First I would just like to thank you guys for all of the useful information on this site. I have learned so much from reading your posts and discussions.
So i was wondering if you guys can help me decide if this is a good investment opportunity. I have saved up a sum of money and I am looking to invest in something for the long run that will also provide me with a decent cash flow.
Its an 8 Unit property asking $263,000 I figured out the folowing information assuming they accept an offer for $250,000. It has 3 2 bedroom units and 5 1 bedroom units.
Purchase Price $250,000.00
Down Payment $50,000.00
Finance $200,000.00
Monthly Mortgage $1,135.00
Being coservative the 2 Bdr’s go for about $700/month and the 1 Bdr’s $500/month
The building was built in 1971 and most of the units have been remodeled in the past 3 years. If i figured the numbers out right it sounds like a great deal.
I don’t know what interest rate and loan term you are using for your financing, but a commercial mortgage for $200K will probably have an interest rate around 6.25% and amortized over 15 years. On these terms, the debt service on your mortgage will be $1715 per month.
Under the 50% rule, half of your rental income is needed to cover your operating expenses such as property managment, taxes, insurance, repairs, maintenance, vacancy and rent loss, advertising, leasing fees, cleaning, common area utilities, trash removal, dumpster rental, and any utilities not paid by the tenants and anything else specific to your property.
The other half of your rental income is your net operating income (NOI) and is needed to cover your debt service. Whatever is left over is your cash flow. Commercial lenders like to see an NOI at least 130% of your debt service. With an NOI of $2300 per month, your maximum allowed debt service will be $1769 per month, so you are just barely under than threshhold.
Under this financing, your scheduled rents give you $73 per month cash flow per unit. If this is not good enough, then you have to buy at a lower price, raise rents, reduce overhead expenses, or some combination of all three.
Now, what is the first year return on your investment for the $50K down payment you plan to make on this property? Provided your cash flow holds up and you have no extended vacancies or expensive repairs, you are looking at $7020 in pre-tax cash flow the first year, giving you a 14% yield. Is this good enough for you?
Ok i used a mortgage calculator for a standard home loan and not a commercial loan.
So the fees of a mangement company are part of the 50% rule?
I believe i can get more for the rents which will bring me to around $100 a unit. I would be happy with a 15% return on my 50K for the first year. It seems like a good investment where i can potentially make some cash in the short term and also the long term without requiring a lot time.
Yes, your rental operating expenses include managment fees. Under the 50% rule, you allocate the first half of your expected rental income to your operating expenses. The second half is allocated to your loan payments if you use financing. Whatever is left over is your pre-tax cash flow.
This is not a bad deal. However, don’t you think that you can keep some of that cash by financing some of the purchase cost and take a little less of as NOI. Take some of the $50K and buy more properties???
Where are the potential surprises on the property? Is there any deferred maint? What’s the occupancy now? What indicates you can raise rents?
You will not be able to finance this like a home, it’s a commercial asset. We’re seeing 25% down required, fixed over 5 years, amt over 15 in the high 6’s to low 7’s. If this is your first commercial investment, the bank’s going to require you have “dry powder” in an account at the the bank too.
You might get the seller to carry back some to alter the leverage ratios but candidly this isn’t the best of deals we’re seeing. You can expect a 30-40% IRR in many markets. Fall in love with the math, not the property.
A thorough lease/market analysis is important before running return rate numbers. It’s critical to understand the micro-lease market of the immediate area and whether there are any other competiting products coming on line (like shadow condo market or new completions of apartment construction). Your ability to make the debt service payment relies on the rents - don’t just sketch numbers on a page - know the truth, do the foot work first. Then get a commitment from a bank and re run the financing. Re run the AMT with a direct quote from a lender willing to give you $$ if the numbers fly and then see if your returns are where you want them to be. Always talk to the money man early unless you can close with cash. If you tender an offer to the seller without knowing where 75%++ of the money to close is coming from (and costing you), you put yourself in a weak negotiating position.