Commercial Leases and the Right to Subrogate

By Brian Madigan LL.B.

An interesting issue arises in most commercial leases. The Landlord will arrange to obtain a policy of insurance to protect it against various risks and perils including damage by fire.The Tenant occupies the premises and may be the party who either caused the fire or should have been able to prevent it.

The fire results in damage to the Tenant’s leasehold improvements and chattels. Usually, the Tenant will have his own insurance. The fire was bad enough, but what about a claim to pay for the landlord’s damages? Is this fair?A point in issue, is that under most commercial leases the Tenant was paying for this “cost to the Landlord” all along under the TMI (taxes, maintenance and insurance).

So, in effect, the Tenant would be reimbursing the Landlord monthly for the insurance premium, and then again, by paying for all the damage caused by the fire.Let’s have a look at a case in the British Columbia Court of Appeal North Newton Warehouses Ltd. v. Alliance Woodcraft Manufacturing Inc., (2005).Alliance was negligent by storing flammable products which resulted in a fire and substantial damages to the North Newton building.

Clauses in the Lease

Here is the actual wording under various clauses of the Lease:

clause 8.3(a):

The Landlord shall, during the Term and any renewal thereof, take out and maintain in full force and effect insurance against all risks of physical loss or damage to the Building, and such fixtures and improvements as the Landlord shall determine, including the perils of flood and earthquake and including gross rental value insurance, in amounts equal to the full insurable value thereof calculated on a replacement cost basis, and subject to such deductibles as the Landlord may reasonably determine. Provided however that the full insurable value shall not include, and the insurance shall not cover, any property of the Tenant, whether owned by the Tenant or held by it in any capacity, nor Leasehold Improvements nor any other property of whatsoever kind and description located at the Premises whether made or installed by or on behalf of the Tenant. The Landlord shall, upon 30 days' written notice from the Tenant, advise the Tenant of the amount of the deductible referred to in this subclause.

Clause 8.3(d) provides:

Notwithstanding any contribution by the Tenant to any Insurance Costs as provided for herein, no insurable interest shall be conferred upon the Tenant under policies carried by the Landlord.

Clause 10.1(b), which is of significance in this case, requires the tenant to repair at its expense all damages caused to the premises by its negligence:

Except as provided in subclause 10.1(c), if the Premises are damaged by fire or other casualty not caused by the negligence of the Tenant or those for whom it is responsible in law, and the damage is covered by insurance held by the Landlord under this Lease, then the damage to the Premises shall be repaired by the Landlord at its expense provided that the Tenant shall, to the limits of insurance it ought to have received under the terms of this Lease, be responsible for any costs in excess of insurance proceeds received. The Tenant shall, at its expense, repair all Leasehold Improvements and any installations, alterations, additions, partitions, improvements, and fixtures made by or on behalf of the Tenant and all damage caused by its negligence or the negligence of those for whom it is responsible in law.…

The Court Decision

The Court stated, referring to another case:…It is well established that a covenant to obtain fire insurance will relieve the beneficiary of the covenant from any liability for the fire losses that may be suffered by the covenantor....

This statement appears to accord with the leading decisions on this issue, a trilogy of Supreme Court of Canada decisions: Ross Southward Tire Limited v. Pyrotech Products Limited, 1975 CanLII 25 (S.C.C.), [1976] 2 S.C.R. 35, 57 D.L.R. (3d) 248; Agnew-Surpass Shoe Stores Limited v. Cummer-Yonge Investments Ltd., 1975 CanLII 26 (S.C.C.), [1976] 2 S.C.R. 221, 55 D.L.R. (3d) 676; and T. Eaton Company v. Smith, 1977 CanLII 39 (S.C.C.), [1978] 2 S.C.R. 749, 92 D.L.R. (3d) 425.

The following represents the discussion of the legal principles by the Court:

• These cases afford support for the proposition that where there is in a lease a covenant by a landlord to insure, the tenant should benefit from it unless there is something inconsistent with such a result contained in the lease document.

• Here the tenant Alliance has paid the landlord an amount for the insurance obtained by North Newton covering fire damage to the building.

• It seems to me that, as Laskin C.J.C. observed in the Ross Southward case, a tenant who has paid for an expected advantage as between itself and its landlord should benefit from those payments, and loss issues thereafter are between the landlord and its insurer.

• In such circumstances, to allow the insurer of North Newton to pursue its subrogated action against Alliance would render nugatory benefits accruing to the tenant under the covenant of the landlord to insure.

