Scranton, PA · Member since 2017 · 20 posts · 0 votes
Hey everyone!! So Ive been doing multi family buildings and some self storage partnering, however I’ve never really done anything commercial myself. I came across a private deal in my hometown that I am truly interested in. It is a commercial property that consists of 7 apartments upstairs, with three commercial spaces downstairs. All storefronts, with 2 large chain fast food restaurants and a tobacco shop. It is smack dab in the heart of the downtown area of the city, with a very large amount of 9-5 workers getting their lunches there. It is currently fully occupied. Right now any apartments in that area have a 1-2 year waiting list to get in. Yearly rental income is $170,000. Taxes are $22,000 a year, and the asking price is $1 million. The problem that I have is I don’t know what to offer on this deal. Like I said, I’ve never done commercial and I’m not sure how to valuation this property. Can anyone help or give me some opinions? Thanks!!
Accountant · La Mesa, CA · Member since 2017 · 477 posts · 476 votes
8y
Patrick, trust but verify. You are going to need to check and make sure all the numbers they are providing you are correct. Don’t only get the rent rolls for the past 12 months, but look at the actual deposits. Look at the expenses for the past 2-3 years to make sure they didn’t defer some maintenance to increase their NOI artificially for the sale.
Accountant · La Mesa, CA · Member since 2017 · 477 posts · 476 votes
8y
@Patrick Gerrity Generally with commercial properties the value is the NOI divided by the average cap rate for that type of property within the local market. You may want to talk to local realtors and brokers to get an idea for what the local cap rate is.
The building sounds great, but it also sounds like there is not much opportunity for forced appreciation. That means you will probably get your money back at the average cap rate and not sooner.
If the cap rate is 10%, for example, the building's value is $1.335 million. If its 5%, the building's value is $2.67 million.
Thank you for that info! I am confused though how if the cap rate is lower the building is worth more? Wouldnt it be the opposite? (forgive the newbie here)
If the cap rate is 10%, for example, the building's value is $1.335 million. If its 5%, the building's value is $2.67 million.
Thank you for that info! I am confused though how if the cap rate is lower the building is worth more? Wouldnt it be the opposite? (forgive the newbie here)
Same here! But I will chime in. The cap rate is the rate of return you expect to get on your investment. If you are buying a property that is newer and in a good area, this would be less risky property to own, so you would expect to get a lower return. If you're interested in a property in a tough area and it had a lot of deferred maintenance, you should expect to get a higher return after you make the improvements of course.
That's why @Brian Schmelzlen was referring to forced appreciation. That's what investors typically look for in commercial units to get higher returns. If you can increase the NOI then you will increase the value of the building. Therefore purchasing with a higher cap rate and then lowering it over time will make your returns great!
Rental Property Investor · Dallas, TX · Member since 2017 · 1k+ posts · 1k+ votes
8y
@Patrick Gerrity The cap rate is another way of saying how much will the market pay for a $ of (unleveraged) returns. Therefore, if an investor pays $10 for every every $1 of earnings, it is a 10% cap rate. But another investor can value the same cash stream differently.
For example, an elderly couple might be willing to pay more because they feel that the "quality of cash flow" (consistency) is more predictable. Thus, it is a better fit for their needs. Hence, they might be willing to pay more for the same stream of cash flows. They might pay $15 for the same $1 of cash flow or a cap rate of 6.67%.
Initially, it can be confusing understanding this inverse relationship. But the framework above might help you to view it from a different perspective. Hope this helps!
@Patrick Gerrity The cap rate is another way of saying how much will the market pay for a $ of (unleveraged) returns. Therefore, if an investor pays $10 for every every $1 of earnings, it is a 10% cap rate. But another investor can value the same cash stream differently.
For example, an elderly couple might be willing to pay more because they feel that the "quality of cash flow" (consistency) is more predictable. Thus, it is a better fit for their needs. Hence, they might be willing to pay more for the same stream of cash flows. They might pay $15 for the same $1 of cash flow or a cap rate of 6.67%.
Initially, it can be confusing understanding this inverse relationship. But the framework above might help you to view it from a different perspective. Hope this helps!
Thank you, that is a big help. Supposedly the CAP on this is 12%, however that is what the owner claims. I am hoping that I can can get the property for $850k, and at that point I can swing it. Also the cashflow is outstanding based on the numbers provided.
Real Estate Broker · Manchester, NH · Member since 2014 · 630 posts · 420 votes
8y
@Patrick Gerrity the numbers provided look like they took out taxes and insurance and called that the total "expenses" for the property. On almost every residential apartment building that I've seen in my market (mixed-use can affect the amount you spend on maintenance, but it boils down to whose responsible for what in the commercial units) operating expenses run somewhere between 45% and 60% of the gross income... but usually if utilities are paid for by the tenant, I see 50% operating expenses.
So $170K x 50% = $85,000 NOI
$85,000 / $1M = 8.5% cap rate
That's a pretty good deal for something in my market, but ultimately it boils down to the condition of the building, stability of the tenants (because the vacancy factor for a storefront could be a lot longer than an apartment) and how this cap rate compares to other "true" cap rates in the area.
Accountant · La Mesa, CA · Member since 2017 · 477 posts · 476 votes
8y
Patrick, trust but verify. You are going to need to check and make sure all the numbers they are providing you are correct. Don’t only get the rent rolls for the past 12 months, but look at the actual deposits. Look at the expenses for the past 2-3 years to make sure they didn’t defer some maintenance to increase their NOI artificially for the sale.
@Patrick Gerrity Generally with commercial properties the value is the NOI divided by the average cap rate for that type of property within the local market. You may want to talk to local realtors and brokers to get an idea for what the local cap rate is.
The building sounds great, but it also sounds like there is not much opportunity for forced appreciation. That means you will probably get your money back at the average cap rate and not sooner.
Thanks Brian, Im now in touch with my broker to get his take. Also, Im looking more for a cash flow asset vs. appreciation over time, so the cashflow is really what brought me in. Our downtown is on an upswing but you know how that goes, its a roller coaster!
Rental Property Investor · Dallas, TX · Member since 2017 · 1k+ posts · 1k+ votes
8y
@Patrick Gerrity As pointed out by @Brian Schmelzlen, you need to ensure that everything checks out. For instance, you should cross-reference the T12 P&L with bank statements, tax bills and utility statements. Taking it one step further, you can work with your property management team to give you a lease audit. Essentially, they will go through the lease to tell you the good, the bad and the ugly. I would highly suggest you hire a trained professional for a lease audit.
It would also be better if you connect with local real estate investors, brokers and lenders who can better help you in valuing this investment.
Wayne, NJ · Member since 2012 · 17 posts · 20 votes
8y
The NOI divided by the cap rate and you’ll get the value of the property. When you know all three plus knowing the local market, you can make a decision on what to offer. But use a local broker in the area to make sure those numbers are correct.