Purchasing An Apartment Building In Hamilton? Here Are The Steps.

Purchasing An Apartment Building In Hamilton

When purchasing an apartment building in Hamilton, there are many considerations for the mortgage lender. The qualification criteria when purchasing an apartment building are completely different than purchasing a residential property or even a residential rental property (like a duplex). In this case, there is more focus on the amount of income the property is generating to operate the property. This is in contrast to to a residential property where the focus is on the personal finances of the borrower.

Step 1: Income And Expenses

The income that is being generated in terms of rent from the units in the apartment will be added up and from that the expenses will be deducted. These expenses can include factors such as a 4% vacancy rate. The bank will assume that all of the units will not be filled 100% of the time. Other expenses like property taxes and management and maintenance are also factored in. Once you deduct those expenses, you have the net income that the property generates.

Step 2: Debt Ratio Dictates The Maximum Mortgage Amount

The net income from the property is divided by the amount of the mortgage payment and this ratio cannot be less than 1.3. That means that the net income that is generated by the property must be at least 30% higher than the cost of the mortgage. In this way, the maximum mortgage amount that the property qualifies for is determined. The debt service coverage of 1.3 is one factor that is considered when purchasing an apartment building in Hamilton.

Step 3: Determine The Capitalization Rate

Another factor that is considered is the capitalization rate. The capitalization rate is the net income divided by the value of the property. An acceptable capitalization rate depends on where the apartment building is located. In a sense, it is “assigned” by the lender. Lower income areas and less sought after areas have a higher capitalization rate. In more sought after areas where do you get more rent per unit, generally speaking, the capitalization rate is set lower. For example, in Hamilton the capitalization rate may range around 4.5% to 4.75%.

Step 4: Value Of An Apartment Building In Hamilton

Now that you have the net income and the capitalization rate, it is possible to estimate the “true” value of the property. Since you know the net income and you know the capitalization rate for that area, you can calculate the value of the property.

Step 5: Do Some Calculations

For example, let’s say we are looking at an apartment building in Hamilton with eight units yielding a gross income of $82K per year. When all of the expenses are extracted from that amount, you end up with $40K/year. This means that the mortgage payments cannot exceed $31K per year. Why? Because $40K (the net income)/ $31K (yearly mortgage payments) = 1.3. If the mortgage payments exceeded that amount, the ratio would be lower than 1.3.

Thus, the maximum mortgage is $680K because right now, a $680K mortgage will result in yearly payments of $31K.

Since we know that the cap rate in Hamilton is 4.29%, then we can calculate the value of the property:

$40K (net income) / 4.29% = $932K

So in this example, the property is worth $932K based on the cap rate in the area and the net income the property generates.

Step 6: Down Payment Required When Purchasing An Apartment Building In Hamilton

Now we know the maximum mortgage amount and the value of the property. So, purchasing this property in Hamilton for $932K (our estimated value), that means the buyer will have to come up with $252K as the down payment ($932K – $680K). That’s 27% down. If you “overpay” for the property, then the buyer will need to come up with the difference. In other words, if the seller wants $1.2M and won’t budge, that means the buyer will need to come up with $520K (43% down).

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Sean Howard is a Mortgage Broker. His office is located at 651 Fennell Avenue East in Hamilton, Ontario. If you would like to speak with Sean, he can be reached at 905-574-9200 #216. Alternatively, you can contact Sean here.

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