• Ultimately, the policy rule underpinning the proposition that the insurer cannot pursue a tenant for damages in circumstances such as those present in the instant case is based on the proposition that it makes little business sense for a landlord to covenant to insure and for a tenant to pay the premiums if the tenant is not to derive some benefit from the insurance.

• One might properly say that there is something approaching a presumption in favour of a tenant benefiting from a landlord's covenant to insure.

• That is the legal principle that I take to be established from the trilogy of cases decided by the Supreme Court of Canada.

Comment

This case went to Court largely because two common clauses were not inluded for the benefit of the tenant, and they are:

1) additional named insured, and

2) waiver of subrogation.

You will appreciate that in this case, it is not really North Newton as the Landlord suing Alliance Woodworking its Tenant, although that’s what the Court documents say. It is the Landlord’s insurance company suing the Tenant’s insurance company for reimbursement of its loss.

Most of the time, careful practice would have the Tenant require the inclusion of a provision to the effect that he is to be added to the Landlord’s policy as an additional named insured. It is trite law, that the insurer cannot seek remimbursement from its own insured, so that’s generally the end of it. In some cases, the parties do not wish to have the Tenant added to the policy, so the second best solution will also work. This is to have the insurance company agree to waive its right of subrogation as against the Tenant.

Subrogation is the right of the Insurer to “stand in the shoes” of its insured and sue anyone that the insured might have been able to sue. Here, the insurer will agree that it will not sue the Tenant, but it can still sue anyone else.In this case, the Court concluded that even absent those two usual safeguards for the tenant, the tenant would still be protected from ultimate liability. Simple payment of the insurance premium as part of the TMI was considered to be sufficient. Application for leave to appeal to the Supreme Court of Canada was denied.

However, if you are a tenant negotiating a lease, still include the “additional named insured”, and “waiver of subrogation” provisions.

Brian Madigan LL.B., Realtor is an author and commentator on real estate matters,

Coldwell Banker Innovators Realty

905-796-8888

http://www.ontariorealestatesource.com/

Great areas in the GTA

Please Note: Click on picture to enlarge

By Brian Madigan



It is rather interesting to have a look at this particular map and chart. It shows areas that have performed well over the last few years.



The most important information, of course, is to note which areas have underperformed. Unless there is a very good reason for this, these will be the areas which will play "catch-up" in the future.

Brian Madigan LL.B., Realtor is an author and commentator on real estate matters,
Coldwell Banker Innovators Realty
905-796-8888
http://www.ontariorealestatesource.com/

Looking for a Good Location: Buy a Business!

• 
  
  By Brian Madigan LL.B.
  
  One of the most difficult things to find in real estate these days is a good location. All the best spots are already gone.
  
  So, what should you do? You might consider actually buying a business. This way, the location is suitable, and the lease with the Landlord is already structured. In fact, it might be quite favourable.

Let’s assume that you wish to set up your own small restaurant or café. The problem that you will face is that if you are looking for an established area, all the restaurant locations are gone. Why not consider something compatible? Look for a coffee shop, a bakery or other food related premises. You might find some, with good terms remaining on their leases. And remember, you now have a guarantor for your new business. You don’t need a friend or a relative, you have the former owner. This may be all you need to get into the business.

Then, you will have to evaluate your costs of conversion. You took over an old bakery, but you want an upscale restaurant. The kitchen is in place, the washrooms are in place as well as other ancillary services. Also, don’t forget about the zoning, it’s in place and permits a food related business. You’ll have to double check here, but it should work. One word of caution, if you are in a plaza, the owner may have promised that there would only be one restaurant, and you’re supposed to be a bakery. So, you still need to do your “due diligence”.

Buying an established business can be one of the best opportunities to secure:

1) A prime location
2) A guarantor for your new business
3) Ideal zoning
4) Minimum downtime associated with conversion and start up
5) Beneficial financing from the vendor

Very often, these basic business opportunities are overlooked, because buyers are either seeking to rent premises directly from the Landlord or expect to carry on with the old business “as is”.

Don’t miss out on a good location. Buy an old business and convert it!

Brian Madigan LL.B., Realtor is an author and commentator on real estate matters, Coldwell Banker Innovators Realty 905-796-8888

http://www.ontariorealestatesource.com/

Caledon Heritage Property

By Brian Madigan LL.B.

This is an excellent Heritage House backing onto the Credit River in Cheltenham.

It's well worth the drive. It has commercial zoning, so you may use it either as a residence or for commercial purposes.

