This is supposed to be a good deal, but the numbers don't work

7 Replies

I found this 6 unit multifamily.  Here are the numbers:

Monthly income: $5450

Yearly income:  $65,400

Total reported expenses:  $22,900 for the year

NOI: $42,510. He is asking $425,000 for the property which puts it right at a 10% cap rate.

His lender is willing to allow a wrap around, so I could take over current financing for $336,000 at 5.5% interest (the current rate of his loan) for 15 years.

The seller is asking for 20% down or $84000.

I am looking to bring on a private lender for the $84,000 down payment and expecting about 7% interest (15 year am but ballooned in 5).

With these two debts, the debt service would be $3590 per month or $43080 per year. This puts the property at a negative cashflow (NOI is $42,510).

So here is my question....it is my understanding that a 10% cap rate is a good rate to buy a property at....but these numbers don't work, is it because of the 15 yr loans versus 30 year loans?

Also, it is my understanding that in a multifamily, it is best to assume a 50% operating  expense budget, so 35% seems very low to me....there are no calculations for vacancies or capital improvements, but there is property management in there.

The possibility for improvements is to have rents increased to catch up with current market by about $500 per month total (that's after cleaning up the property, catching up to market rents, and putting in rules to keep the grounds clean and safe).  There is room in the back to build a laundry space which could be coin operated, but I don't think that would increase rents and income enough to cover the expense of a new building and equipment.

So, am I missing something that makes this a good buy, or is it best to walk away?

Thanks in advance for any input.

Sean

The cap rate shouldn't be the end all be all figure for a property analysis. If the numbers don't work, they don't work, and it is inadvisable to try and finagle them to get them to work. 

If his pro forma numbers don't account for either vacancies or CAPEX as reflected by a 35% budget for operating expenses, then the numbers sound poor.

However, if you are confident that your rehab could bring in an extra $3000 in gross rents/month, then that might change your analysis. But you'd have to also account for the fact that your initial rehab costs are going to change your initial cash outlay -- especially if you don't have cash on hand to do it, and you're going to have to bring in hard money or a partner to do so. 

So you are saying that you want this deal with 100% financing and the amortization and management to be paid for by the cash flow.  Assuming that your expenses and other cost are correct, then you will have "invested" less than $2000 a year. I would say thats a good deal since your tax benefits are well in excess of that. I assume that you have an exit strategy that justifies the purchase since your cash flow even after the rent increase and repairs is only marginally better. This seems like a long term hold so maintenance will be you biggest concern.

As for whether the economics of the deal are correct, there is not near enough information.

Not only are you not accounting for all of your transaction expenses just simply by calculating the debt service only against NOI your numbers do not work.

While your cap rate may be at 10% your cash flow will not jive based on your debt service, that is your expenses will be too high. Remember cap rate is calculated independent of your own personal financial situation. 

I would say for someone who has $84K to $90K of their own money this would be a good deal but since you are going to borrow or thinking to borrow the $84K your personal finances are too weak and this building as a business will not do you any good. You have to look around for something with a cap rate much higher maybe closer to 16% using the same private money of $84K. Anyway the numbers have to be good including your cash flow not just cap rate. 

Sean Price since this is commercial, ask to see the sellers schedule E for the property for 3 years. Also, ask your broker to find comparable properties in the area. Have the CAP rates compressed or are there other 10%ers in the area?

It sounds like the numbers provided are skewed in favor of the seller to make it look more attractive. No vacancies? Right off the bat that is suspicious. How about repairs? Did they cover other expenses such as taxes, insurance? Is there any electric or water provided? Were those accounted for? You MUST factor these in. I often see agents and even some brokers give pie in the sky numbers that don't truly represent the OE of the property. If this is an agent or broker that is giving you those numbers I would ask them why they omitted critical information that would give a buyer the true NOI and the ability to make a sound decision whether to purchase it or not.

@Sean Price I don't remember who said it, but someone says that you should generally use the 60% rule for commercial multi-family as capex runs higher for these properties. Also with 15 year amortization you will see greatly decreased cash flow as well. Finally with the second loan to cover the down payment, it is very likely this property will have positive cash flow.

I personally never liked using cap rates listed by sellers. Since this is a commercial properties, you should be able to get a detailed list of the rent rolls, and capital expenses for the last few years. Also the actual costs for taxes and insurance. You then should be able to determine the actual cap rate yourself. Remember to buy the property based on how it is performing now, not on proforma data.

Thank you everyone for the input.  I do realize that Cap rate is only one factor....and I also realize that at 35% expenses, the numbers are skewed toward the sellers side to try to increase the cap rate.  I have requested the schedule E and rent rolls for the last three years to try to get accurate numbers.

I am new to multifamily, so will keep collecting info on the deal....and I realize this is probably a no go, I just needed to make sure that I was not missing anything

Thank you all so much for the feedback. I really appreciate it.

Sean

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