My husband and I have been flipping single family homes North of Boston since 2015. This year we took a leap into what is now our largest project. We purchased an old doctors office, went before the zoning board and obtained the necessary approvals to convert this building into 3 residential rental units plus 1 commercial space. The building was purchased for $503k (cash) and the cost to bring the building to code and complete the residential units has us at an all in cost of $889k. Currently the 3 rental units have signed leases with rents totaling $5812/mos. I will be occupying the commercial space to use as my real estate brokerage. The market rent for that space is $2800/mos for which I will have a lease signed. The total operating cost for this building is $29500 however I'm budgeting for $40k as a precaution until we have a full year of actual numbers to go on. My husband now is considering selling and has asked me to figure out cap rate, ROI, etc and I am stuck. How do I figure out if it makes more sense for him to sell or to hold it? I swear the commercial world is so different than the residential world. Any guidance you can give me will be greatly appreciated.

Thank you in advance,

Cynthia Nina-Soto

Congratulations @Cynthia Nina-Soto , sounds like a great project. At the very least, you should absolutely think about leveraging / financing the property so that you can pull capital / equity out.

Cap Rate is very easy to figure out --- Cap Rate = NOI (Net Operating Income) divided by the property value

It's important for you to start figuring out the current value of the building. What are cap rates in the area for mixed used buildings? If we assume your expenses are $40k a year, and the building is valued at $1m, then your cap rate is 6.33%.

Note, a lender might discount the rent that you are paying for the commercial space since it's an inside deal. 

Thank you @Dan K. Looking at what is selling in the area I'm coming up with an estimated sale price of $1.4M which then would give me a cap rate of 4.52% is that right? Then what we are looking for is a lower not higher cap rate?

Your NOI is = [(5,812 + 2,800)x12] - 40,000 = $63,344

As the value of the property goes up, the cap rate will go down. So if you think the value of the property is $1.4m, you are correct, the cap rate would be 4.52%

Because of high property valuations and a generally hot market, properties in the Boston area have what we call "compressed cap rates" -- meaning the cape rates are relatively low.

The next thing you need to think about is financing payments. If somebody were to purchase or you were to finance the property, there is a debt service that is due (similar to mortgage payments for a single family). At a 4.52% cap rate, cash flowing while making debt payments is likely difficult. In all likelihood, the interest rate for a commercial property would exceed 4.5%.

There are other factors to consider, like the depreciation of the building. In addition, if you were to sell the property today, what would you do with the proceeds? You may have a significant tax bill due unless you are trying to do a 1031 exchange. Having to pay a big tax bill is a great problem to have, but it's still a bit of a problem.