Consider some of the possibilities when it comes to the commercial opportunities:

Personal services

Bed and Breakfast

Upscale spa

Hair Salon

Medical Offices

Medical Clinic - physio, chiropractic, nutrition,

Dental Clinic

Vetrerinarian

Professional Offices

Lawyers

Accountants

Insurance

Real Estate

Education and Training

Private School

Corporate Training

Actually, there are endless possibilities. If you have something in mind, and you're not quite sure, then please give me a call and I'll see if it fits. Actually, a funeral home and automotive repair are both allowed, but I don't like the idea, so if that's what you have in mind, don't call. At least, don't call about this property, it's far too nice, but I have others that might work.

Brian Madigan LL.B., Realtor is an author and commentator on real estate matters,

Coldwell Banker Innovators Realty

905-796-8888

http://www.ontariorealestatesource.com/

Five Financial Reasons for Owning a Home

By Brian Madigan

So, you think that you would like to buy some real estate! In particular, you would like to buy a house.Let’s summarize the principal financial advantages:

1) use of rental income

2) use of leverage

3) forced savings

4) appreciation in value

5) tax free capital gain

Use of Rental Income

Let’s face it, you have to live somewhere. So, you will probably start out renting something. Here, you’re just paying off someone else’s mortgage. In the long run, they own the property, and you have nothing, but you paid for it.

So, it makes sense to buy something, even if it’s not quite as nice as what you could afford to rent. You just use the same money that you would otherwise have paid in rent.

This is basically free investment money, and it makes a lot of sense to use it.If you’re planning to rent, do so only over the short term, that’s for a year or two. Clearly, if you plan to be in one place for three years or more then you should consider buying.

Use of Leverage

Here is an opportunity to use “other people’s money”. Donald Trump loves this approach. Assuming you plan to get into the market but you think that the prices are a little high. This is typical, your parents and grandparents thought the same thing.

What is your real opportunity cost? You were planning to buy a $300,000 home. You have $15,000 saved, but you decide to wait one year. What happens? If the market goes up 5%, that same house is now worth $315,000 one year later. If you put your $15,000 into a high yielding bank account you received $750 in interest. And, it’s fully taxable, so you only have $375. That means that you had to save another $14,625 somewhere else just to buy the same house.

However, if you bought the house last year, you would have used the bank’s money to secure a first mortgage at favourable rates. This would enable you to participate in the increase in value and not fall behind Your profits are based on the total investment in the property, yours and the bank’s. The increase is based on the full $300,000 asset.One other way to look at it, is the ‘cash on cash” return. Here, you invested only $15,000 of your own money and you made an extra $15,000.

So, that basically means that you doubled your own money in one year.On the other hand, if you passed on the property and without the principal of leverage working for you, you would have made $750 on your money in the bank, and been left with $375 after tax.So, what’s the difference? Basically, $14,625 after one year, if you use leverage.

Forced Savings

If you have a mortgage, it will fundamentally operate as a forced savings plan. Assuming that you obtain a 25 year amortized mortgage, you will pay both principal and interest in your payments. After 25 years, it’s paid for! No more payments, you own the property.

So, in our example, after 25 years, you were forced to save $285,000 just by having a mortgage. Remember, the first $15,000 was your money, and the bank financed the balance. Your new asset results from the principal paydown provisions contained in your mortgage.

Capital Appreciation

Property values go up over time, and so does everything else. Part is simply due to inflation and the devaluation of the dollar, and part is due to increased scarcity.

Your plan by purchasing property is to:

1) keep up with inflation, and

2) participate in an equity increase due to the increased demand for your property in the future.

What might you expect? You know, there’s 1,000 years of history to suggest that real estate values double every 20 years. That’s about 5% every year. You have to remember that over a 20 year period, you will likely have at least 2 business cycles (maybe 3) and you will have experienced a boom, bust and recovery. However, all in all, you are still left with a doubling in value every 20 years.While you really don’t profit with the inflation protection, you can profit substantially if you purchase well-selected property.

And, historically just about all properties seem to be in higher demand, not simply the very best ones. Unlike the stock market, it’s hard to get a bad piece of property.

Tax free Capital Gain

Our present system of taxation exempts a principal residence from the imposition of capital gains tax. So, our system is a little different from the United States where they can deduct mortgage interest yet they are taxable on the future gain. This is the system in place here for investment properties.

One of the most significant features and biggest advantages under our Canadian tax laws is the principal residence exemption. The moral here is that you should buy the biggest and best house that you can possibly afford.

