FINALLY!! Moving into Commercial Property and need help

General Real Estate Investing
1

Ok,

It’s been a while since i’ve been on the forum so please be gentle (j/k). Anyway, straight to the point. After dealing with residential real estate for a while (4 duplex’s and 1 3-Family) I’ve decided to try my hand at commercial REI. I’ve jumped back on the boards getting tips from everyone and think i’ve found a nice property to take a look at. Tell me what you think (according to the agent):

Property: Two Story Brick 12 Unit: 8 2bd/ 4 Studios
SalePrice: $500k
20% DP: $100k

2bd: $650 p/u
Studio: $465 p/u
Gross rents per month: $7,060 (84,720 per yr)

Expenses:

Water: $236.58
Gas (2yr avg): $770.83
Electric: $624.83
Garbage: $50
Insurance: $166.67
RE Taxes: $463.25
Maintenance(5%): $353
Vacancy(5%): $353
TOTAL $3018.16

CapRate: 8.9%

Now, here’s where I’m having my FIRST problem. I’m not sure what to estimate as an “average” interest rate for a 12 unit prop or the perspective terms I may face like 15-30yr (hoping you all can help with ideas). I’ve used bank financing ONCE for my primary residence but never for commercial obviously.

ALSO, I’ve read that I can’t evaluate CREI as I would residential so the $100 p/u is a bit more flexible (ie: $75 p/u is acceptable). With this being said should I let $50-$75 p/u slide when I religiously went for $100 p/u in duplexes (granted they were pre-foreclosures)

If you can, please give me the bluntest answer possible as I don’t even want to see this prop if it doesn’t make sense. I’ve HEARD that 6.75 is a decent/average IR for CREI due to the Fed cutting rates but I’m not sure. Thanks ahead for your critique’s!!

2

First, let’s take a look at the deal:

Gross rents: $7,060
Operating Expenses: $3,530
NOI: $3,530

Mortgage: (30 yr, 7.5%, $500K) $3,496

Monthly Cash Flow: $34 or $3 per unit per month OUCH!

This is not a good deal. Not even close.

Remember, you should include the total purchase price in your cash flow evaluation. Someone is paying for that 20% - i.e. - YOU. Every property will cash flow if you put enough down and pretend that the downpayment is free. However, there is an opportunity cost to that money, certainly at least the interest that you could have made on it.

Now, for your question about financing. I applied for a commercial loan for 10 units yesterday. They quoted me 7.5%, which is a little under prime. I have heard people say that you can get a 30 year loan on commercial property and that is what I based the evaluation on. However, I have never gotten a commercial loan longer than 20 years.

Your numbers are off because you underestimated the expenses. How about advertising, legal fees, evictions, court costs, office supplies, damage done by the tenants in excess of the security deposit, capital expenses, entity maintenance, etc, etc, etc?

Good Luck,

Mike

3

Thoward,

I agree with what PropertyManager is saying, however there are things that could be changed to help. For instance if the market in your area allows, raising the rents, and passing the utility costs on to the tenant, could easily make this property cash flow an extra $1000 monthly.

This is one of those deals a person would have to really dig into in order to see the real deal.

Richard Stephens

4

with that ltv and dscr i’d suggest going to a greenpoint or a wells fargo near you, get a commercial LO and you should be looking at rates as low as current jumbo rates (6.5% give or take 100 b.points). if they cannot approve you at that dscr is actually below 1.2 you’ll be looking considerably higher as far as rates goes.

5

I can hear the alligator chomping already, run!!! There are 40 yr. terms on the secondary market if you are more concerned with cash flow as opposed to equity buildup. Also, check how you’re getting your cap rate. 84,720 (revenue) - 36,216 (expenses) = $48,504/$500,000 (sale price) = 9.7%. Maybe I’m missing something in your numbers but you may want to check that you’re using the right formula to get your cap. Good luck.

I would maybe start to think about it at $400,000, at $500,000 I don’t see how it could work.

6

Thanks everyone for the comments, its a great help. As far as the numbers go I haven’t gone much further then the numbers obtained from a listing printout (yes, from an agent) so I still have to go and prove the owner wrong in the numbers he’s provided (including the cap rate).

As far as my estimates, I’m thinking a sale price of $400k with a 20% DP @ 30yrs (7.5%) might work out.

i.e: $7,060/2 - $2,594.39= $77.96 per unit.

Now, the great thing about this is that IF i can swing it using the formula at this sale price, and using the estimates given from the seller (just for now but i don’t trust them) I would have an “extra” $511.84 a month for the cash reserves PropertyManager was speaking about AND to make up the $23 per unit i’m missing.

To answer Richards comments on rents, I looked into it and the average rent is $600 for a 2bd in the area (near college, subway, shopping, etc) so raising the rents isn’t an option currently but definetly in time. As for utilities, it seems as though they’re included in the rent currently. I’ve already made a couple phone calls and HOPE to have an idea what it might cost to split utilities between 12 units.

