Need feedback on my first commercial residential offer- is this a good deal?

21 Replies

Hi everyone, I would love some feedback on a property that literally fell in my lap. A 6 unit building next my complex went up for sale. At first it looks amazing, property next door to mine, PM is the same PM that manages my units, however after looking at their financials I am not sure the numbers look good. It is an older building with a duplex, triplex and SFR on a lot. both duplex and triplex are 1/1 with carports, and SFR is 2/2 with garage, built in the 60s. Neighborhood is B/C with this property being a C. Seller is older couple who wants out of the game, very motivated, own the property free and clear, they tried selling it back in 2007 via seller financing but foreclosed on the investor (investor was a newbie with no landlord experience, didnt do repairs, blamed everything on the tenants, and purchased at the height of the market so eventually stopped making payments and they took back the property. Now they've listed it for $260K, potential rents (if all units are rented is $3200 and $38,400 annual). two units are vacant and completely remodeled, and one tenant gave her notice. Based on these two numbers and what my expenses are (water, trash, insurance, taxes, PM at 8%, 12% vacancy (comparing to my units), 10% cap x and 10% repairs), even if I offer full price I would be positive cash flow.....where do I sign right?

here is the problem.  I requested 3 years of income/expense sheets for the property from my PM.  (remember the property is free and clear).  and the property has been negative cashflow for the past 3 years not including insurance and property taxes

2013 income $15K, expenses $15K

2014 income $19K expenses $21K

2015 income so far $13K expenses $26K - granted they did alot of repairs and paint to get the property ready for sale. but even at $13K for 1/2 the year, at full year the rent is roughly $26K, $12,400 short from my anticipated gross annual rental income.

I've heard of people on the podcasts and here on BP where they've turned around poorly managed properties, but since this PM is the same as my property's PM, and there really isnt that many PM in the area that are competent, and this property is negative cash flow for three years and its owned free and clear.  I am waiting to hear back from my PM why the expenses and vacancy so high.

This is my first deal as seller financing (and commercial property) I would like to approach as seller financing since I've found out this retired owner also has other SFR that he wants to get rid of, and if this goes well I would like to approach him on the other ones as well.

What do  you guys think is it a good deal, what should I offer?  Initially I was going to present the seller with 2-3 offers, one at full price with 0% and 0 downpayment for 30 years, and another two with less sale price, but with some downpayment and 0 or 4% interest depending on the purchase price and downpayment.  But now that I have the real expenses sheet, I dont know how low to go, because even if they just deed it to me, I will still be negative cash flow.  

Also I wouldnt need to do any work to it right now from what my PM tells me, they revamped it trying to get it ready to sell.

Any input and help would greatly be appreciated.  

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@Bob Bowling I own a fourplex next door, this would be my first commercial property.  I am still new to trying to value a commercial property, and it being predominantly a 1 bedroom/1bathroom set up still trying to figure valuation.  If it was 4 units or under I can quickly do price comparisons to value this property.  But since commercial apartments are valued based on the income their generate, I am having a hard time with this one.  If you can provide me with constructive feedback I would greatly appreciate it, otherwise there are other websites on the internet you can visit to talk down to people.  

Originally posted by @Sandy Salazar :

@Bob Bowling I own a fourplex next door, this would be my first commercial property.  I am still new to trying to value a commercial property, and it being predominantly a 1 bedroom/1bathroom set up still trying to figure valuation.  If it was 4 units or under I can quickly do price comparisons to value this property.  But since commercial apartments are valued based on the income their generate, I am having a hard time with this one.  If you can provide me with constructive feedback I would greatly appreciate it, otherwise there are other websites on the internet you can visit to talk down to people.  

 Hello Sandy. You said that the property was managed through a PM, and if so, it is likely that they kept detailed records of all income and expenses for the current owners. Before making an offer, I would ask to see those detailed records.

Looking at the income, I would guess that the vacancy loss is far higher than 12%. Also in terms of expenses, considering this is a few separate buildings, I could see those being high if it was time to replace the HVAC or roof on a couple of buildings. If those things are what account for the high expenses, you shouldn't expect to spend that much for a while. Also what utilities does the owner pay on that property? I have seen before properties that started out as single family and units were added, but nothing was separately metered.

402-965-1853

Hi @Anthony Gayden ,

Thanks for the feedback.  12% vacancy is my estimate based on my 4plex having that vacancy rate, but based on the rent roll sheet that I received from 2013-2015 this property vacancy is roughly 60% in 2013 and 50% in 2014 and so far 30%.  

The financials I received is a one page income/expense sheet where the categories are pretty explanatory (trash, water, plumbing, carpet cleaning, general cleaning, management, etc...) my only concern is a category that the PM titled "maintenance" and the lowest was 6K and highest was $11,800.  I am still waiting on the PM to explain what those were.

As landlord I would be responsible for water and trash, each unit is separately metered for gas and electricity.  Roof looks decent, but I can check when was the last time it was changed.  The units dont have centeralized AC, but wall units and the triplex has a swamp coolers that the PM told me we have to maintain yearly, "but doesnt cost that much."  