Brian Madigan LL.B., Realtor is an author and commentator on real estate matters

Coldwell Banker Innovators Realty Brokerage

905-796-8888

www.OntarioRealEstateSource.com

Conditions and Escape Clauses

By Brian Madigan LL.B.

There is always a great deal of confusion and discussion concerning conditions and escape clauses contained in agreements relating to real estate. But, it is really rather straightforward and the documentation depends upon how the escape clause was written in the first place.

There are really just two categories:

1) pending deals (which require confirmation), and



2) confirmed deals (which include an escape).



Pending deals are generally described by a condition precedent clause, and confirmed deals with a provision for escape are evidenced by the condition subsequent clause. The condition precedent clause begins with the words “this agreement is conditional upon….” and the condition subsequent clause begins with the words “the purchaser shall have the right to terminate…”.

Conditions Precedent

There is no deal, until the condition is fulfilled, satisfied or waived. Usually, the condition will relate to a specific matter like mortgage financing or the physical state of the premises. Once it is satisfied, then in order to confirm the transaction and make sure that there is a binding agreement between the parties, this matter needs to be documented within the relevant time period.

This documentation can be accomplished in several ways which include either both parties signing or just one party signing. If a waiver provision has been included since the condition might be to the benefit of one party only, then a Waiver can be executed by that party alone. In many cases, realtors will often have both parties execute an Amendment deleting this clause. This is unnecessary.



True Conditions Precedent



This is a sub-category of conditions precedent, but it is rather unique in nature. The condition benefits both parties. Examples might include the compliance with the provisions of the Planning Act or registration of a condominium. If a vendor and purchaser enter into an agreement to convey a piece of property that is to be severed from a larger property and it doesn’t get severed, then there is no deal. Same thing is true with respect to a condo.

If a purchaser were to offer to buy an apartment on the 27th floor of a building and it never gets registered then there is no deal. No one can waive this requirement. It benefits both parties. And, both parties cannot waive this requirement because there still is no severed property or apartment on the 27th floor. The actual decision is out of their hands and rests solely with a third party.

Another example might be a condition related to the assumption of a first mortgage upon the consent of the first mortgagee. If the mortgagee doesn’t consent, then there is no deal.

Here, the only step that can be taken by the parties is to extend the time to permit fulfillment of the condition. They cannot waive the condition itself or delete the condition in the case of the Planning Act example or condominium example. In respect to the first mortgage assumption, both parties could delete that provision and agree to a new first. So, when drafting such a condition concerning mortgage financing, it would be wise to be aware of the rules related to true conditions precedent.

It is also noteworthy that almost every new condominium agreement of purchase and sale contains a true condition precedent clause.

Conditions Subsequent

In this case, the deal has been struck. The contract is binding but it does contain an “escape clause”. The buyer has for example the right to terminate the agreement upon certain conditions. These are all the same reasons that you might have included in a condition precedent, ie. mortgage financing, condition of the premises etc.



The advantage is that if you do nothing, the deal is a “go”. So, when the relevant date arises, there is actually nothing to do. You simply allow the time period to expire, no running around getting document signed, nothing like that. However, this doesn’t seem to influence many realtors who insist on having either waivers, fulfillment statements or amendments deleting this clause signed. The purpose of this clause in the first place was to eliminate all this extra paperwork.

The leading case dealing with all three types of conditions was Turney vs. Zhilka in the Supreme Court of Canada in 1959. The Court preferred the use of conditions subsequent. Within about 10 years the Law Society adopted conditions subsequent as the preferred way of doing business (except when a true condition precedent was required). The real estate industry never adopted the change. As a result, the Law Society went back (about 20 years later) to using both types and that arrangement continues to the present time.

Brian Madigan LL.B., Realtor is an author and commentator on real estate matters,
Coldwell Banker Innovators Realty, Brokerage
905-796-8888
http://www.ontariorealestatesource.com/

Rate of Return Analysis: Looking Both Ways

By Brian Madigan

There are three (3) distinct approaches when it comes to the valuation of property:

1) cost,
2) direct comparison, and
3) income.

The cost approach is the best way to value a newly constructed building. The cost of the land, the cost of the building and a profit margin are tallied to provide a figure. The feasibility probably has to be tested through the direct comparison approach. In essence, is it saleable? If so, then a builder will accept the risk and proceed with construction.

The direct comparison approach works best for resales, that is, if there are plenty of accurate and suitable this particular approach becomes.

