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Apartment buildings: Value not immune to interest-rate increases

With governments “printing money” and inflation creeping into all aspects of our daily lives, it...

With governments “printing money” and inflation creeping into all aspects of our daily lives, it was only a matter of time before the federal government increased the interest rate to curb spending.

However, a lot of people were surprised at just how quickly this happened.

Let’s take a fictitious example of an apartment building a broker may have evaluated at $8 million six months ago. 

GRAPHIC: How interest rates could impact financing for an $8-million apartment building acquisition. (Courtesy Baron Realty)

Note the down payment requirement changed by more than $500,000 over the past six months, i.e., the buyer would need to have an additional half-million dollars in non-borrowed funds in order to be able to close this transaction.

Why does this matter?

The down payment requirement is key in successful sales. The rate of down payment used to be 20 to 30 per cent, further increased during the past few years to 40 to 50 per cent, and now an almost impossible 60 per cent plus.

Sure, there are all-cash buyers in the market; these buyers know “their value” and will act accordingly (buying at a discount, because they know the majority of regular buyers will not be able to produce or justify the down payment required today).

Vendors need to be aware that in a fast-shifting interest rate market, deals can fall apart at the financing stage just because the downpayment can increase so drastically from one month to the next.

Hence, if a buyer showed proof of funds with offer in October but had to wait for the vendor to finalize the environmental report until April, the same buyer may not be able to close the deal.

How vendors can navigate the current market:

– Hold on to the asset until a significant interest-rate decrease happens, to maximize the number of buyers available and willing to purchase. Of course, nobody has a crystal ball as to when this will occur; this strategy can be an issue if the building has maximized its value and is now on the decline, or for private owners who are sellers for different reasons (dissolutions of partnerships, changing life directions, no longer being able to manage the building, etc.)

– Be prepared with all the documents needed in the sale process, the most important of which can be environmental reports (which can take six weeks to six-plus months). Without a “clean” environmental report, the buyer will not be able to obtain financing.

– Watch for deal delays and know that short delays are very valuable – as long as you trust the buyer has not simply committed to short delays to tie up the deal with the intention to renegotiate the timelines later (buyer reputation is key).

– Buyers must be willing to commit in writing (at the offer stage) to provide more down payment than is required at offer time.

– The value of an apartment building should always be taken as the value today; in a fast-changing world, even the “safest” real estate investment asset class is not immune. If you have an evaluation from six months ago, it will surely not be accurate today.

– The marketing of a property should keep in line with the changing market dynamic. Based on the asset and timing, a bid process, an asking price process, or a process of no price (just a range with its respective loan potentials) and “offers anytime” may be appropriate. But, the best way to market will be determined at listing time, not based on the broker’s record from last year.

Reputable brokerages custom-tailor each marketing process, and will bring in the right buyers based on the asset and vendor requirements for deal timelines. As an example, we’ve generated from five to 12 offers on each of the listings Baron Realty has taken over the past 18 months.

Baron Realty specializes in matching buyers and sellers of apartment buildings. Ramona works in partnership with Mikael Kurkdjian and a team of real estate professionals to bring the best boutique-brokerage services to the apartment transactional space in Ontario and Quebec. 

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