Buying a multiunit – meaning a building with five or more units – can be a great opportunity for investing in real estate. But before diving in, it’s important to know everything that’s involved with such a purchase, and the requirements that come with it. Here’s our advice if you’re interested in investing in multi-family real estate.
A multiunit property, or multiplex, is a rental property with more than one rental unit. The important thing to remember is that the process and the rules for the purchase of a multiplex with five apartments or more is different from those for the purchase of a multiplex with four units or less.
To purchase this type of real estate, which is considered as a commercial asset, you’ll need to apply for a commercial mortgage loan. That’s one of the biggest differences between buying a building with five units or more and buying a building with four units or less, for which you would apply for a normal mortgage loan, same as if you were buying a regular home. The differences between these two kinds of loans lie in the qualification criteria.
Qualifying for this kind of load will mainly depend on the profitability of the building, although other criteria will also be taken into account, such as your experience in real-estate management, the location of the building, its state, the occupation rate of the units, and the liquidity at your disposal after you’ve obtained financing for the property.
The bank will calculate the rental income as well as the expenses, which includes mortgage payments, insurance, taxes, heating, electricity, and maintenance and administration services. Generally speaking, you should aim for a debt coverage ratio of 1.25. In other words, your cash flow should exceed your expenses by at least 25%.
To find out whether a multiplex will be able to generate income, don’t rely solely on the gross income multiplier (GIM), which is calculated by dividing the sale price by the income. For a more accurate analysis, take your expenses into consideration too by using the net income multiplier (NIM) and the capitalization rate (cap rate).
You can calculate your net income after subtracting all operating costs (electricity, heating, property taxes, insurance, upkeep, snow removal, management or maintenance fees, etc.). For example, if you paid $1.4M for a building with 5 units and your net annual income is $90,000, that means your ratio is 15. To get a good return, aim for a ratio between 10 and 16.
The cap rate is a percentage that gives you an estimate of the income property’s value. This information represents proof of the rental property’s price when you apply for financing.
You get the cap rate by dividing your net income by the sale price. The higher the cap rate, the better the net operation benefits compared to the sale price.
The cap rate can fluctuate with inflation, current interest rates, and the real-estate market.
Please note that even though it’s not part of the calculation for your loan, your personal financial situation will still be evaluated. Your bank will want to make sure that you manage your money well and that you can handle any unexpected events (urgent repairs, vacancies, notary and accounting fees, etc.).
Other than commercial mortgage loans, you could remortgage another of your properties. This is called leveraging, and it consists of refinancing one asset to buy another using all of your authorized credit, knowing that the interest on a mortgage loan is tax deductible for rental properties.
Outside of bank loans, you could also borrow money from a family member or from a private business partner. The important thing is to get advice from an expert to make sure that your plan is your best option.
The percentage you need as a down payment to purchase a 5-unit multiplex versus a 12-unit multiplex is the same. But the location of your future property could make a difference in the minimum you need for a down payment.
Generally speaking, for a building in a city with over 10,000 inhabitants, banks ask for 25% of the purchase price as a down payment.
However, the down payment can be lowered to 15% if you have mortgage loan insurance. For example, if you get insurance with the Canada Mortgage and Housing Corporation (CMHC), you will be granted a 10% reduction in the down payment requirement. You could also benefit from a better rate, as it will lead to less of a risk of loss for the bank granting you the loan in case you default on your mortgage.
Another advantage: a decrease in the interest rate of an insured loan, despite the premium you’ll have to pay, means that you’ll get better returns on your down payment than with a conventional loan.
Thinking of purchasing a building in a small town? The bank may determine that it’s a higher risk. For example, if an employer in the area laid off a large part of their staff, this could lead to an exodus and reduce your pool of eventual tenants, or even potential buyers if you decided to sell your property.
Lenders may seek to mitigate the risks by granting less financing or asking for a larger down payment. Generally speaking, the down payment should be 25% of the sale price, or 15% if your loan is insured by the CMHC. Keep in mind that it varies case by case.
Tip: If your property has a commercial space on the ground floor, the same down payment is required, but your debt can only be amortized for up to 20 years, instead of 25 years for entirely residential buildings.
These rules apply in all provinces in Canada.
To make a good multiplex investment, it’s crucial to be well-prepared to limit any surprises as much as possible and make managing the building easier.
The better prepared you are, the better your experience will be and the higher your chances of achieving profitability with your new property.
You also have to take a good look at the financial resources you have available in case of any unforeseen circumstances. Usually, you need to be able to reinvest at least 10% of the building’s value.
The answer to this question depends on your situation and your objectives. Many people jump right into commercial real estate because it’s more profitable. But for commercial properties, we recommend starting with relatively small buildings with five, six or eight units.
Finally, keep in mind that real estate requires more time and management than other types of investments. You need to make an effort to make a profit, or hire a building manager.
It’s also an asset that will probably take longer to sell than a stock option. Conversely, it’s a tangible investment vehicle, which some investors appreciate more. Feel free to talk about your project with one of our advisors. We’re here to answer your questions.
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