Problematic Pricing

Are Buyers getting priced right out of the apartment building market?

Apartment building market prices remain consistently strong all over the Metro Vancouver area due mainly from the limited supply. What constricts or releases that supply is you, the apartment owners. However there are many influences outside of your control that seem to affect most people’s decision making process.

The biggest concern we hear is “what do I do with the money?” This is a problematic scenario, as it diminishes any motivation to keep investing. For example, when you sell your property the gain will be susceptible to a tax of approximately 22%. Even after you receive market value for your property, and pay taxes, you no longer can afford an apartment building of equal size, defeating the purpose of re-investing your money. Without more profitable alternatives, apartment owners will continue to keep their money safely invested in their current properties. For this reason, sales typically occur as a couple wishes to retire, or no longer wants to dedicate their time and energy into the upkeep of the property.

The problematic pricing scenario. Now we understand the limited supply aspect, how does this affect the Buyers investing in the multifamily market? As prices for property continues to climb, the average working individual is unable to afford buying investment property. It could take a person his or her lifetime to build up over half a million in equity, which in today’s market isn’t sufficient as a down payment for most investment properties. This restricts the demand to a relatively limited market of Buyers in Metro Vancouver; ones that already own property. These investors are more sophisticated and experienced than the first time Buyer, who may not understand many of the aspects of ownership, such as average expenses for properties. Additionally, current property owners will be well informed of market conditions as they have already done their homework from previous investments and built relationships with brokers that keep them updated with the latest product. Experienced investors maintain a strong understanding of market prices and conditions, making it rare that they will over pay for your property. As the prices continue to increase, this class of purchasers will be become the dominant force within the marketplace. Shifting from the individual family owned and operated, ma and pa operation, to investors owning portfolios.

The tipping point. As Buyers continue to get priced out of the market, restricting demand, equilibrium will be reached. This point occurs when there are so few Buyers able to afford property, it matches the tiny percentage of retiring apartment owners. At this rare economic pinnacle one of two things could happen, given the market is determined by what people are willing to pay. One, other economic forces will come into effect, like the stock market, or interest rates increasing, which would release supply. Two, the same market drivers continue, prices will have to flat line as Buyers will not overpay for property and there’s not enough competition between investors to bid up pricing.

The solution. One possibility we recommend to our clients who are contemplating selling their property is a vendor take back mortgage. What constitutes a vendor take back mortgage? When a Buyer wants to purchase your property he is likely needing financing. Instead of putting the entire cash value received from selling your property in the bank, and paying tax on the full amount, there is an opportunity to defer some of the tax and make a good return on a portion of your money, while banking the rest. With the banks requiring large down payments, and therefore not offering enough financing, you can provide the financing or even additional financing by way of a second mortgage. According to Alnoor Jiwa, founder of The Mortgage Store, the majority of apartment buildings are financed through CMHC, which now allows the registration of second mortgages to facilitate a purchase transaction. The amount of the second mortgage is subject to CMHC underwriting criteria, these can be in the form of a Vendor take back or private mortgage, says Mr. Jiwa. There are many benefits to taking this approach. Firstly, when you are selling your investment, a vendor take back mortgage allows for greater leverage when negotiating the price, as it permits a buyer to purchase a building that they could not finance otherwise. Since you previously owned the property, you can be comfortable knowing the level of financing the building can support. Second, in some cases you may be able to defer the tax. As we all know there’s no way around paying the full capital gains, however, in these cases instead of paying the entire lump sum upfront, the portion that has been mortgaged back on the building can be taxed as it gets paid off for up to five years using a prorated formula. You can be assured your investment is secure as the mortgage will be registered and include assignment of rent clauses. Basically in the event of default, you as the mortgagor have legal options enabling you to collect payment. If there are any further complications your money will remain safe as the subject property can be refinanced by banks or lending institutions, or resold at market value, with you getting the proceeds while retaining the original down payment. For more detailed tax advice, talk to your accountant or lawyer. Overall a vendor take back mortgage provides you safe and secure option to reinvest your money.

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