Is it better to build and sell the property for immediate profit, or build and hold the property for long-term revenue flow?
Who is buying apartments today?
What Determines the Cap Rate?
- Occupancy level and length of stabilization.
- Location. Vancouver has some of the lowest cap rates in the country and Atlantic Canada has some of the highest.
- Construction type. Assuming equal net operating income (NOI), a concrete building should sell for a lower cap rate than a frame building because it lasts longer.
- Rent levels. New construction should be leased at or very near market rental rates. Meaning, the new buyer can’t raise the rents more than normal rental inflation.
- Lower Capital Expenditures. Since the building is brand new, there should be virtually no capital expenditures for ten years and maintenance and repair should be lower when compared to an older building. This positively affects the NOI.
New Apartment Cap Rate
- Is the building sold full, with two years of stable operating history?
- Has the building just been leased up?
- Is the building built and vacant?
- Or is it just a piece of land with a vision?
Better NOI Growth
A critical factor determining a new apartment building’s cap rate is its better NOI growth compared to the growth of its operating expenses. Inflation is a fact of life in North America, and over time a landlord can expect to raise rents (and thus his or her NOI) by a certain percentage each year, depending on market factors, government regulation, and so on. As buildings age, one can expect operating expenses to grow as well. Newer buildings are assumed to have better NOI growth because the older a building is, the more likely its operating expense growth will exceed its NOI growth.
When the operating ratio falls below 50%, the net income grows exponentially if both revenue and expenses inflate at the same rate. This is especially important and accretive in newly constructed buildings where expense ratios are typically below 35%.
Consider an older building where the half of its monthly revenue is eaten up by operating expenses. Year to year, operating expenses are likely to increase by, say, 5%, while the forces that limit rising rents will likely constrain NOI growth to just 3%. If operating expenses and NOI start on an equal footing, and operating expenses grow at 5% and NOI grows at just 3%, very quickly, the dollar value of operating expense growth exceeds the growth in the building’s NOI.
Now consider a newer building where operating expenses take up just 30% of monthly revenue. If operating expenses grow by 5% and NOI growth is constrained to 3%, the dollar value of NOI growth in the first few years increases, since 5% of 30% is lower than 3% of 70%. The chart below illustrates this.
All these factors above need to be taken into consideration when determining the cap rate for a new building. In summary, a fully stabilised concrete building in Vancouver should have the lowest cap rate in the country, and a vacant frame building in rural Atlantic Canada should have the highest cap rate.
Tell Us About Your Project
Global Director Buildings
Mansoor Kazerouni is an Architect with over 27 years of experience and a significant portfolio of projects completed or underway across Canada, the United States, the UAE, Jordan and India. These include high density high-rise residential buildings, hotels, office, retail, institutional, and complex urban mixed-use developments. A number of these projects have been nominated for and received Urban Design and Architectural Design awards.
Mr. Kazerouni is the Global Director of Architecture at IBI Group, leading a team of over 1,400 Architects, designers and Engineers located in 60 offices worldwide.
Mr. Kazerouni has been a guest lecturer on the subject of architecture and mixed-use design at universities, conferences and various panels. He has also been interviewed on the subject by newspapers, architectural publications, television and other media.
Mr. Kazerouni's abilities and expertise in his field have been recognized by his appointment to the City of Mississauga's Urban Design Advisory Panel, the City of Markham’s Urban Design Advisory Panel and the City of Vaughan's Urban Design Advisory Panel. He is also a past Advisory Board Member of the Urban Land Institute, a member of the Ontario Association of Architects, the Alberta Association of Architects, the Nova Scotia Association of Architects, the Architects Licensing Board of Newfoundland and Labrador, and a member of the Royal Architectural Institute of Canada. He has testified as an expert witness at the Ontario Municipal Board and at Arbitration Hearings related to development sites.
Darryl McCullough CCIM SEC
Broker - Royal LePage Lakes of Muskoka Realty Inc., Brokerage
President - Crescent Equity Management Inc.
Since 1972, I have been given the opportunity to interact with seasoned partners and clients in structuring and organizing both simple and complex real estate transactions involving acquisition, disposition, finance, and consulting in Canada and throughout the United States. It has trained me to bring a unique, personal client-centered approach to each assignment, from simple to complex transactions and the diverse clientele who own them.
In 1984 I received the Certified Commercial Investment Member, CCIM, designation (www.ccim.com); an internationally recognized identity confirming amortized knowledge in the disciplines of investment, development etc.
Another prominent membership I thankfully am able to continue holding is with the U.S. based Society of Exchanges Counselors (www.secounselors.com). This organization shares my belief in pursuing and demonstrating problem solving techniques in the real estate industry based on proven principles of integrity, professionalism, and accountability. Through this organization I continue to dedicate myself to what is true in the discipline of real estate problem solving.
Technology coupled with a learned research and analytical skill set now allows me to carry out these functions with selected projects from my adopted Muskoka home.
I continue to maintain an ever changing “student” learning status not only related to the physical asset, but equal or more importantly, drawing out corporate/personal situations and objectives and then knitting together ultimate benefit packages based on creative solutions via time honoured formulas.