I was recently looking at a property that had retail on the first floor and 9 apartments on the second floor. There is a vacant basement that could be rented for storage & a 3rd story that can be built out for additional apartments. I contacted the listing broker and they sent me rent roll and operating expenses. At first, things looked pretty good...$50k+ annual NOI & an 8% cap rate which would only get better by building an additional 6 apartments. There was no vacancy with long term tenants in place, but most of them were on month-to-month leases. Then I realized that the NOI assumed 0 vacancy...strike 1. By adding the possibility of vacancy, cap rate dropped below 7%. Then, I saw a note that showed the current owner's loan payment amount & realized that even using his numbers, it has a negative cash flow.
The property was being listed with seller financing, which was a great find. However, I still wanted to check to see if the listed price was about right, or way out of the ball park. Problem is, it's kind of rural and there aren't many other properties in the area to compare to, so what is the best way to find the actual value of the property? With a little bit of up front investment, this property still has the potential to make good money, but I would like to know that the asking price makes sense. Any suggestions would be greatly appreciated.
with nothing similar to compare it to I would just use the cap rate of other businesses sold to compare it. Then again you still need to offer only what makes since to you for a positive cash flow. You shouldn't pay for something that isn't there which is why value add investing works.
First off remember the asking price is useless. You determine the price the property is worth to you. Don't buy it if the deal doesn't work.
Determine what you think is an acceptable cap rate. To do this you often do have to find comps., but it also has to reflect what you are willing to accept.
Also, you can use their numbers, if the return is acceptable to you. If they tell you it has a cap rate of 8% then you run the numbers put in your assumptions and then determine the price using their cap rate and your assumptions.
Remember to include expenses such as vacancy rate (which may be somewhat high since there are so many month-to-months), don't forget to include repairs and maintenance, utilities, taxes, insurance, and replacement reserves. Remember if the tenants have been in there a while, what type of maintenance will be needed to get the unit ready to rent again.
Take your numbers for expenses using theirs as a guide, but you need to be realistic and be able to defend your assumptions. Take their numbers for the income then make an offer based off these numbers.
(The NOI you have determined to be realistic (their expressed income - your believed reasonable expenses) / their expressed cap. rate.)
Make sure you are not lock into anything until you have the opportunity to review the actual numbers and have the opportunity to talk to tenants and research the expenses. Remember taxes change.
The renegotiated price should be based on their cap rate, but with the actual numbers and your reasonable perceived expenses. Be able to defend your numbers if/when they come up with questions about them.
You can dream all you want about how you will be able to improve the property once you own it, but when negotiating you need to let them know you are buying on facts not speculation.
Thanks to both of you for your responses. The idea of getting seller financing on this property is what originally caught my attention. However, if the current owner is already losing $60+ per month, he's not going to sell it for a lower monthly payment than his current out of pocket expenses. I know that when trying to calculate the value, potential/future additions don't count towards the ARV. On top of that, the pro forma financials had ignored vacancy rates and only had $2,500/year budgeted for maintenance. When I add vacancy and a maintenance budget in, the NOI drops to about half of the pro forma NOI...which equates to an ARV of about $165k less than what it's listed for based on the stated cap rate.
Any way I look at it, this "deal" loses money. Thanks again for your input.
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