Looking at a small apt building of 24 units as a buy and hold listed at $695,000. It was renovated last year so not much room for value-add. Rents are on the higher side as well. Roof and HVAC reserves have been accommodated in the proforma analysis based on the remaining life. Proforma CAP is 14% and Current CAP is 12%
Few questions:
1. Currently 4 units are vacant. Do I used the potential income for these units in my analysis? I think I should but wanted to get feedback.
2. Expenses are on the lower side (including the reserves for the roof and hvac) at 34%. With potential gross revenue of $147424, the NOI is $97300, it looks like a good deal. If you would have to send in an offer, what would it be? Would you base it on 50% expenses?
3. With 50% expenses and 14% CAP, the offer price would be ~$526,500 and 12% CAP the offer would be $614,300. Which is a better offer? I am trying to send a reasonable offer than an unintelligent one.
Any help is appreciated.
PS: Some numbers are random to keep anonymity of this property
There are not multiple cap rates. There is only market cap rates. That is calculated on closed sales of similar properties. Your PGI would be at market rents and your expenses should be market.
If the property is not operating at market then you would calculate value as I outlined below in another thread, Also reserves are not an operating expense and is not a part of NOI.
Nope. it will ONLY change the value NOT the cap rate. Two exact same buildings have the POTENTIAL to gross $100,000 rents. Bob is a smart investor and operates to market and has a NOI of $60,000. Similar properties have sold at a 8% cap rate so if Bob sells he can expect to get about $750,000. Frank is lazy and stupid and his building is half empty and he is paying his brother in law too much for janitorial, repairs and maintenance and his NOI is only $20,000. At an 8% cap rate a novice seller would think his property is only valued at $250,000! Numbers don't lie. But Bob knows it will cost him about $100,000 to get the property up and running just like his identical property. Fire the BiL pay some leasing fees and a little maintenance. Now counting on the lost rents until he gets the property up and running he will only be out about $150,000. So Bob has a property capable of generating $60,000 NOI. At market cap rate of 8% the property is worth $750,000. But it will cost about $150,000 of elbow grease to get there. So Bob would buy the property at a 8% cap MINUS the costs to get there $150,000. So he pays $600,000. See? the cap rate is the same, the value changed.
There are not multiple cap rates. There is only market cap rates. That is calculated on closed sales of similar properties. Your PGI would be at market rents and your expenses should be market.
If the property is not operating at market then you would calculate value as I outlined below in another thread, Also reserves are not an operating expense and is not a part of NOI.
Nope. it will ONLY change the value NOT the cap rate. Two exact same buildings have the POTENTIAL to gross $100,000 rents. Bob is a smart investor and operates to market and has a NOI of $60,000. Similar properties have sold at a 8% cap rate so if Bob sells he can expect to get about $750,000. Frank is lazy and stupid and his building is half empty and he is paying his brother in law too much for janitorial, repairs and maintenance and his NOI is only $20,000. At an 8% cap rate a novice seller would think his property is only valued at $250,000! Numbers don't lie. But Bob knows it will cost him about $100,000 to get the property up and running just like his identical property. Fire the BiL pay some leasing fees and a little maintenance. Now counting on the lost rents until he gets the property up and running he will only be out about $150,000. So Bob has a property capable of generating $60,000 NOI. At market cap rate of 8% the property is worth $750,000. But it will cost about $150,000 of elbow grease to get there. So Bob would buy the property at a 8% cap MINUS the costs to get there $150,000. So he pays $600,000. See? the cap rate is the same, the value changed.
@Account Closed - excellent!
@Account Closed Thanks for setting me straight. Guess I got carried away. Yes I need to find the market CAP rate.
Another question for more experienced folks: Would you use the listing broker as your agent or would you get a buyer's agent? Based on what I have read so far, people would just send in their offer direct to the listing broker and work with him/her to get things done.
In short; "That Depends"... In my humble opinion.
If you are sound and experienced enough to deal with the Listing Broker, u may tend to have a better chance at manipulating a better deal cause they can double end it "in-house" and not have to share the commission with another agency. You just have to make sure your due-diligence is AIR TIGHT!
If you are not quite 100% "SURE" about how you will handle, fully evaluate and counter what is thrown at you, arming yourself with your own experiences Agent/Broker will be a big help.
As you know, it doesn't take much to make a costly mistake.
Now - Go get it!!
@Account Closed@Rob Harris
Thanks a lot guys. In the offering the nearby properties sold at a 7.5% CAP rate but I will find out the market rate if its any different.
However just for the sake of analysis, lets say the market CAP is 14. Should I still take 50% as my expenses to come to a purchase price? How do you account for low expenses due to the recent renovations?
