revenue generating property. It is a supposedly R2 zoned property. It looks like a left right duplex but it`s been converted into a rooming house sort of thing with 16 rooms.

My question is, assuming the investor lives in one of the suites and everything is legal. Can I expect the same kind of appreciate rate as a normal house would go through the next few years?

why I ask is because the price is currently base on the revenue, and is much higher than a normal residential property so I figured in 5 years, the price may not go though the same kind of appreciation as other properties. It might instead be based on how much the rent has gone up? I want to know this because it`s one of the factors I put into my analysis sheet.

Thanks very much again in advance!

Nepoez

 

[BobHudson]

My working assumption is that the appreciation in a commercial property is tied directly to the revenue and income it generates, moreso that supply/demand market factors that influence residential properties.

 

[nepoez]

Hi Bob,

Thanks for the response. So basically to estimate how much I would be able to sell it for in 5 years I should assume 0% appreciation(market factor), and calculate how much it can sell for by the following. I will throw some numbers in for example.

Property purchase price now, $1,000,000
Rental income: $10,000/month
Cashflow: $2000/month

- estimating the rent in 5 years. So if the rent goes up by 10% a year, in 5 years it will go up 50% thus $15,000/month
- Now that the rent is much higher, the cashflow will also be much higher so let`s assume the cash flow in 5 years will be $5000/m
-now I want to sell, so I adjust the selling price so that it`s high enough that the cash flow is back to around $2000 like when I originally purchased or $3000 due to inflation.

Does this sound about right? Or am I totally off?

QUOTE (BobHudson @ Jun 9 2008, 12:51 PM) My working assumption is that the appreciation in a commercial property is tied directly to the revenue and income it generates, moreso that supply/demand market factors that influence residential properties.

 

[PeterKinchMortgageTeam]

QUOTE (nepoez @ Jun 9 2008, 11:54 AM) Hi Investors it`s me again.

My partner and I came across a potentially great revenue generating property. It is a supposedly R2 zoned property. It looks like a left right duplex but it`s been converted into a rooming house sort of thing with 16 rooms.

My question is, assuming the investor lives in one of the suites and everything is legal. Can I expect the same kind of appreciate rate as a normal house would go through the next few years?

why I ask is because the price is currently base on the revenue, and is much higher than a normal residential property so I figured in 5 years, the price may not go though the same kind of appreciation as other properties. It might instead be based on how much the rent has gone up? I want to know this because it`s one of the factors I put into my analysis sheet.

Thanks very much again in advance!

Nepoez

Rooming houses are tough to finance. Weather its owner occupied or not, you (and any subsequent buyers) will most likely be looking at alternative lenders with posted plus rates and a lending fee. In addition, you`ll likely need a fairly hefty downpayment so make sure that you work those additional costs into your calculations.

Rooming houses can have great cashflow - unfortunatly, it probably won`t help you get financing on the subject - though it may help to improve the cashflow of your portfolio for any subsequent purchases of standard single family dwellings.

 

[nepoez]

Thanks Peter,

By the way, I find your presentations at the 2 quick starts I`ve been to very educating. Prior to your reply I`ve just forwarded the deal to my mortgage broker to have a preliminary assessment on just how likely I`ll be able to get financing on this. If what you say is the case and alternative lending is required I assume the interest will be at least 2x the prime rate. If that is the case then the asking price will not work, and I`m also assuming it might be hard to attain 800k of private money. I`m kind of thinking out loud, but with the purpose of fishing for feed back from anyone that finds this topic interesting.

Thanks again!

Nepoez

QUOTE (CanadianMortgageTeam @ Jun 10 2008, 12:34 PM) Rooming houses are tough to finance. Weather its owner occupied or not, you (and any subsequent buyers) will most likely be looking at alternative lenders with posted plus rates and a lending fee. In addition, you`ll likely need a fairly hefty downpayment so make sure that you work those additional costs into your calculations.

Rooming houses can have great cashflow - unfortunatly, it probably won`t help you get financing on the subject - though it may help to improve the cashflow of your portfolio for any subsequent purchases of standard single family dwellings.

 

[invst4profit]

Basic monthly cash flow should increase with the increased purchase price based on the buyers increased investment.
I would not expect the same profit on a 1,000,000 property as I would on a 2,000,000 property.

