The Canadian Real Estate Market Reality Check

Real Estate Market Fundamentals
Don R. Campbell

I'm not sure if you have been reading the newspaper headlines lately; they are sure making it sound like we are in for quite the ride. The stock market is proving to be a wild ride - up one minute, dramatically down the next. The debate whether or not the US economy is in a recession seems to be a daily headline.

Times of economic fluctuations, throughout history, have proven to be some of the best periods of time to study the fundamentals and buy positive cash-flowing property in key areas. We have been talking to many senior Real Estate investors who have been waiting for a time of turmoil to add to their portfolio.

Often, turbulent times will scare the unsophisticated, emotional, 'get-rich-quick' investors out of real estate, while the sophisticated long term Real Estate investors act at full-throttle, knowing fair well that they are picking up bargains during times of fear. For example, both the Kyoto scare and the September 11th scare provided good buying opportunities for investors.

It is an interesting observation to watch human nature in action. People will wait for 'clothes, food, cars, etc' to go on sale before they buy them at a discount... however, as soon as an investment property comes 'on sale' in a slower market, unsophisticated investors stop buying and wait until it goes up again, missing the opportunity to buy at a lower price. What makes the difference?

This graph (click here),, courtesy of the Bureau of Economic Analysis and Business Week, reveals that year-to-year variability in economic growth has declined markedly over the past two decades, the major highs and lows of the past have disappeared (even during major financial uncertainty). You can see in the graph that during the last 19 years (in red) the variation in year-to-year growth in real GDP has only varied from 0% growth (1991) to 5% growth (1997).

Massive year-to-year swings have almost been eliminated in the past 20 years, and as we look to the future, our economy is poised to continue with this moderate variation and upwards growth trend. The Canadian economy has proven to be a safe and predictable place to put your long term investments. It has been proven that those who jump in and out of real estate markets (trying to market time) are the investors who end up losing over the long term.

I imagine you've heard the old saying "When the U.S. sneezes, everyone else catches a cold." Well, that does not completely hold true. Yes, it is true that the U.S. is a large economic power and a strong trading partner to Canada, but if you look at this second graph you will clearly see that each time the U.S. economy has entered into a recession the Canadian economy only followed with a recession 2 out of 3 times. In the last 45 years, the U.S. economy has spent approximately 70 months in a recession, and the Canadian economy has spent approximately 44 months.

Another point to make on the graph (linked to above)is that in the past 45 years the US economy has spent almost 13% of that time in recession (with Canada only spending about 8% of the time in a recession). During the last 45 years, investing in the real estate markets (both Canadian and U.S.) with a long-term view has been lucrative. Sure, if you tried to time the market, and sold at the wrong time due to headlines or rumours you could have lost a ton of money; however, investing based on fundamentals has lead to major gains despite the US economy being in recession almost 13% of the time. Don't buy into the hype and fear.

The fact of the matter is the economies and real estate markets must self-cleanse by taking short breaks that weed out the pretenders. But look at this: from the flip side (in Canada's case), for the past 45 years, 91.8% of the time we were not in a recession and we experienced growth. I like those odds.

By all measurable factors, our research still indicates that the Canadian economy is 'well positioned' to weather the economic storm. We'll still see waves and turbulence, but that will just shake out the emotional short-term investors and provide us with better opportunities. Over the past years, the Canadian economy has managed to create budget surpluses while managing to reduce our debt burden. As well, our unemployment is near its lowest level in 33 years with more Canadians working than ever before, despite the slow-down in manufacturing.

Currently, the Canadian economy is experiencing its second longest period of economic expansion, and business investment into Canada is entering into its twelfth year of growth.

Sure, if the U.S. enters into another recession (the debate is still out if they are currently in one), we will feel an impact but, as the research graphs linked to above show, it does not necessarily correlate that the Canadian economy will follow suit. Keeping a long-term perspective during this time will help you sleep at night. Pick your investment regions well, let your system work FOR you by asking the key questions from the Property Goldmine Scorecard (found in Real Estate Investing in Canada).

Now is a great time to find some select properties in Top Investment Towns and to take care of some clean-up projects, improve your management and buying systems, improve your marketing, strengthen the relationships with your team and tenants, and line up more Joint Venture capital.

Congratulations on not getting too high when the market goes up quickly or too low when the market goes through its inevitable gyrations. By removing the obsessive 'Day-Trade' mentality out of your real estate investments, you will create amazing returns over the coming 7 years. Don't follow the masses unless you are happy with below average. The opportunities are there. Your job is to invest like a sophisticated investor and follow the fundamentals.

Financing Rental Buys
Peter Kinch

Using CMHC mortgage insurance can lower the interest rate on cash-flowing properties.

