Poll
How much time do you spend reading financial articles (per week)?
Less than 1 hour
1-2 hours
2-5 hours
5+ hours
Do not read

 
Link exchange
Are you interested in link exchange? Contact Us
Home » Credit and Debt
Lending value versus market value continued
Category :- Credit and Debt

Author :- Peter Cook and Robert Flee 
* Please rate and share the article if you find it interesting *

Posted on October 18, 2014, 6:36 am
(2 Ratings)

In the previous issue, this column began to explain why there is often a difference between lending value and market value. The authors focused on the various sources of revenue and expenses used by lending institutions and CMHC when determining the value of an apartment building and provided several suggestions to help maximize a building’s lending value.

In this issue, the focus will be on capitalization rates, how they are determined and what makes them vary. There is often a difference between the market cap rate buyers are paying to purchase the property and the cap rate lenders and CMHC are using to determine the value for lending purposes.

 

Factors that influence cap rates

Capitalization rates are mainly determined by looking at comparable data using existing sales prices of buildings in a particular area. However, this is not the only factor in determining cap rates for lending purposes. Lenders and CMHC also consider risk as an important element for determining the value of a building.

A borrower can expect a relatively high cap rate on a building in need of capital improvements located in a smaller urban center with a struggling economy. Conversely a well-maintained, low vacancy high rise in a larger urban centre will have a lower cap rate.

 

What makes cap rates vary

Supply and demand will impact whether cap rates will increase or decrease. The greater the demand for apartment buildings,  the lower the cap rate and in contrast, the lower the demand the higher the cap rate.

Cap rates will be impacted as returns on other investments such as bonds and stocks fluctuate. For instance, if interest rates on long term Government of Canada bonds increase or stock market returns begin to improve, cap rates will begin to rise as investors look for a risk premium over other investments.

 

Two views on cap rates

Borrows often have an optimistic and futuristic perception of  the building they’re about to purchase while expectation of  future property value is not usually taken into consideration by the lender. Although a purchaser may perceive future increases in market value through renovations and higher rents, lenders and CMHC generally don’t consider future value when determining the lending value of your property.

Generally speaking, investors have a more optimistic view of revenue streams and valuation because they are forward looking – they focus on what they will do to improve the operating performance and value of a multi-family property.

Whereas, lenders have a more static view of valuation and operating performance – lenders want to establish a hard net operating income to measure mortgage serviceability (debt service coverage) and loan to value.

According to Phil Deschenes of Veritas Valuation Inc., “Often these two viewpoints result in a variance of 25 to 50 basis points between market based cap rates and lending value cap rates.” Phil explains, “It isn’t a matter of lenders and CMHC missing the mark, it’s more a function of employing disciplined and purposeful lending practices driven by reasonably conservative underwriting criteria.”

Clearly market participants - investors, lenders and CMHC all have different vantage points from which they analyze and value multi-family investments.

Considering the relative strength of the Canadian lending community in comparison to our American counterparts, perhaps we should be thankful that lenders and CMHC have a moderating effect on the industry.

 

Other factors that may influence cap rates

• Current and historical vacancy rates for the building and the immediate area;

• the overall condition of the property;

• the age and economic life expectancy of the building;

• building history and reputation;

• whether the current rents are below or above market rates;

• the location of the property;

• desirability of the location within the community;

• current and past economic conditions of the city;

• the number of units and type of building;

• suite mix;

• demographic profile of tenant

 

Given the information above, a better understanding of the reasons for the differences between lending value and market value may help mange expectations when the time comes to purchase or refinance a property.

 

Source: http://www.firstnational.ca/docs/comm/CAMFinancingMar2011.pdf


Comments : Peter Cook and Robert Fleet are Apartment Financing Specialists with First National Financial LP. Together they have originated over $4 Billion of mortgages. Their combined 32 years experience with mortgage financing has lead to frequent speaking engagements across the country.
Rate this article   

Sort»
How Cancer Insurance is Different from Critical Illness Policy
Cancer insurance is not critical illness insurance....
(0 Rating)
--------
What You Need to Know about Life Insurance for Canadians with AIDS
Don't be afraid to navigate the life insurance market as a C....
(0 Rating)
--------
18 Tips to Cut the Cost of Your No Medical Life Insurance
You probably know how to save money on life insurance, thank....
(0 Rating)
--------
Why Seniors in Canada Need Funeral Insurance
Funeral insurance is a policy that is specifically designed ....
(0 Rating)
--------
Reduce Your Fleet Insurance Premiums Now
Fleet insurance costs are directly related to claims costs, ....
(0 Rating)
--------
We do not like ads, banners, Google ads or any other kind of promotion. We promise to never put such ads on our site.
 
Greengeeks.com-Leading Web Host Provider
Our web provider, has very reliable support (: 2013)

Contact us for more details

Canadian Financial Articles Directory has articles how to invest in precious metals in Canada, how to store precious metals, how to buy and sell precious metals on Ebay, how to protect your gold and silver, how to buy precious metals trusts, what books to read to invest in gold and silver, what alternative investments to choose from


ABOUT THE SITE

AUTHORS/READERS