A view of the residential market

Director of Commercial Lending , First National Financial Corporation
  • Oct. 1, 2014

Darryl BellwoodThe residential investment asset class is one of the most stable classes of investment properties in which you can buy. 

One of the biggest challenges for owners is being able to increase the net operating income for the property. It can prove to be more difficult than anticipated due to many factors.

For example, it is extremely difficult for property owners to increase rental rates at the same frequency utility costs increase. Or with the federal government focusing on tightening the mortgage rules for the residential mortgage market, we have now entered an environment where homebuyers require more equity to purchase new homes and condominiums. 

This has caused a shift where potential buyers return to the rental market. Renters on the other hand are demanding more from the owner, expecting higher quality furnishings and amenities consistent with better quality rental. 

There are many options

The unit is their home, whether it’s for the short or long term. Since there are many options and averagetogood quality product in most rental areas across the country, the renter and owner seem to both be focusing on the delivery of quality product, with a strong sense of community being fostered in their properties.

One of the most common areas where rents are driven is in the area of renovations where the buyer purchases an underperforming property and then proceeds to upgrade the units to the quality expected by the renter.  The monthly rental rate is then increased, to reflect the better quality of finish in the unit.

This concept continues to work quite well in the major urban centres across Canada. This does not however, work for all properties, which leads to the question of figuring out creative ways in which owners can increase their net income. 

Some areas getting attention are student rental properties and furnished suites. Both generally have higher net operating incomes than apartment buildings.

People seeking short-term rentals

In many communities across the country, there usually are a number of people in situations requiring short-term rentals, e.g. students, brief contract employees and migrant workers in search of employment. Students, with many of them international, will be concentrated in many areas where post secondary schools are located, while at the other end of the spectrum, contract employees and transient workers obviously move to areas where employment takes them.

Student rental in many areas has very low supply leading to higher rates paid per month by the student. Many property owners allow leases over the school term, but charge higher rates per unit to account for the higher vacancy associated with the rental.

Other owners may convert the property to shared accommodations, renting individual rooms to the student with a shared kitchen for all of the tenants. Full amenities are generally provided including all utilities, cable and internet. The rates charged per room are higher than if the same owner leased a self-contained apartment unit to the same group.

The emergence of furnished suites has resulted, along with a greater proportion of suite hotels and medium stay facilities. They have all existed for many years, albeit generally targeted by investors with an appetite for more risk and with the expertise in managing them. 

However, in an era where cash flow drives return, they are gaining in popularity due to the high cash flows and greater returns offered. They do fit the transient niche in the market but are not your standard apartment unit and they are not a hotel.

Higher rents can be charged

They generally allow for stays of weeks or months or even longer periods and range in services provided, many times including many of the services hotels have to offer.  The difference for an owner is that higher rents can be charged due to the duration of the stay involved and the services provided. 

Investors must have the time and patience to manage these assets and be prepared for the higher maintenance costs associated with keeping the furnished units at marketable levels and ensuring the furnishings are not dilapidated or in disrepair when trying to rent the unit.

As an investor in these asset classes, the lending criteria can vary, but lenders generally look at lower leverage parameters (between 65 and 70 per cent) depending on the type of furnishings and the tenant composition in addition to the operating business aspect of the property.  Lenders will always look at the worst case scenario, i.e. as if they had to take back the security to realize repayment of their loan. 

In this type of scenario, the lender becomes the investor or owner of the property and they may be required to convert the property to a standard apartment building. If this is the case, the lender will stress the asset in their underwriting by discounting cash flows to market apartment rates but will also look at the existing cash flows, all the while comforted by the fact that if the security was taken over that, the property could be sold at the current balance outstanding in order to pay the loan in full.

Darryl Bellwood is a Director of Commercial Lending with First National Financial, Canada’s largest non-bank lender. He is active in most markets in the country with a focus on investment real estate. All feedback is welcome and he can be reached at [email protected].

Darryl Bellwood is the Assistant Vice President, Commercial Financing with First National Financial, Canada’s largest non-bank lender. Darryl provides commercial mortgage financing solutions for all types of commercial real estate…

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Darryl Bellwood is the Assistant Vice President, Commercial Financing with First National Financial, Canada’s largest non-bank lender. Darryl provides commercial mortgage financing solutions for all types of commercial real estate…

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