More real estate investors are making the shift these days from buying single-family homes or condos to multi-family apartment buildings. As an investment strategy, buying a multifamily building definitely has its benefits - the most obvious of which is that you are able to create some economies of scale by having only one property to maintain and one property manager to look after it.

However, there are differences between residential and commercial mortgages. First, the costs associated with commercial mortgages are much higher - interest rate, fees, legals, inspections, environmental studies and appraisals, for instance. Yet, there is one major exception - a Canada Mortgage and Housing Corp. (CMHC) insured mortgage. Read on to learn how the huge CMHC fees may become your friend as an investor...

Typically, anyone looking to get a Commercial mortgage is expecting to have to put more money down, pay a higher interest rate and a higher fee. But if you buy a good quality apartment building with CMHC insurance, the interest rate can actually be less than the best fully discounted rates available to residential buyers and often as much as two per cent lower than an uninsured mortgage on the same building.

When buying a residential property, high ratio insurance is available from one of four insurance companies, and the loan to value can be as high as 100 per cent. However, for most lenders, the fact that the loan is insured doesn't change the interest rate. With a commercial mortgage however, CMHC is the only player in the high ratio sandbox. With literally no competition, they can set their own rules. As such, they have compiled some intimidating fees and limiting rules to offset the perceived higher risk associated with insuring a commercial mortgage.

Loan to value ratios

To start with, there is no 'zero down' 100 per cent financing available with commercial real estate. CMHC will only go to a maximum of 85 per cent loan to value (LTV). If any component of the property is not residential (e.g. restaurant, dry cleaner, mixed use), then the loan cannot exceed 75 per cent. In fact, the non-residential components of the building cannot comprise more than 20 per cent of the gross floor area. And, unlike residential mortgages, CMHC will charge an application fee based on the number of doors you are buying.

Properties with one to four units will have an additional fee of $600 per door. Properties with more than four units have a fee of $150 per unit to a maximum of $50,000. In addition to these fees, the insurance premiums can be as high as 4.5 per cent of the loan amount on a mortgage that is 85 per cent LTV. If you want to extend your amortization beyond 25 years, there is an additional quarter point premium for every five years beyond 25 up to a maximum of 40 years (as long as the economic life of the building is at least five years longer than the amortization period). These premiums can be added to the loan amount, but are due and payable upon advancement of the mortgage.

Because of these additional costs, a lot of investors dismiss using CMHC as a source of funds. However, what a lot of people don't realize is the significant savings they can get on the interest rate. The major difference in rates stems from the fact that any lender who picks up this mortgage is effectively getting a CMHC certificate of insurance against the borrower defaulting on the loan. Even with the lenders factoring in some risk pricing, the cost of a CMHC-insured commercial mortgage is surprisingly inexpensive compared to a conventional commercial loan.

Hold or flip

The key to knowing whether or not a CMHC-insured commercial mortgage is right for you is the length of time you intend to hold it. If you are buying the property with the intention of flipping it within a year or two, then the fees and costs associated with getting it, do not make it worth while. However, if you are making the purchase as a long-term hold, then the lower interest rate will more than justify the additional costs after the third year or so.

Now you're probably thinking, "That sounds great - but what's the catch?" Well the catch is that you have to qualify for the CMHC loan. Or to be more precise - your property has to qualify - and the REIN™ could be the problem. One of the key areas that CMHC looks at is cash flow of the building, and this is the area that poses the single biggest challenge today.

Cash flow strategy

CMHC is fairly strict in its cash flow analysis of a building. They like to see a debt coverage ratio (DCR) of 1.1 for a building with one to six units, between 1.2 and 1.3 for more than six units and up to 1.6 for non-residential units. (Note: DCR is the ratio of income to debt; e.g., a 1.2 DCR means that there is a $1.20 of income for every $1 of debt. In other words - positive cash flow.)

Anyone who has tried to buy a multi-family building in Vancouver, Calgary or Edmonton recently will tell you that it is hard enough getting positive cash flow with 25 per cent down, let alone 15 per cent. So don't be surprised if your application for a CMHC -insured loan comes back at 65 per cent LTV or less. If this does happen, there is a way of dealing with it as long as you know that the rents are going up in your building (as is the case in many Alberta apartments these days).

Take the CMHC insured first mortgage at the discounted interest rate and low loan to value and back it up with a more expensive second mortgage at closing time. The interest rate and fee may be pricey for the private second, but if the rents go up enough to make the numbers work with CMHC - simply refinance out of the private mortgage once the cash flow matches CMHC's DCR requirement.

The only caution to this is that you must know what you are doing. If you have misread the market and your rents don't go up, you have to be in the position to carry that expensive second mortgage longer - so it is definitely not something to gamble with. Do your homework carefully.

