How to Underwrite Multifamily Investments in Ontario
How to Underwrite a Multifamily Investment in Ontario for CMHC Financing
The Ontario multifamily real estate market offers a world of opportunity for investors seeking cash flow and long-term appreciation. However, to maximize your returns and qualify for favorable financing—specifically through the Canada Mortgage and Housing Corporation (CMHC)—you need to master the art of underwriting. Thorough underwriting is the key to determining a property’s profitability, risks, and your qualification for financing options.
This post will walk you through the essential steps to underwrite a multifamily property with five or more units in Ontario. By the end, you’ll have the tools to financially analyze a deal and ensure it aligns with CMHC requirements.
Understanding Multifamily Investment in Ontario
Ontario’s real estate market, particularly in major cities like Toronto, Ottawa, and Hamilton, is characterized by economic growth, population increases, and strong rental demand. These factors make multifamily properties a lucrative investment, especially for seasoned investors looking to scale their portfolios.
Benefits of CMHC-Insured Mortgages
CMHC-insured mortgages are particularly attractive for multifamily investors:
Lower Down Payment Requirements: Leverage your capital more effectively.
Competitive Interest Rates: Save on borrowing costs.
Extended Amortization Periods: Enjoy lower monthly payments and improved cash flow.
Reduced Lender Risk: CMHC-insured loans encourage lenders to fund multifamily projects.
Stability in the Market: Insured mortgages help maintain market stability even during economic shifts.
To qualify for these benefits, however, you need to dig into the numbers and ensure the property meets CMHC’s financial and legal criteria.
Key Financial Metrics for Underwriting
Before we jump into our step-by-step underwriting guide, it’s important to understand the key financial metrics you’ll rely on during your analysis.
1. Net Operating Income (NOI)
NOI reflects the property’s profitability before financing costs:
Formula:
NOI = Effective Gross Income (EGI) - Operating Expenses
NOI is crucial for determining the property’s value and profitability.
2. Capitalization Rate (Cap Rate)
Cap rate helps assess the potential return on investment:
Formula:
Cap Rate = NOI ÷ Market Value
A higher cap rate indicates a potentially better return (but often with higher risk).
3. Debt Service Coverage Ratio (DSCR)
DSCR is used by lenders, including CMHC, to evaluate a property’s ability to cover its debt obligations:
Formula:
DSCR = NOI ÷ Annual Debt Service
CMHC generally requires a minimum DSCR of 1.1 for properties.
4. Loan-to-Value Ratio (LTV)
LTV determines how much financing you can secure relative to the property value:
Formula:
LTV = Loan Amount ÷ Market Value
CMHC allows for a maximum LTV of 85% for multifamily properties.
5. Operating Expense Ratio (OER)
OER measures the efficiency of managing the property:
Formula:
OER = Operating Expenses ÷ Effective Gross Income
Aim for industry benchmarks (typically between 30-50%).
With these metrics as your foundation, you’re ready to jump into the underwriting process.
Step-by-Step Guide to Underwriting
Step 1: Gathering Property Information
To begin, collect complete and accurate data about the property:
A detailed rent roll (including rental income history).
A record of all operating expenses, including taxes, utilities, insurance, maintenance, etc.
Information about the property condition and any pending capital expenditures.
Market data for comparable properties in the area.
Ensure the data is reliable—verify with seller-provided documents.
Step 2: Calculating Net Operating Income (NOI)
To calculate NOI:
Calculate Potential Gross Income (PGI): Multiply the total number of units by market rent.
Subtract Vacancy and Collection Losses: Use local market averages (typically 2-5%).
Determine Effective Gross Income (EGI):
EGI = PGI - Vacancy Losses
Subtract Operating Expenses: Operating expenses may include property management fees, utilities, repairs, and insurance.
Arrive at NOI:
NOI = EGI - Operating Expenses
Example:
PGI for a 10-unit building at $1,200/month = $144,000.
Vacancy loss (3%) = $4,320.
EGI = $139,680.
Operating Expenses = $55,000.
NOI = $139,680 - $55,000 = $84,680.
Step 3: Determining Capitalization Rate (Cap Rate)
Research the market’s average cap rate for similar properties. For example:
NOI = $84,680.
Market cap rate = 5%.
Market Value = NOI ÷ Cap Rate
Market Value = $84,680 ÷ 0.05 = $1,693,600.
Compare the property’s cap rate to the market to assess its performance.
Step 4: Calculating Debt Service Coverage Ratio (DSCR)
Example:
NOI = $84,680
Annual Debt Service (ADS) = $60,000
DSCR = NOI ÷ ADS = $84,680 ÷ $60,000 = 1.41.
This exceeds CMHC’s minimum DSCR of 1.1—qualifying the property for financing.
Step 5: Calculating Loan-to-Value Ratio (LTV)
Example:
Loan Amount = $1,250,000
Market Value = $1,693,600.
LTV = Loan Amount ÷ Market Value = 1,250,000 ÷ 1,693,600 = 73.8%.
This is well within the CMHC limit of 85%.
Step 6: Assessing Operating Expense Ratio (OER)
Example:
Operating Expenses = $55,000
EGI = $139,680.
OER = Operating Expenses ÷ EGI = $55,000 ÷ $139,680 = 39.4%.
This is within the industry benchmark of 30-50%, indicating efficient management.
CMHC Financing Requirements
To qualify for CMHC-insured financing:
The property must meet building code requirements.
Borrowers must demonstrate financial stability and provide personal guarantees.
Required documentation includes rent rolls, financial statements, market appraisals, and legal due diligence.
Legal and Regulatory Considerations
When investing in Ontario multifamily properties, be mindful of:
Ontario’s Residential Tenancies Act: Protects tenant rights and outlines landlord obligations.
Zoning Bylaws: Ensure the property complies with local regulations.
Environmental Regulations: Address liabilities such as asbestos or contamination.
Legal Due Diligence: Conduct thorough title reviews and contract evaluations.
Minimize Risks, Maximize Returns
To reduce investing risks:
Conduct thorough due diligence.
Use conservative financial projections.
Diversify your portfolio across markets.
Ensure legal compliance and maintain adequate insurance coverage.
Unlock the Power of Multifamily Investing Today
Underwriting multifamily investments in Ontario may feel like a complex endeavor, but with the right tools and understanding, you can confidently evaluate opportunities and secure favorable CMHC financing. Use the formulas and steps outlined here as your toolkit for financial analysis.
Now it’s time to take action—start exploring multifamily investment opportunities, crunch those numbers, and build your portfolio with confidence.