 

[nepoez]

So does this go the other way too then?

QUOTE (invst4profit @ Jun 10 2008, 01:55 PM) Basic monthly cash flow should increase with the increased purchase price based on the buyers increased investment.
I would not expect the same profit on a 1,000,000 property as I would on a 2,000,000 property.

 

[BobHudson]

QUOTE (CanadianMortgageTeam @ Jun 10 2008, 03:34 PM) Rooming houses are tough to finance. Weather its owner occupied or not, you (and any subsequent buyers) will most likely be looking at alternative lenders with posted plus rates and a lending fee. In addition, you`ll likely need a fairly hefty downpayment so make sure that you work those additional costs into your calculations.

Rooming houses can have great cashflow - unfortunatly, it probably won`t help you get financing on the subject - though it may help to improve the cashflow of your portfolio for any subsequent purchases of standard single family dwellings.

Don`t forget the other big issue with rooming houses: INSURANCE. Ther insurer that you currently use may not be interested. You will pay much more for insurance on a rooming house.

 

[Thomas Beyer]

two factors drive appreciation or value growth:

a ) the income growth .. usually income growth is, more or less, inflation as a rule of thumb, but could be higher or lower than that depending on supply and demand for this type of property (retail, office, industrial, multi-family ..)

b ) the multiplier or P/E ratio or CAP rate that is applied to that net income stream .. this is a key driver of building value .. so even with rising incomes the value could be flat if the multiplier is going down. Different cities and different property types use different CAP rates or multiples, from perhaps 5 (or 20% CAP) for a trailer park in a small town to as high as 25 (or 4% CAP) for a rare office tower in a major city like Vancouver or New York City.

In other words, appreciation is a function of GOING IN YIELD + EXPECTED GROWTH of that income stream .. so if the expected income growth is high then the multiplier will be high !

CAP rate is net operating income (NOI) divided by price.

CAP rate is also referred to as yield.

P/E ratio or multiplier is the reverse of it. So if the CAP rate is 5% (i.e. 0.05) then the multiplier (or P/E ratio) would be 20 or 1/0.05

In general, CAP rates are lower in larger cities or when times are good. CAP rates are expected to rise slightly due to rising interest rates as a piece of real estate competes for capital with a risk free bond. So if the risk free bond is higher yielding, CAP rates would go up too.

 

[nepoez]

Thanks Thomas for another detailed reply. However as the newbie that I am, I`m not really absorbing what you said.

So if the going-in CAP rate of a property is only 2.5%, it is not a good investment?
How does the going in CAP rate affect the price of a $1m rooming house in 5 years?

I guess what I`m trying to do is figure out if a property is good investment. For residential properties I can sort of tell if a residential property is overpriced or not based on the cash flow. I know as long as it cash flows in an area with good economic fundamentals I`ll probably do OK. Residential properties` appreciation rate might be easier to be determined(base on the QS a healthy area should be more or less 6-8% avg)and there`s more demand for them so I know I can eventually sell it. However, the property in question is a whole new ball game for me. Cash flowing might not be enough to justify buying, or justify the asking price.



QUOTE (thomasbeyer2000 @ Jun 11 2008, 08:18 PM) two factors drive appreciation or value growth:

a ) the income growth .. usually income growth is, more or less, inflation as a rule of thumb, but could be higher or lower than that depending on supply and demand for this type of property (retail, office, industrial, multi-family ..)

b ) the multiplier or P/E ratio or CAP rate that is applied to that net income stream .. this is a key driver of building value .. so even with rising incomes the value could be flat if the multiplier is going down. Different cities and different property types use different CAP rates or multiples, from perhaps 5 (or 20% CAP) for a trailer park in a small town to as high as 25 (or 4% CAP) for a rare office tower in a major city like Vancouver or New York City.

In other words, appreciation is a function of GOING IN YIELD + EXPECTED GROWTH of that income stream .. so if the expected income growth is high then the multiplier will be high !

CAP rate is net operating income (NOI) divided by price.

CAP rate is also referred to as yield.