Sometimes, however, the building is not just a building. It’s a business, it makes money, it produces an income or a return for its owners. So, how is that property to be valued? Does it really matter about its cost? And, the proper comparative property suitable for the direct comparison approach will be another income producing property with the same return.

So, that begs the question: how do you figure out the return on the investment?

We really have to look at three separate rates:

1) direct capitalization rate,
2) yield capitalization rate, and
3) discount rate.

This is a rather simplistic approach, but nevertheless, most other and more sophisticated analyses really just involve a greater degree of inputs to minimize the risk of the guesswork inherently involved in the process.

The direct capitalization rate is forward looking. It takes the current facts and assumes that those facts will continue without interruption in the future. All things being equal, it’s a best guess of what’s to come.

The yield capitalization rate and the discount rate are somewhat different. They look back from the future. It’s like looking in a rear-view mirror! They make the assumption that you have experienced the expected returns, and if that were the case, then what was your rate of return? All things being equal, it’s the best guess of what happened.

It’s important to realize that neither approach is really any better or worse at predicting the future. The only difference between them is the math. That’s the only science to it. The art is the guesswork! And, whoever is good at that, will be the better investor.

The Direct Capitalization Method

This is really the common, basic, standard and simple method of tackling the rate of return question.

In order to figure out the cap rate (according to this formula) you need to have a sale price and some income. What is the percentage return? A $ 100,000.00 property producing $ 10,000.00 in annual income will yield 10% of its value annually, and will have a 10% cap rate. If the income were $ 8,000.00, this would yield a percentage return of 8 %, and a cap rate of .08 . Similarly, a $ 12,000.00 annual income would translate into a 12% annual percentage return and a .12 cap rate. The cap rate can be expressed as either a percentage or a decimal.

The constant here is the value of the property. However, the nature of the building should change somewhat. If you’re getting an 8% return, then the building is probably low risk. It’s well-built, good construction, fully-tenanted with triple A covenants and in situate in a good location.

If you’re getting a 12% return on your $ 100,000.00 building, then it’s higher risk than the first. It’s in worse shape, has poorer quality tenants and is sitting in a worse location. That’s the theory. If that’s not the case, then you should buy it.

There are some general formulas when you are dealing with the direct capitalization method:

Income
______ = Value

Rate

~~~~~~~~~~~~~~~~~~~~~~~

Income
______ = Rate

Value

~~~~~~~~~~~~~~~~~~~~~~~


Value x Rate = Income



The value proposition in the formula is relatively straightforward. It means the “sale price” or the purchaser’s cost of acquisition. However, it can also include adjustments to reflect the cost of improvements.

Income in the formulas refers to net income. It is not simply the last particular annual financial statement. The statement has to be normalized in some way. So, it really should be based on several years of statements to pick up items that appear periodically (but, not yearly). For example some items have to be replaced every 5 years, some every 10 years. As a result, a normalized operating statement of income (NOI) will include 20% of the first item and 10% of the second.

In addition, a vacancy allowance and bad debts will have to be taken into consideration. You first start with the estimated gross annual income. Deduct the allowances for vacancies and bad debts, to arrive at the effective gross income. Then, you must deduct the annual operating costs to arrive at a net operating income. This is still before depreciation. It is also before the owner’s personal income taxes.

What about TMI (taxes, maintenance and insurance)? Sure, they all have to be factored in and accounted for in the calculations. If there is a vacancy, not only will the owner be losing the income, but will also be obligated to attend to the expense of the TMI personally.

As the cap rate increases (assuming that we knew what it was) the value of the building decreases. The cap rate bears an inverse relationship to the sale price or the value.

Consider, a building producing $10,000.00 in annual value. What’s its value? Look at the application of the rising cap rate!

Cap Rate Income Value

.08 $ 10,000.00 $ 125,000.00

.10 $ 10,000.00 $ 100,000.00

.12 $ 10,000.00 $ 83,333.33

In other words, the purchaser who wants a 12% return can only afford to pay $ 83,333.33 because the income is not changing. Someone content with a 10% return could afford to pay $100,000.00, and someone who was simply willing to accept an 8% return could pay as much as $125,000.00 to achieve this result.

Obviously, the mindset of the prospective purchasers will be an important factor in determining the price.

How much is it worth? Well, what else can people do with their money?

Yield Capitalization Method

This method looks back from the future and places a present value on the stream of income. The direct capitalization method involves assessing a single year’s income and projecting it forward to achieve a value. The yield capitalization method will take a stream of income received periodically throughout a certain measurable period of time in order to determine the present value.

