Can you buy an apartment building for 5% down?

Yes, but just because you can doesn’t mean you should

I get asked this all the time, especially since the introduction of CMHC’s MLI Select program in March of 2022. Suddenly property owners were not just able to buy an apartment building for 5% down, they could in fact refinance and pull equity on existing projects.  This resulted in a FLOOD of applications as 95% of investors bought in and applied for max financing at a time when the overnight rate was only 0.25%.  Most investors were unaware that there would be a 4.75% increase in the overnight rate in the next 18 months.

Mortgage rates however are determined by bonds, and specifically the Canada 5 year government bond, and the Canada Mortgage Bond for CMHC (CMB).  The GoC was around 1.5%, meaning that CMHC loans could still be obtained at very low rates of around 2% to 2.5%.  By the summer of 2022 the GoC had risen to 3.5% where it has sat ever since.  Today’s CMHC rates are around 4.75% to 5% for a 5 year term, and are anticipated to fall sightly over the next 24 months, but nowhere near 2021 levels.

The logic (I am told) to leverage your building to the hilt, was that money was cheap, and over the long term your debt becomes an asset as the money you borrow becomes cheaper over time when it is eroded by inflation.  This has put many investors in dire straits with over leverage, negative cash flow, and rent increase restrictions from the affordable program.

The real reason for taking a 95% loan?  GREED, plain and simple. One can buy and control 5x the assets vs. the standard 25% down payment substantially boosting your return on investment, most notably the cash on cash (CoC) return.  This was a booby trap that many newbies (and veterans) fell into.

The BIGGEST downside is your inability to raise rents (and values) once you opt into the program.  I refinanced a property in mid 2022 and was told by my mortgage broker that out of all of their CMHC files, I was the ONLY one that applied for standard financing, and he could not understand why I would not opt in.  Today the reason is obvious, as I am increasing my rents by hundreds of dollars, while those who opted in have to sit and watch their values stagnate while my building soars in value.

The other downside, is that CMHC still uses 2019 income values to calculate median renter income.

That’s right – you can’t opt in to MLI Select unless your rents are at or below 30% of the real median total household income.  To give you an idea, here are a few of those ‘max’ rents for a few major urban centres you may be looking at investing in:

Toronto: $1348

Vancouver: $1673

Calgary: $1738

Edmonton: $1665

Saskatoon: $1090

So taking a look at Saskatoon, where the median renter income is $43,600 means that at 30% of that income, the renter can not exceed $13,080 in rents in a year ($1090).  This program does not make much sense today since rents a 2 bedroom are around $1600/month.  The $1090 rent applies to all units regardless of whether they are bachelor, 1 bedroom, 2 bedroom, or 3 bedroom. Perhaps a building that has greater than 5 units, with all bachelor units may qualify but not much else.

The reason the program was heavily utilised in Edmonton is that renter incomes are high, and rents (were/are) very low compared to the rest of the country.  At a median renter income of $66,600 a renter can pay up to $19,980 in rent per year, or $1665.  When the MLI Select program was introduced in March of 2022 rents in Edmonton were about $1200 for a 2 bedroom, so virtually every rental unit in town was able to qualify under the program. Fast forward to today, and within 6 months only some 1 bedroom, and bachelor suites will work.

Provided CMHC continues to use 2019 renter income levels, the program will become obsolete as rents in virtually all cities in Canada will be significantly higher and will not qualify.

So how am I supposed to buy a building today?  Well first of all, lets assume you were lucky (or silly) enough to purchase a project with 5% down. Closing costs on a typical 12 suiter will easily surpass $50,000 so your ‘5% down’ deal is actually more like 10% down and you are actually staring in the ‘hole’ in a negative equity position right out of the gate.

As investors we want, and demand some form of upside to our deal, as well as long term appreciation. Typically with some makeup we can make the building more attractive and get a large rental increase for our troubles, also known as the BRRRR strategy.  We need to be careful doing short term financing as the costs are high, and the rental market can swing down quickly while we are doing our upgrades.

A much better approach is standard CMHC or a conventional loan on a 5 year term with modest leverage (15-25% down), and implement a gradual improvement program while maintaining high building occupancy.  There are several reasons why this method makes sense:

  • You will have cash flow over the 5 year period.
  • You won’t get caught in a high vacancy, rent reduction period, or a half empty building if the markets turn.
  • You will have significant mortgage pay-down – Unlike MLI Select or a bridge loan where pay-down is essentially $0.
  • You will benefit from upside twice – first from the initial upgrade, and then lead the market in rent increases for the rest of the term.

I know everyone wants the big BRRRR, and occasionally this strategy with high leverage will work, but these deals are few and far between. The proven path ‘get rich for sure’ method described above is foolproof provided you buy smart with modest leverage, sufficient cash reserves, and a good plan.

Happy (long term) investing!

Cory Sperle