If you could lower the maintenance costs, and lowered the vacancy rate to 12% how would you value this property and what would you offer based on its existing financials?  Thanks again for your insight.

Originally posted by @Sandy Salazar :

Hi @Anthony Gayden,

If you could lower the maintenance costs, and lowered the vacancy rate to 12% how would you value this property and what would you offer based on its existing financials?  Thanks again for your insight.

 I still don't have enough info. How much are the taxes and insurance? Also are you putting 25% down and getting a commercial loan with 20 year amortization? How much do the utilities cost on average per month per unit? We obviously can't base utility usage on past years since there was high vacancy.

I would say it is over priced. The quick and dirty analysis of commercial properties that I use is the 60% rule. Basically all expenses (capex, maintenance, insurance, taxes, utilities, property management, vacancy loss) will take 60% of your gross income. You said that fully occupied that would be $3200/month. So what remains would be $1280. Assuming that you put 25% down ($65,000) and were able to obtain a commercial loan with 5.5% interest and 20 year amortization on the remaining $195,000, your monthly payment would be $1341. So using the 60% rule you would cash flow -$61.

Even if we used the 50% rule, we would only get positive cash flow of $259 a month, or $43.16 per door, which is subpar.

402-965-1853

Hi @Sandy Salazar - I would look pretty squinty-eyed at everything... 

@Anthony Gayden is right, the PM should know pretty much what's going on.  

That being said, I would not listen to anything they might say re expenses or conditions, etc, rather I would dig deeper - someone knows what's going on with this parcel, right? 

Originally posted by @Sandy Salazar:

... The financials I received is a one page income/expense sheet...

...my only concern is a category that the PM titled "maintenance" and the lowest was 6K and highest was $11,800. I am still waiting on the PM to explain what those were.

Best of luck, and let us know what happens!

@Sandy Salazar here are my thoughts on your valuation question. Like you mentioned, the issue is how to valuate a commercial property that has no income right? And there is no way you're going to buy a property based on what the sellers could be getting.

Because this property is technically losing money, it doesn't a Net Operating Income. As a matter of fact, it has a Net Operating Loss. Which makes the whole cap rate valuation a little weird. Because you cant expect the seller to pay you to take the property off their hands right? haha. (i wish)

I think your best bet is to treat it like a value-add flip. Figure out exactly what you could get in 1, 2, or 3 years (whatever your exit strategy is) from now if you raised rents to market, managed better, and brought down unnecessary expenses etc. Be very conservative in these assumptions. After that, subtract your expected renovation costs. Finally, discount that final price X% based on how much your time is worth. For example.

Final value in a year - $300k

Renovation costs - $50k

Personal discount - 30%

Offer - $175k

There have been a few forum posts about this topic, but in general, it seems like this is the consensus among experienced investors. 

Best of luck Sandy!

@Sandy Salazar

Interesting dilemma indeed. You got some good advice on how to value the property and it sounds like the main theme is - be conservative. To me, the red flag is the high vacancy rate over the past three years. Definitely dig deeper into that with your PM. It's not necessarily the PM's fault - sometimes the owner refuses to put in money to make the property more competitive on the rental market. However, you should get both the PM and the owner to give you detailed, clear explanations for the abnormally high vacancy. Get both versions of the story.

The main question is: if your PM couldn't keep the units occupied under the current owner, what will have to change to keep them occupied when you take over?

@Anthony Gayden Taxes is roughly 3K and I received an insurance quote for $1500.  I do think that the property is over priced, and thank you for your insight, I will definitely look at the 50% rule and 60% rule.

@Doug M. I am trying to get the details of the maintenance fees.  Thanks for the feedback.

@Tyler Flagg Thank you for the detailed analysis, I wish they would just deed me the property =).  I didn't really think about the exit strategy since I am more of a buy and hold type investor.  But maybe I should look at what I would need to do if I had to sell.  I know that when it was previously sold at height of the market it sold for almost 400K, so I do see room for potential capital appreciation, especially if purchased at 175K

@Leonid Sapronov I imagine the vacancy rate is due to the units being predominately 1 bedroom/1bath.  Its not my favorite combination, but I didnt expect it to be that high of a vacancy.  I will try to find out from my PM why, although I know she tends to be picky (which I appreciate) when selecting tenants for my property, because she wants to make sure that the existing tenants will blend with the new tenants and not cause problems.

My next question to all of you guys is if I do seller financing, what other fees am I looking at when closing, since I will be working with the listing agent.  Do I get a commercial appraisal? commercial property inspection?

Thank you again for all your insights and feedback.

@Sandy Salazar

If the low vacancy rate is really because of the type of units, then it's not something you can change. But somehow I doubt that's the only reason. If it IS the only reason, then what makes you think you can decrease vacancies once you buy the place? You could tell your PM to be less picky about choosing tenants, but that would contribute other risks.