This method is somewhat more sophisticated. It can take into account variances in returns over time. Generally, the value will be established before tax. That makes sense because it’s the easiest way to compare two buildings. But, that approach alone omits an important factor, and that is, that all purchasers are not created equal. Some pay tax and some don’t. Most major developers have to pay income tax. A capital gain is not a capital gain if you are “in the business”. It’s simply “ordinary income” and must be paid annually at full rates. However, other prospective purchasers may not pay any tax at all, including pension funds, REIT’s, and non-profit organizations. Various offshore investment companies may pay limited or no tax in their own legal jurisdictions. So, it’s quite difficult to compare two similar buildings based on price when the issue of potential ownership is also relevant.

An Investor Analysis

Not everybody has to buy real estate. So, there needs to be a way to compare a real estate investment to something else in the marketplace.

If you loaned money on a mortgage or a bond, you would have a rate of return and at the end of the term you would get your money back.

So, an investor is looking for two things:

1) expected return “of their investment” (principal), and
2) expected return “on their investment” (interest).

Let’s consider an example and the various steps in the process. An investor sees an opportunity to buy a property for $ 150,000.00 and allocates land and building on an 20/80 basis. The land is worth $ 30,000.00 and the building is worth $ 120,000.00.

Here are the four (4) steps in the process:

1) Establish a rate of return “on” the investment

The investor needs to know what a reasonable rate of return would be. For example, the investor might conclude that he needs 10% on his money, because he has other opportunities available. This is the discount rate or a rate selected from other types of investments for purposes of comparison. More about discount rates later.

2) Establish a rate of return “of” the investment

The building has a remaining economic life of 40 years. Funds should therefore be returned over that period of time. The land will still be there, hopefully “as good as new” in 40 years.

3) Calculate the recapture rate

Divide the remaining economic life into 100% (just the building)
This will be 100/40 = 2.5%

4) Determine the overall capitalization rate

Add the discount rate applicable to the land value to the discount rate and recapture rates applicable to the building:

20% of land value at 10%
.20 x .10 .02

PLUS

80% of building at 12.5% (10+2.5)
.80 x .125 .10

____

.12

Here, the .12 is a 12% return. This may or may not compare favourably to other alternatives.

This method allows the investor to compare the investment potential of the property with a mortgage or a bond or similar financial instrument. The investor achieved a rate of return on his investment over time (interest) and he got all his money back (principal).

The Discount Rate

The one further issue of some relevance is the discount rate. It has nothing directly to do with the property. It is designed to be used only for purposes of comparison. In some cases, it is also referred to as the “opportunity cost”. At other time sit may be referred to as the “safe rate” or the “hurdle rate”.

The benchmarks used are usually safe, no risk investments like treasury bills or Government of Canada bonds. In other words, if you can get a 7.5 % guaranteed return for the next 20 years from a Canada bond, then you’re going to have to get that amount and MORE, if you’re going to invest in anything more risky than that. An investor will want to add up the risk components including; the risks inherently associated with the property (theft, vandalism, declining property values, competition etc.), the risks associated with illiquidity (loss of other opportunities) and the risks associated with poor management.

In the final analysis, it is a judgment call. The rate of return is 12%, that’s 4.5% more than the bond. Is it worth it?

Another very important question is: What are the discount rates other potential purchasers will apply to this transaction? What if you can get 7.5% as a safe rate, but they can only get 4.5% in their own country? Their safe rate is lower than yours. They will want this property more than you. They will apply a lower discount rate to this transaction than you will. The result, is of course, that they will outbid you for this property since it looks far more attractive to them, than it does to you.

Ok, that was simply for the first deal. They outbid you, got the property and changed the cap rates for that type of property. Now, you can redo your numbers and the newer lower cap rate will apply.

But, don’t feel too badly, maybe you already own some similar properties. Remember the inverse relationship between cap rates and sale price. All your properties just went up in value. Maybe you can now put on a new bigger mortgage and spend some time on an island in the south seas?

In summary, to value a building using the income approach, you will want to use two separate methods, direct capitalization (looking forward) and yield capitalization (looking back). Neither are right and neither are wrong, but they are both somewhat factual and objective. That’s the science to it. The art comes from the application of the discount rate which as we have seen is entirely subjective.

Brian Madigan LL.B., Realtor is an author and commentator on real estate matters,

Coldwell Banker Innovators Realty

905-796-8888

http://www.ontariorealestatesource.com/