Deal Eval

I know this is not a deal, but I’m wondering how bad it is. The reason is that it is part of the package and I’m getting a pretty good deal on the other property. So the question is how mispriced is the office building. Using the 2% rule and some other multifamily multipliers it is horrible, but I’m wondering if things are valued differently on the commercial side.

9 unit office building - 165 parking spaces
1 vacancy (500/mo potential)
Gross rents 10,900/mo leases up in 2.5 years…at all same time (don’t like that).

Taxes: 1333/mo
Insurance: 700/mo
Utilities: 2300/mo
Lawn/Snow: 400/mo
Maint: 200/mo
Mgmt: 200/mo (tenant manages they say)
Total: 5183/mo

Asking 997k

Thanks

Here is how I see it:

GOI:$10,900
Operating Expenses:$5183
NOI:$5717
Debt Service:$6633.07(30 year fixed @ 7%)
Cash Flow:-916.07 OUUUUUUUUUCH

So just by that analysis alone suggest this is a very very bad deal so I would run not walk away from this one.

so you feel it is about 150k overpriced? (150k over 30yr about 1k/mo).

is that how most commercial properties a bought? with even cash flow on 30 year notes? even flat cash flow seems scary to me.

what price would be a good deal on this office building? when I have that number I can see if the whole package makes sense. I think it is around 600, but I want to make sure I’m not being unrealistic.

Here’s the financial part of my evaluation:

 Effective Gross Income = $10900/month

 Expenses  = $5133/month (not $5183, you have a math error) 

 Net Operating Income =    EGI – Expenses  =  $10900 - $5133 = $5767/month = $69204/year

 Value assuming 10% cap rate = $69204/.10 = $692040 (assumed to be price paid)

 35% Down payment = $242214 (current LTV’s are 65% to 70%)

 Mortgage = Price  – Down payment = $692040 - $242214 = $449826

 Mortgage payment ($449826 amortized @7% over 30 years) = $2993

 Debt Service Coverage Ratio = NOI/Mortgage pmt = $69204/(12*$2993) = 1.9 (excellent)

 Cash flow = Monthly NOI – Mortgage pmt = $5767 – 2993 = $2774/month = $33292/year

 Cash-on-Cash Return = Cash flow/Down pmt = $33292/$242214 =  13.7%

A few comments.

  1. You note that one unit is vacant but don’t include any vacancy in your EGI. I assumed this is a wash in my numbers but in fact, in this economy, your vacancy will be substantially higher if you lose any more tenants.

  2. Operating expenses might be reasonable at 47% ($5133/$10900) but don’t include reserves. What do you get for the $200/month tenant manager? Don’t spend a dime until you confirm all the numbers.

  3. For the purpose of calculating the cash-on-cash return, I assumed your down payment is your total out of pocket expense and ignored due diligence and closing costs. These are typically 1%-2% and are minimal.

If you could buy this property for $600k the cash flow is $3172 and your cash-on-cash return is 18%, which is becoming interesting. The main problem I see is that you could go completely dark in 2½ years. Or, more than likely, your tenants will expect substantial rent discounts during this period and will know they have you over a barrel. The banks know this, so even thought the numbers might look good, they will be skittish to lend. If you have no experience with office space, they won’t touch you.

Only you know the quality of the premises and of the tenants. If the rental market were sound, you could have the current owner offer them lease extensions now for, say, the same rent. Their acceptance would be a condition of your offer. With the market the way it is however, they might just choose to wait.

At an average rent of $1362.50/month ($10900/8 tenants) I’m guessing the tenants are not IBM or Microsoft and they would likely choose to wait and then renegotiate fiercely toward the end, or simply move. If I were a renter, that’s what I would do. The current owner undoubtedly knows this which might be his reason to sell now. You can make the numbers come out as you wish, but you can’t make the tenants stay.

A word of caution about the buying retail and office space in this economy; if you haven’t already figured it out, business ain’t that good right now and tenants are dropping like flies. Drive down a busy street in any city and you’ll see more and more retail and office space for rent. It’s only getting worse and will continue to do so. This is the time to buy cheap, and a year from now might be the time to buy cheaper, but only if you know what you’re doing and only if you have the wherewithal to wait out the bad times.

Watch yourself.