Yeah that vacancy rate is insane... Is it because of the location or the property is just in bad shape? With vacancy that low I have to assume it's not in a good area. With it cashflowing negative as well for the last 3 years I'd really say look elsewhere unless you've got experience turning places like this around and significantly reducing the expenses here

@Leonid Sapronov I am not sure if the vacancy is because they're 1 bedrooms, none of my other investment properties have 1 bedroom set ups.  I do see improvement in increase in rent received from 2013 @ 15K, to 2015 @13K to date.  I dont know the scenario of how actively involved the owner is.  The PM tells me that she pays out all the expenses, repairs and refunds from the rents she receives.  I am only speculating that because its a free and clear property, they're not dealing with vacancies in an urgent matter?  Where as I am in in a bimonthly contact with my PM when I have vacancies.

Would it be too unrealistic to offer a low price and zero interest for seller financing? 

Thank you for your prompt feedback!  

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Well, I think the PM should be able to shed some light on the vacancy mystery. Don't give up until you get a clear answer that you are happy with! There's always a reason.

I've never done a seller financed deal, nor have I ever heard of anyone getting a 0% seller financed loan. Not to say it's never happened, but from what I know, if you can get 0% interest, you should consider yourself very, very lucky. With that kind of offer you are giving them very little incentive to finance the property, unless they are really desperate to get out of it (or there is something seriously wrong with it).

Making the seller an offer is really almost an art, especially if you are trying to be creative. You can lowball them, just make sure that whatever price you come up with, there are analysis numbers to back it up. You want the seller to know that the price you came up with is a result of analysis and not just handwaving - they'll be a lot more likely to negotiate with you in that case because you will have specific income/expense items to discuss. Otherwise, you just risk pissing them off :-)

@Leonid Sapronov The listing agent came at me with a "starting" point of 1/3 downpayment, 5% interest, 3-5 full payment amortized over 30 years.  Of course these terms are to their benefits, especially since the PM told me they are aware that its negative cash flow and it seems like we're the only buyers they're talking to.  I did call my insurance company and they informed me that if the roof is more than 20 years old they won't insure me unless I get a new roof, PM informed me of the 12 years she managed the property they've never replaced the roof, but there was a minor change, so I imagine that will have to be factored in the price.

@Vincent Crane The neighborhood its in is lower income, predominately working class.  I have experience in that neighborhood.  My fourplex was a foreclosure that was vacant and needed a lot of rehab.  We gutted and rehabbed one unit at a time until we rented it and saved money to rehab the other ones.  It was difficult, took 2-3 years but it grew 50K in appreciation and is stable now.  This will be my first commercial property and predominantly one bedrooms.  This complex is decent for the neighborhood.  The two vacant units are remodeled and ready for move in, seller initially wanted them vacant for showing, but has told the PM recently to begin the renting process.  

The one improvement I can make is that there is currently an empty laundry room that I can set up for extra income.  My fourplex has a service that they service the washing machine/dryer and I collect a percentage based on the usage. 

@Anthony Gayden the 1 bedroom is 550sq feet and the 2/1 is 900 sq/ft.  Not too small considering I have a 2/2 condo that is 900 sq/ft.  The 2/1 has a garage, the rest have 1 carport and 1 parking space, similar to my fourplex.  From talking to my PM it seems that she is very picky with the one bedroom rentals, there are a lot of people coming in to get info for rentals, but she's not renting it to them because she knows it will not be long term. A couple with 2 boys came in looking for a one bedroom because thats all they can afford, but she knows that they will either destroy that rental or move quickly when another affordable one comes up.  Its just that kind of neighborhood.

Thank you all for your great questions and feedback.

I heard Brandon say the other day that he gets like $300 a month from laundry at one of his places actually, but then again you pay extra water and electric

Originally posted by @Vincent Crane :

I heard Brandon say the other day that he gets like $300 a month from laundry at one of his places actually, but then again you pay extra water and electric

I think that was for Brandon's 16 unit complex.  I break even at my fourplex for laundry, but I have it more as an amenity and convenience for my tenants than having to drag their kids and laundry to hot laundromat in town. The company I use services the machine, there's a poster they put up with directions on how to use and an 1800 number to call in case it need of repair/replacement and collect the money, and they send me a check based on a tiered payout based on usage.  I break even when considering water, gas and electricity usage.

Ah okay. Yeah he has like 6, fourplexes, I'm not sure how that's configured but he considers it to be one apartment even though they're all actually separate? I'm not sure how his is set up but yea.

would love to have a 16unit =), this is my first step towards that, hopefully if I can make the numbers work.

Hey Guys,

First and foremost, thank you to all who have contributed to this post, all of your comments got me thinking and finding a way to analyze this property.  At the end of the day we had to pass on this one, we just couldn't make it work.  Even at an offer of $130K and "hoping" to reduce the average vacancy and repairs by different percentages, I would be still be negative for at least the next 4 years.  It just didn't make sense.  On the upside I gained valuable insight on how to analyze a property and knowing that I can walk away from a property, even when the price is so low.  Good luck with your REIs!

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