Can anyone help structure this deal. Offer price is $1,525,000 with Gross Operating Income at $263,912 and Expenses at $84,467 and seller is willing to hold a second at 25%. How can i put together an offer that includes the 25% seller financing and 75% conventional funding?
See if this would work for you.
Based on your numbers, you’re getting the building for 11.7% CAP rate. Most banks even if the seller is willing to hold a 2nd will want down payment from the buyer. This is how I would approach this deal.
Buy it for the $1,525,000 with the owner holding 25% in 2nd position, 20 year amortization at 7% interest = $35,469/yr ($2,955.83/mo) If you can get him to agree at a lower interest the better.
Put down an additional 25% ($381,250). I would look for a partner/private lender and pay 10% interest, interest only payments plus give 25-50% equity interest on the property. Your yearly payments on this would be $38,125.
The balance of $762,500 (50% of purchase price) will be bank financing on a 20 yr. amortization at 8% interest (if you can get it lower better). Payments will come out to $76,534.27/yr ($6,377,86/mo)
Combined payments on the 1st mortgage, 2nd mortgage, private lender/partner = $150,128.27
NOI of $179,445 - $150,128.27 = $29,316.73 Left over which goes to you. Plus, you own 50% of the building without pulling any money out of your pocket other than closing costs. Bank financing should be easier since the bank will be at 50% LTV.
Hope this helps. Good luck.
Sounds good! Thank You.
Thank you for the idea you gave.
I had a terrible time computing before but now I understood how it’s done. You explained it very well.
When your doing commercial property don't believe anything anybody say's or presents to you either verbally or in writing.
First, just because a seller presents you numbers written on paper does not mean they are correct! When I see expenses at 32% of gross income I know there is a problem as the rule of thumb for commercial property is 50% expenses and 50% to debt service! If you have any experience investing in commercial property you can look at the low expense numbers and know something is wrong?
You as the investor have to forensicly analyse the numbers your presented and you have to project your actual numbers to successfully manage and operate the project! Do not take any number your presented with a grain of salt as they are often incorrect and lack factual substance.
Probable all the expenses have not been covered and your numbers for short term (Physical Year) and long term (5 year or longer) prudent reserves for upkeep and maintence are not being met? My bet is someone has been using this property as a cash cow and has not been properly covering maintence and replacement cost’s!
Now with an adjusted net for debt capital at roughly $132k and I hope you have deducted from your gross an appropriate vacancy factor for the area, you can now estimate expenses to hold.
Always go after the largest available 1st mortgage as it is likely the cheapest money you will find, I figured these new numbers conservatively as you may do better in fact, I want to present numbers that are conservative! Remember if you manage to do better your a hero, if you do worse it will be the last time an investor will work with you?
New 1st 75% = $1,143,750 @ 7% 30 year due in 5 years - $7,609 mth or $91,308 a year.
New 2nd 15% = $ 228,750 @ 8% 30 year due in 5 years - $1,679 mth or $20,142 a year OC.
Estimated cash flow = $21,550 per year!
Now you need yourself or a partner to put up:
New partner 10% = $152,500 plus closing cost’s under what ever terms and conditions of a partnership agreement?
You are not going to find any new loan for more than a 5 year term for multi unit commercial property!
Wouldn’t the % of expenses depend greatly on each individual property? For example, maybe it’s a newer property, or was recently renovated, and with all new equipment and fixtures, the expenses are well under the 50% you say is average. That is not to say that maintenance reserves should be neglected, however. I would think this number is going to vary based on the condition of the property, and the market you’re in.
I think the best thing to do is look at a lot of properties and compare the numbers, and ask a couple experienced property managers if the numbers look right.
It just takes some common sense to invest in real estate, first I am not the guy to invent the theory that 50% of apartment income will be dedicated to cost's and expenses and 50% will be available for debt service and cash flow.
Actually portfolio investors, institutional investors, REIT investors, corporate investors, hedge funds, mutual funds, officers, directors, managers, accountants, etc. have been using this ratio probable since before I started into real estate, it was the way I was taught 25, 30 or 35 years ago!
And this ratio is taught by every real estate investment guru, institute, school, academy and REIA in the country. I would guess that somewhere back in the Days when Dave Del Dotto, Al Lowery and the like were learning about investing in real estate someone determined a investment standard that was in fact correct, and it got handed down to real estate investment students!
Now, if I am correct the fair market rents in most of the country have not been increasing as quickly as the cost of labor and cost of materials, and I don’t expect fair market rents to excelerate at the same pace at any point in the near future!
If you make a list of all direct / indirect cost’s, expenses and management you will find that although you can choose to milk the property and use it as a cash cow, if you go through and make a full list of every reserve item, and you calculate a “Life of Item” timeline according to manufactures standards and usage / wear and tear you will find that 50% is just about right!
Now I will conceed that it could be 49.9% to 50.1% or 49% to 51% depending on how you determine the usable life span of a roof, carpet, interior / exterior paint, kitchen and bath remodels, window coverings, kitchen and bath floors, appliances, heating / cooling, hot water, etc.
But the best responsible standard is basically 50 - 50!
To maintain a property in the same or better condition than when it was bought requires cash and the only way to have this cash is to put sufficient funds away in reserve and that amount is the difference between all cost’s, expenses and management and half of rental income.
Even a brand new property has to start building a reserve because to keep it brand new looking and feeling will require big money in 5 or 10 years, and to keep units looking sharp and renting in the top half of average rental income for it’s area requires sufficient cash, and don’t forget everything will cost more in 5 or 10 years.
My one tidbit of info is that reserves are a below the line item NOI being the line. Reserve requirements do not effect valuation because they are below the line.
=Effective Gross Income
- Debt Service
= Before Tax Cash Flow
If the owner is smart he will not accept an offer where you are taking the reserve monies and recording them an expense. An expense can only be recorded when it becomes an outgoing cash flow. Taking the entire reserve requirement per year above the line will significantly reduce the offering price. It should be handled as follows:
If you think you are going to have significant capital expenditures in the out years you need to use the DCF 10 year model to determine an offering value. The DCF model gives you the greatest flexibility with uneven cash flows. The bank may require you to take 5% of effective gross rents but, on any given year you may only spend 2% and on other years you may spend 20%. You need to look at the life of each item in the building like GR said and make a schedule of values and determine when during your 10 year projection you expect them to hit. Then you need to take those values and show them on the DCF when they will hit as a capital expenditure. To determine what that amount that you will be set aside per month you need to use the sinking fund factor. The sinking fund factor will set up payments per period to achieve that future expense value at a set investment rate of return. Since you will want that money liquid as possible you will need to use a money market rate or a saving account rate etc…
Say I need $20,000 is five years for a new roof. Get yourself a HP 10B or 12C calc or similar financial calc and do the following. Excel works great too.
Sinking Fund Factor
PV (present value) = 0
FV (Future value) = 1
Rate = 2% per year .00167 per period (if this is the rate you’re using)
Periods = 60 (5 yrs x 12 pmts per year)
PMT = -.01586
.01586 x 20,000 = $317.22187 pmt
You can do the former for every item and add them up for your total monthly reserve set aside.