help analyzing a 4-unit (with possible 5th) deal

[Jim H.]

I'm looking for some help analyzing my first potential deal. 

It is a 4-unit with under-market tenants in place. The overall condition is good and the neighborhood is A-level. Tenants pay all utils except water/sewer.

There is also a full sized raw space for a 5th unit (2Bed/1Bath) that needs a lot of work to make rentable (about $100k is the estimate).

My agent thinks we can get it for $920k (given the work needed), with only 5% down, which is below asking and below comps (all full 5-units) which are going for around $1.1-1.2m.

It has 7 parking spots with room for 2-3 more, and is zoned for 11 units total (permitted only for 4, so buying as residential, but planning to convert to commercial). There is a decent sized lot where more could be built later.

Upgrades possible include finishing the basement for storage and laundry, charging for additional parking, and bringing rents up to market level.

Adding in all the operating costs plus debt service, with allowance for maintenance & vacancy, and at market rents, the property runs a $20k/yr loss. (Does not include any additional revenue or costs from upgrades.)

My total cash in after a year would be about $65 for DP/closing, $20k in loss from operating costs, and whatever portion of the renovation costs I can't borrow (up to about $100k). 

The investor-friendly agent I'm working with recommends a cash out refi after 6-12 months (after the 5th unit is built out, so it would be appraised at the level of the nearby comps), and then put that into another property (rinse, repeat).

It seems like it could still be worth it, even at an operating loss, but I feel like maybe I'm missing something. 

Any thoughts on this possible investment? Thanks.

[Robb Rafferty]

In my experience with doing real estate financial modeling for developers and commercial building acquisitions there are 4 basic profit return components which are Cash flow, Appreciation, Loan Amortization, and Tax Shelter.

In your case, I think the key focus should be on the commercial mortgage or loan amortization structure and rate. The purchase price and rent seem about right, except it’s risky to have an operating loss. I would consider that unacceptable risk factor.

I still recommend doing a detailed analysis over a 10 year period.

Robb R.

Financial Data Analyst