All things being equal; right market, location, growth potential, etc…How do you know when a deal is a deal? Is it all about cash flow or do you also consider the time it takes to recoup your initial investment - I heard this recently.
Here’s an example
16 unit MFH
Price (willing to pay) $825,000
Adj Income - $113,240
Expenses (They’re saying $39K) - $50,000
NOI $63,240
W/20% down, annual debt service at 7% - $52,668
Other Expenses - $8000
If I’m doing my math right, this should cash flow at $23,640 per year.
($1973/Mo)
The total initial investment would be $222,500
(down paymt, closing cost (6%), inspections, etc.)
It will take 9 years to recoup the initial investment using this cash flow.
What do you think? What are the criteria to look at when determining a deal?
Hmmm… I don’t know, according to his figures he’s in ok shape. He’s got a cap of 9.6% and the dscr is just above 1.2. This is what most lenders are looking for to qualify on a good deal.
825,000 sales price
165,000 down payment=20% down
660,000 loan amount
7% loan@ 30 years
4,391.00 principle & interest
666,67 = 8,000 expenses
5,057.67 per month p&i & expenses
5,270.00 per month net operating income
212.33 per month cash flow
noi of 63,240 divided by sales price of 825,000= 8% cap rate
It does cash flow with the above assumptions but I would not consider it a good deal. It also depends on where you are at. Average cap rates in los angeles are 4-5 % but in texas this would be a lousy deal.
Please correct me if you see any errors. Thanks
I don’t see any math errors (ok, I didn’t even check the math), but I do question the assumptions. I don’t know where you’re going to get a commercial loan for 30 years at 7% in today’s market. In my experience, commercial lenders typically want to loan for terms of 15 or 20 years and the current interest rate is more like 8% to 9% (I know those were Steve’s assumptions, but I still think they are wrong). I also question not including the $165,000 down payment in the cash flow calculation. Of course, if you assume that there is no cost to that $165,000, then your cash flow analysis is correct. However, I always include the entire purchase price in the cash flow analysis because the downpayment came from somewhere. There is an opportunity cost to that $165,000. Putting $165,000 into this deal means that it’s not earning interest or otherwise making money in another investment.
Regardless of the math, I do agree with you that this is not a good deal.
Yet another example of how important it is to cash flow a property using the Cash In Vs. Cash Out approach. Paying 50K per unit for a place renting for $590 a month per unit is financial suicide.
I have not bought in over a year now so you are probably correct. The last deal I did was for $495,000 8 unit @ 6.75% for 30 years fixed. I have done nothing but commercial my last six deals and they where all 30 year fixed. I am in California is that maybe different than where you are I don't know? From what I have seen It seems to me that real estate prices are more in Cali but the financing is better.
I completely agree with your cash flow/down payment situation. To many people start playing fast and loose with the #'s when they want a deal to work because they fell in love with the building.
The 165K is the investment for the buyer. Like you said about earning interest elsewhere with this money, the buyer is choosing to put this money into a property with an expected return rate. Each investor has their own standards, some won’t deal without at least 20% roi which would be about 33k profit a year. Remember that when the property is sold, as long as it still has it’s purchased market value, the investor will get that 165k back. Not to mention the money that he earned on it during the time he owned the property.
In this case, if we assume Norm’s numbers are right and we assume he can get a commercial loan for 30 years at 7%, then the investor is getting a cash on cash return of a whopping 1.5% per year. Since he could easily get about 5% with a bank CD without the risk and headache of a rental property, then the opportunity cost (LOSS) on the $165,000 investment is 3.5% per year and that is if you think that 5% is the best return he could get on that money.
I was figuring a 30yr at 7% just as the original post suggested and yes these terms are definately out there for a 80% loan with good credit. With these figures he’s pulling in 63,240(noi) - 52,690(annual payment) = 10,550. That is a 6% return on his 165,000 initial investment if all goes well. Not less than a CD but definately not much more…
I think you missed the other $8,000 in expenses Norm listed. As I said in my post, I used his figures. Cash flow of $212 per month ($2,544 per year) divided by $165,000 for a cash on cash return on 1.5%.
From a financing standpoint, you can find commercial funding with loan maturities ranging from 20-30 years—last week’s pricing for a 5/30 was approx. 6.78%…
I didn’t factor in the other 8k in expenses but the original poster says the expenses are 39k in parantheses but he bumped them up to 50k to be conservative it appears. So I guess the poster needs to nail down the expenses.
The expenses of 8k are listed under the annual financing payments, seeing he’s putting those together logic would suggest his 8k figure is an estimate of the costs to close the loan. So if that’s the case that has nothing to do with the performance of the property in the long run, only the first year. Again though poster needs to clarify…