Buying multi-family commercial buildings can seem fairly intimidating and costly at first, but once you understand the 'rules of engagement' and are comfortable with the inherent risks, you'll find it can be much more rewarding than buying single-family homes. Just ask anyone who has bought a few. If you do make the shift to the commercial side of the investment pool, at least you'll now have a better understanding of some of the rules of engagement

Peter Kinch is the owner and senior mortgage broker with Port Moody, B.C.-based The Mortgage Center - Canadian Mortgage Team. He is a co-author of 97 Tips for Canadian Real Estate Investors. Peter will be one of the key presenters at the upcoming REIN™ ACRE System program in Vancouver. Click here to read all the details. This article was prepared with the cooperation and help of Neil Shopsowitz at Centum Capital Group Inc.

Corporations From Other Provinces
Barry McGuire

If you want to buy real estate in a corporate name in a province other than where you are incorporated, that corporation must be registered in your target province or open up a unique corporation in that province. For instance, if you are already incorporated in Alberta, then it's no problem; however if your corporation is formed in another province, say Ontario, and you want to buy real estate in Alberta, then you have to 'extra provincially register' your Ontario corporation.

The process is fairly simple although there are a few pitfalls. To extra provincially register your Corporation in another province you need to send certified copies of your current incorporating documents to the Corporate Registry in your target province. If all is well, your Corporation will be give 'extra provincial registration.'

Recently, one of our British Columbia members wanted to use his BC Corporation in Alberta. His deal was closing in 10 days. I explained the above process to him. His BC lawyer sent us certified copies of BC incorporating documents. Meanwhile we had done a name search on the name of his BC Corporation. Unfortunately the name of his BC Corporation was already in use in Alberta. Our member gave us a couple of other names to try. We searched those names in the database and found that they were also taken. Finally it was decided to simply assign a number to his BC corporation here in Alberta. The result was that Acme Holdings LTD, is now known in Alberta as 1234567 BC LTD.

Meanwhile, of course, we had already received mortgage instructions from the lender in the name of the existing BC Corporation. We had to get back to the lender, explain the difficulty and ask for new mortgage instructions showing the name of the new extra provincially registered Corporation. It took the lender three tries to give us instructions we could live with. This process, from beginning to end took three weeks. Fortunately our member was able to obtain an extension to the closing date.

Summary:

1. If you want to use an existing corporation to buy real estate in another province, you must, "extra-provincially register" that existing corporation in the new province. This process takes some time.


2. To speed things up, once you make the decision to extra provincially register, you should immediately do a name search on your existing corporation to see whether that name is available in the new province.


3. Lenders do not necessarily know or understand this process. You should speak to your broker/lender and tell them you are extra-provincially registering. Get them the name of the extra-provincially registered corporation as soon as possible.

Barry McGuire is a Real Estate lawyer who has been helping Canadians for the past 35+ years. Barry is a co-author of the Canadian best-selling book 97 Tips for Canadian Real Estate Investors.

Final Thoughts
Don R. Campbell

Congratulations on staying on top of the market, and NOT getting caught up in the fear and greed that surrounds Real Estate. Remember this great quote from Warren Buffet, "Be fearful when others are greedy, and greedy when others are fearful." Right now is a great time to take calculated actions and buy well- selected Real Estate in fundamentally strong towns.

Once again, by focusing on long-term fundamentals and not short-term day-trading mentality investors are doing incredibly well in regions all across the country. More listings are providing wonderful buying opportunities (many with cash flow) and those who study the Real Estate Insiders' research know exactly where to buy and where to avoid.

We are currently working on a substantial amount of exclusive research; our growing research team is working at full speed. As a matter of fact, February - April will see a huge amount of this research being released, including a major report update covering the recent Gateway program (this will be released at the Vancouver ACRE System) and the new report outlining the transportation changes in Toronto and the GTA.

All of our research is designed to help you become a knowledgeable and sophisticated investor who is not looking at the market through rose colored glasses, and help cut through some of the doom and gloom headlines in the media right now.

We'll tell you the truth about the market, so you no longer have to guess - you'll know. This research is coming quickly, so please feel free to forward this edition of the newsletter to everyone you know who would find value in having this knowledge. Then they can subscribe to this newsletter (and receive the early-bird notification of this research release) by clicking on this link and completing the form.

Suffice it to say, knowledge is incredibly important right now, and because we REFUSE to sell property to our clients, we can remain totally unbiased.

See you on myreinspace.com and we will see you at the next ACRE System program in Vancouver. And if you are in Edmonton on Thursday, February 7th, come to a special real estate discussion panel outside the Chapters Bookstore at West Edmonton Mall at 7:00pm. Bring your questions.

Sincerely,