Is commercial the same analysis as mult-family?

Question

I'm a realtor and want to run the numbers on a commercial piece of property to present to an investor.

I've got a piece of software that runs NOI, cash on cash return, cash flow over time...etc.  It is for multi-family but it appears that I could just enter gross income the same way for the commercial rental I have.

Is this correct?

Bradley Glaves · Answer

Julie,

Commercial is all about the numbers...if the numbers are strong then it warrants a lower Cap Rate.  Not so strong, a higher Cap.

In SFR or smaller MFU there is an emotional component because people are after all "going to live there". This is a personal judgment call and it often clouds the financial call.

In commercial if the numbers are strong that means the product is still in demand. Week numbers, the demand is off.

Savvy investors don't buy on proforma they buy on current cash flow (usually 12 months trailing income and expenses or NOI).  That's what the property is worth today.  If there is upside available (that can be substantiated) then you can show this on a proforma with notes on how to get there, but they will still buy on current cash flow.

The big problem as a Realtor is when you show your Seller all the great stuff you have put together (CMA, Comps etc.) and you have the proforma as part of the information they will automagically want to price the property at proforma, not based on current NOI.

Now you are going to have a hell of a time getting his price back in line...

Good luck! And Happy Thanksgiving. Brad

Jon Holdman · Answer

As a buyer, when you see the word "proforma" you should read "pretend".  Sorry Karen, but if the seller want's to pretend about what the building could produce and use that as a basis for the price, the seller should get the building to actually perform at that level.  As a buyer, base your valuation on the actual numbers, not what might happen.

Karen Morison · Answer

Travis and Nathan have covered everything else, but let me just add that with commercial, you can show an investor the income/expenses as they are currently, and as they might be if the property was optimized.  It's called the "proforma" analysis.  For example, if an apartment building only has an occupancy rate of 85% now, you would need to show the income at that level.  But for the Proforma part, you would show the occupancy at 100%, and sometimes show the rent as being raised if you assert that the rents are currently too low for the market.  Usually on a proforma analysis, the numbers change on the Expense side, too.  For example, you might show how it would look if the tenants started to pay for their own electric, instead of having it included in the rent as it is now.

The important thing about proforma financials is that, as a buyer, you have to remember that this is the optimal way the apartment building (or whatever the asset class is) would be run, but it does not necessarily mean that goal can be reached realistically. As the Seller you want them to see where they could take the property, show it in its best light.  As a Buyer (and Lenders think this way, too), you want to make sure you keep your eyes open to reality, and to remember that Proforma is just a dream, really.

Hope that helps.

Travis Sperr · Answer

Hi Julie,

The biggest difference is financing, 1-4 family has the opportunity of being financed conventionally, typically easier to get financing.  Once you get to 5 or more units a commercial loan is typically required, these loans can be difficult to get done under 500k-1mil.

Otherwise all ratios and metrics are the same.

Nathan Emmert · Answer

The numbers are the same, yes... NOI, CoC, ROI... all those things are financial metrics which can be calculated for any investment (real estate, precious metals, stocks, poker returns).

Obviously the investments themselves will be quite different... mortgages, expenses, etc.