There is some value add in terms of selling land, but that's another discussion
@Account Closed
I hope I explain my question properly as I am asking to learn not sound snobby.
In your above example Frank's building by the numbers is worth 250k. Yet you say since Bob knows he can turn it around he will pay 600k.
When Someone buys commercial property aren't they really buying the income stream that property is producing. Yes there is value to the property itself but to keep it simple like you did in your example above lets just look at the NOI right now.
Why wouldn't an investor just say to Frank Your NOI is 20k and at the market cap your property is 250k. If An investor pays 600k then Isn't he rewarding Frank for being lazy. You even describe this as the novice seller would think his property is valued at 250k. I am the novice and you are correct I think it should be. I guess the real question is why is it not? Property is never valued at what I can do with it, it's valued at what the property is presently doing.
I think your example shows the perfect value play. Bob buys an underperforming property, He then invest some sweat equity into by getting it up and running like his identical property and then sits back and reaps his rewards.
So all of that babble comes down to this.
Why would Bob purchase a property valued at 250k for 600k? Is it solely because he knows he can get the value up to 750k by sinking 150k into it?
Thanks for taking the time to further my education.
Fair question. First you are incorrect in assuming the property is worth only $250,000. You probably got that idea from the majority of posters here that have never done a deal and have no real experience and some guru spouted this Info.
Let's look at it from the market's perspective. Our two identical buildings and a third owned by Bob next door that is a fifth the size of the first two that produces $20,000 NOI at market. At 8% cap rate that property is valued at $250,000. But there is no upside. Should it and the property capable of generating $100,000 NOI sell for the same amount? Of course not. The market is going to see Frank's place as a $750,000 asset. But it has issues. And Frank is lazy not stupid.
So Neil wants to pay only $250,000 for this. But Ben comes in and underwrites this at $500,000 because he knows the $150,000 to get it to market only consists of $70,000 hard costs and the $80,000 is his reward for taking the risk and for his time. He wants the extra $50,000 because he's a nice guy and he is worth it. Now Brian is in the market also and he has a crew sitting around waiting for the next project and his leasing team is telling him they are getting calls everyday for space in a good property. Brian looks at the property and knows he can fix the property for $50,000 because he Is his own contractor and He knows he can lease up within a month of repairs so he has $20,000 less rent loss than Ben would have. So Frank has Ben's $500,000 offer, Neil's $250,000 offer and Brian's $600,000 offer. Now Brian will only spend $110,000 So he is getting a $750,000 property for $710,000. Who will Frank sell to?
Another way to look at this is if Bob builds another identical property next door. As it is completed Mrs. Bob files for divorce and court orders her half. What is the value of the empty building? Bob goes before Judge Neil and tells him he will give up half of the $750,000 building and keep the worthless new building. What's your verdict?
@Avi Garg I usually go solo with my purchases to have the extra 3% for price and concession flexibility or to increase the attractiveness of my offer to the LA when they realize they'll get both sides of the commission.
But if I were a novice and just getting to know how to financial and physical DD, I would be better off obtaining my own outside buyer's agent. Someone that is the best in their craft, from a different brokerage. Good luck!
@Account Closed
Thanks for the further clarification. I have a much better grasp onto it now.
@Account Closed Respectfully I disagree with you on your calculation and reasoning .. Why would I want to pay based on future value added price .. I would rather pay based on the current situation ...
The main play of buying apartment complex is to add value (by fixing up property, increase rents etc) and hence increase the NOI. If I buy the apartment complex based on the increased NOI, I have lost the reason of buying the apartment complex and I have overpaid for it.
Atleast this is what I understand. Yes someone can always offer more and that's the nature of the business.
@Account Closed Respectfully I disagree with you on your calculation and reasoning .. Why would I want to pay based on future value added price .. I would rather pay based on the current situation ...
The main play of buying apartment complex is to add value (by fixing up property, increase rents etc) and hence increase the NOI. If I buy the apartment complex based on the increased NOI, I have lost the reason of buying the apartment complex and I have overpaid for it.
Atleast this is what I understand. Yes someone can always offer more and that's the nature of the business.
Of course you want to pay based on the "current situation". How does that work for a vacant new construction property? And would you expect to pay the same for a $20,000 NOI property operating at its peak and a $20,000 NOI property that could possibly be $100,000 with maybe $150,000 expense?
Your upside is included in the discount that you are buying the property for. It is not an exact $ needed to $ discount. A seller is going to know what his property is worth if he got off his lazy *ss and worked the property to it's capability. You are going to bet that you can get to that $100,000 NOI at a cost of only $50,000 but convince the seller that it would cost him $200,000 so why not discount to your generous offer of $150,000 off?
But that is where the market comes in and someone can buy it out from under you because they think the can get the property up and running and are only asking for a $100,000 discount.