Jbaldwin-Not to sure how I feel about the equity. With the way the markets going now I would be a bit nervous to try and leverage it. BUT, I have been hearing that the commercial sector of the market has been relatively unharmed (any comments from the vets on this??). I figure if I can walk in for $400k then I have approx $75k in cash-out equity using residential standards. Thats a VERY comfortable cushion in my area.

7
I can hear the alligator chomping already, run!!! There are 40 yr. terms on the secondary market if you are more concerned with cash flow as opposed to equity buildup. Also, check how you're getting your cap rate. 84,720 (revenue) - 36,216 (expenses) = $48,504/$500,000 (sale price) = 9.7%. Maybe I'm missing something in your numbers but you may want to check that you're using the right formula to get your cap. Good luck.

Jbaldwin,

I think it is interesting that you “hear the alligator chomping” on his deal when this deal is better than yours using the same criteria. This deal has a positive cash flow $34 per month and yours had a $69 loss.

Also, the cap rate is only as accurate as the information you put in the equation. Garbage in - Garbage out. In the above instance, you used the expenses provided by the seller, which were pure fiction. Therefore, the cap rate is pure fiction. Additionally, the cap rate doesn’t tell you anything useful. IF (and that’s a big IF) you could get an accurate market cap rate, then you could compare your property to the market. However, that still doesn’t tell you how much money you will make, or if you will make any money at all. I never use cap rate - it’s just a big joke.

Mike

8

and on and on we go. if the cap rate is so wrong and misleading why does every investment bank, appraiser, magazine, etc use it as their way to evaluate properties?

also, why is it so hard to get an accurate market cap rate? talk to realtors, other investors, bankers, local development authorities, after that you should have a pretty good idea.

i don’t just use the cap rate when evaluating a property either. first thing i look at is the cap to see if it’s even in the ball park, after that i start plugging numbers into my software which takes into account all expenses and then i know what i’m looking at as far as cash is concerned. but again it’s not 50% of gross, all the banks i deal with use an 8-10% maintenance expense on top of insurance and tax expense. maybe i should introduce you to them.

9
also, why is it so hard to get an accurate market cap rate? talk to realtors, other investors, bankers, local development authorities, after that you should have a pretty good idea.

It is nearly impossible to get accurate market cap data for SFHs and small apartment buidlings because there is NO ACCURATE DATA pertaining to expenses.

Most realtors know almost nothing about rentals. Where did they get the expense data to determine a NOI for properties that have recently sold? Answer: they didn’t! Where does a banker get expense data to determine a NOI for properties that have recently sold? Answer, they didn’t. Again, all I have to do is look at your posts. You made the ridiculous claim that your maintenance expense was only $7 per month and that any other expenses were too infrequent to include in the expense data. That’s what almost all newbies do and why the vast majority of newbies fail. You also ommitted management expense (and a LOT of other expenses) because you were doing it for free. So, if a realtor were to use the expense numbers that YOU provided, the cap rate would be bogus. Since most other newbies fail, their numbers would be as bad as yours. Therefore, it is nearly impossible to get a cap rate that is accurate for SFHs and apartment buildings.

Mike

10

The first thing you always need to do when evaluating a commercial property is to request 3 years Operating History. Then, evaluate the numbers based on the properties history. (Average 3 years vacancies and expenses then inflate by 3%. The rents they are trying to sell you on are usually based on “next years inflated values” so, always

I don’t know what the typical CAP rate is in CT, however, 6% to 7% are usually what you’ll see on a high rise in San Francisco. 5+ units to under 50 are typically closer to 10 to 12% everywhere.

As a commercial mortgage banker and investment consultant, we usually use the recent sales in our area, which divulged the properties historical NOI, the proforma NOI, and the Sales Price, from which of course we can see what ACTUAL typical CAPs are in our markets.

Your expenses are too low. You do need management in there, and you do need to argue for a higher CAP rate/lower price.

Check a Mortgage Banker for best rates. Be sure not to go to a residential mortgage broker advertising commercial loans. A good one will advise you on the “deal” you are or are not getting on a property, rather than taking a loan application and saying yes or no. Also, they’ll shop your deal and find you the best rate. On something that size, a good rate is 6.5% to 7%, depending on other factors.

Proforma Income $84,720
Less Vacancy @ 5% 4,236 although I would figure 8% unless
Operating History dictates 5%.
Effective Gross Income 80,484

Less Total Expenses 27,746 although I would estimate higher
w/o 3 years Oper. History*1.03
Less Management @8% 6,439

Net Operating Income $46,299 @ 10% CAP $462,999 MAX

Less DSC @ 6.75% 28,828 That is where I’d be
@80%*462,999)
DSCR 1.6
Before Tax Cash Flow $17,470

Tracy