P/E ratio or multiplier is the reverse of it. So if the CAP rate is 5% (i.e. 0.05) then the multiplier (or P/E ratio) would be 20 or 1/0.05

In general, CAP rates are lower in larger cities or when times are good. CAP rates are expected to rise slightly due to rising interest rates as a piece of real estate competes for capital with a risk free bond. So if the risk free bond is higher yielding, CAP rates would go up too.

 

[Thomas Beyer]

QUOTE (nepoez @ Jun 12 2008, 08:53 AM) Thanks Thomas for another detailed reply. However as the newbie that I am, I`m not really absorbing what you said.
So if the going-in CAP rate of a property is only 2.5%, it is not a good investment?
How does the going in CAP rate affect the price of a $1m rooming house in 5 years?
CAP rate (or yield) is net income divided by price .. so a LOW CAP rate means a HIGH income multiplier .. or a HIGH PRICE for a certain income. Say the income is $100,000 per year. A 10% CAP would mean you are willing to pay $1M for this asset, whereas a 5% CAP would mean you are willing to pay $2M .. usually because you believe this is a strong asset with enormous upside or it is a quality product in a quality city !

The value then can change 2 ways: either the income changes (up usually but sometimes down if the city is depressed like Windsor or Oshawa right now) or the CAP rate (or multiplier) changes .. up or down. CAP rate changes because of real or perceived changes in a city characteristics, or because interest rates go up or down. So if a risk free bond can yield, say 7%, why would you buy an apartment building or commercial strip mall or an office tower with more risk at a 7% yield .. you`d expect at least 8 or 9 or 10% yield.


QUOTE (nepoez @ Jun 12 2008, 08:53 AM) I guess what I`m trying to do is figure out if a property is good investment. For residential properties I can sort of tell if a residential property is overpriced or not based on the cash flow. I know as long as it cash flows in an area with good economic fundamentals I`ll probably do OK. Residential properties` appreciation rate might be easier to be determined(base on the QS a healthy area should be more or less 6-8% avg)and there`s more demand for them so I know I can eventually sell it. However, the property in question is a whole new ball game for me. Cash flowing might not be enough to justify buying, or justify the asking price.
residential properties sell on DIFFERENT METRICS .. usually NOT income related but supply and demand related. So, is this a nice area ? Do people move here ? Will there be a sub-way station nearby or other transportation improvement ? What are the construction costs for a similar but new asset? In many cases it is hard to cash-flow a single family house in a decent area because the rent is too low for the likely price. Usually only with creative techniques like renting the basement suite and the garage does it work, or in smaller towns or with smaller houses, townhouses, duplexes, ..

so commercial properties and residential properties use different metrics to evaluate !

Essentially REIN teaches a change of use: you buy and hold as a rental property (with income and hopefully positive cash-flow) but you sell it to an owner many years later as a HOME and get a value INdependent of income !

 

[nepoez]

Thanks so much for the explanation. Because of all the answers I received, I now have a much better direction.

I realized the following:

- my analysis is based on residential mortgage which means my projected net income is off.
- even if my projected yield is correct, the yield of 2.5% is too low. There are other investments with higher yield. Even with a 10% rent increase per year, this property will only start to become reasonably priced in 5 years.
- I`ve been preparing for condos and town houses, or in any case, residential properties. This is quite the whole new ball game and I don`t feel confident about this. I should concentrate on what I`m sure about.

Any thoughts about this?

 

[Thomas Beyer]

QUOTE (nepoez @ Jun 13 2008, 09:46 AM) Thanks so much for the explanation. Because of all the answers I received, I now have a much better direction.

I realized the following:

- my analysis is based on residential mortgage which means my projected net income is off.
- even if my projected yield is correct, the yield of 2.5% is too low. There are other investments with higher yield. Even with a 10% rent increase per year, this property will only start to become reasonably priced in 5 years.
- I`ve been preparing for condos and town houses, or in any case, residential properties. This is quite the whole new ball game and I don`t feel confident about this. I should concentrate on what I`m sure about.

Any thoughts about this?
nothing is SURE !

you should focus on
a ) what makes sense in the market
b ) what you LOVE to do
c ) what you can learn or are already good at
d) s.th. that you can get $s for given your experience level

many things qualify: townhouses, trailer parks, condos, apartment buildings, strip malls, gas stations, raw land, ocean view hill sides, organic food farms, oil and gas, water, solar energy, small office buildings, small industrial buildings ...