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#5 How Much Money Do I Need to Start Investing in Apartment Buildings

Uncategorized Nov 21, 2018

Hi!

 

When I speak or teach about investing in apartment buildings, I'm often asked how much money do I need to get into the big leagues of real estate investing.

 Of course, the answer to that question will depend namely on the size of property you are looking at purchasing and based on the amount of capital you have available.  That's part of your planning phase before you start writing offers on multifamily properties.

 Please, if you have not done so already, make sure to download my Ebook: 'Multifamily Investing Secrets Revealed' as it will help you with your planning by having you answer five key questions (click here to download Ebook: https://www.multifamilyinvestingcanada.com/)

 

Accordingly, the answer I give people when they ask me how much capital they need to get started into investing in commercial residential properties, that is apartment buildings of five or more units, is a percentage of market value and it will also depend on the following two factors:

 

  • What is their investment goal, and;
  • How do they intend to finance their purchase, that is through conventional financing or CMHC-insured financing?

 

Let me start with the choice of financing strategy.

If you choose to finance your apartment building purchase with conventional financing, that is financing that's not insured by my former employer, Canada Mortgage and Housing Corporation (CMHC), for starters you'll need a down payment of minimum 25% of the market value of the property as confirmed by a current appraisal. That's because the maximum loan-to-value (LTV) conventional lenders will finance is 75% of market value (or the lesser of market value or purchase price).

 

On the other hand, if you opt to finance your multi-family property through CMHC-insured financing, expect to need a down payment of minimum between twenty and twenty-five percent of market value despite the fact CMHC says it will ensure up to 85% LTV. You may remember from a previous blog post of mine, that CMHC rarely uses market value to calculate the LTV. Indeed CMHC will use a lending value that is lower than market value. In other words, based on CMHC’s lending value, the maximum LTV will be generally somewhere between 20% to 25% of market value assuming you go for 85% of CMHC's lending value.

 

That's for the down payment side of things. However, you'll need to include additional costs to your down payment for closing on the deal such as:

  • Lender fee or mortgage broker fee which is generally 1% of the loan amount
  • Building inspection of approx. $2,500
  • Environmental Site Assessment (ESA) approx. $2,500
  • Searches to ensure the property is compliant with various by-laws, safety standards, etc. $1,000
  • Contingency fund equivalent to three months of mortgage payments or more
  • Perhaps immediate repairs/upgrades if you're unable to get a price reduction from vendor to account for those.

 

So for additional closing costs, at a bare minimum, my advice to you would be to include an extra 5% of the purchase price in addition to the down payment in the amount of upfront capital you will need to purchase your apartment building.

 

So bottom line, if you finance your deal conventionally, plan on needing at least 30% of the market value in upfront capital whereas if you go the CMHC-insured financing route, then plan on having at least 25% to 30% of market value.

 

Now let us look at it from the perspective of your investment goals and ask yourself whether you should increase the minimum down payment. Here too there are two factors you need to consider:

 

  • Your investment goals;
  • The current market cycle.

 

INVESTMENT GOALS

 

Why do you choose to invest in apartment buildings in the first place?

 

Is it for: 

 

  1. Annual net cash flow, in which case you should increase the amount of your down payment, in other words, borrow less from the bank, which in return will give you a greater net cash flow;

 

  1. Is it for a greater return on investment (ROI)? If this is the case, you want to put the minimum down payment possible to increase your cash on cash return. However, understand that as you borrow more money, you increase your investment risk. Are you prepared for this? What's your tolerance for risk?

 

The larger the down payment, the lower the investment risk.

 

CURRENT REAL ESTATE CYCLE

 

Also, part your planning into investing in apartment buildings of five-plus units, you need to be aware at which phase of the real estate cycles the market is at currently. Is it in an ascending phase or descending phase?

 

A market in an ascending phase is characterized by low vacancies the ability to increase rental charges in the near future, which would enable you to increase the value of the property significantly and thereby reduce your investment risk. Another indicator is the confirmed the presence of strong market fundamentals in the foreseeable future. Then, if these factors are present, perhaps you could consider reducing the amount of down payment.

 

But remember, real estate markets are known to shift gear very quickly, sometimes, and not always for the best.  So there again, you should exercise great caution. Thus there remains a genuine risk.

 

On the other hand, if you purchase a property in a descending market where there are weaker market fundamentals, you may wish to be much more conservative in your investment approach and increase the amount of down payment in order to reduce your investment risk.

 

As you can see, there isn't a single answer for all investors and real estate markets as to how much capital you should put down upfront.  Doing your homework thoroughly and being very clear regarding your investment goals and what knowing what is your appetite for risk is accordingly very critical.

 

To realizing the best version of yourself and your life.

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