There was a time that investors wouldn’t dream of buying an income property unless it was a five cap. Nowadays that number can drop to under three.
My clients who buy duplexes and triplexes for investment only (not to live in), often ask me what is an acceptable cap rate in the City of Toronto these days?
It seems that there are no clear ranges for a good or bad cap rate, and they largely depend on the context of the property and the market.
There is an old rule of thumb that states your cap rate should be greater than your cost of financing: for example, if you have a 5% mortgage then a property with a cap rate below or equal to 5% is expected to be a money-losing investment. Most banks still offer rates below 3%, but I do not think that a cap
rate under three is an acceptable rate of return. You have to consider other investment alternatives that may yield better numbers. Remember too that the cap rate does not reflect the future value of any given asset. If you improve the property through renovating, it is possible to yield a higher return down the road, thereby justifying a potential purchase.
I have always been a four-cap guy. Despite how hot the housing market might be, I still like there to be some sort of appreciable return for my clients. When I see a stated cap rate of 3.5, I invariably know that it may be less as Sellers very rarely give us all the real expenses. It is not often that the net income is actually more than what is stated on a rent roll, but expenses are quite often more. That is why if I see close to a stated four cap, then it might actually be a real 3.5 cap. There are no rules to what your return should be, but anything under three would make me question a property’s overall investment value. I know that in a hot market like we have been experiencing, this has become quite difficult, but I still maintain that if a property is purchased for investment, that there has to be some sort of perceptible return.