Silver Spring, Maryland Mixed-Use Property - Input Needed

[Brad Dwin]

Hello BPers - 

I am working with a seller of a mixed-use property in Silver Spring (20902 near Holy Cross Hospital) and I'd like to either wholesale it or keep it as a rental if I can make the numbers work. If I take option B, I will need a cash partner.

Owner - The owner lives most of the year in Florida, husband passed away and would like to sell without a realtor. She isn't super motivated, but I've met with her a few times and I know she will sell it for the right price and of course claims she doesn't want to be greedy. Property is owned free and clear.

Property -  The property is roughly 7,000 SF, although only the residential 2700 sf is publicly recorded. The owner did give me all of her income/expense numbers (including the total taxes and the cost for the special exemption for the office space), which I will  share shortly. This property is two office spaces and one apartment - all with separate entrances. One office space is rented by a dentist for $3600 per month (1.5 years left on lease and when I met him he indicated he is staying), the residential space is renting for $2700 per month (current tenant has been there for more than 20 years already) and there is a third office on the ground floor that is currently vacant (the owner has never really marketed it, but it seems to me to be another $2500-$3000 in gross rent). The vacant office probably needs $10K-$15K work to be ready.

Current Numbers -  Monthly income is currently $6300 between the two occupied spaces and expenses are $1,842 (owner currently pays all utilities, insurance, lead certs, pest control, special exception for office space, taxes, etc.). These were the total numbers for 2015. No management company is involved. No major repairs needed (HVAC is only a year old) except that the vacant space is not rent ready. With the third space rented (ideal for a doctor/medical professional due to proximity to Holy Cross Hospital), this property has a potential for $8,800 - $9,000+ in monthly revenue.

Situation - Because there are no recent comps nearby for a property in this unique category I have been unsuccessful in determining a solid ARV to allow me to work backwards. I know that the owner has already turned down an offer of $650K sight unseen (which was were my initial thoughts were number-wise) and thinks the property is worth $700K - $900K. That's a pretty large window and also goes to the motivation factor. Plus she is going to have her attorney review any offer. She will consider a seller financing arrangement as well and I am not very well-versed on those deals. I know there was an appraisal in 2002 for $1.2M, but property values in that neighborhood have dropped considerably since then. I know, since i used to live a 1/2 mile away. Even the owner doesn't believe it's anywhere near that value in the current condition. I ran one scenario using an ARV of $875K and came up with a number around $715k. But again, figuring out the actual ARV is very challenging and my realtor partners have not been able to find adequate comps - only for the residential piece. The e-appraisal website put the property's value at $736K, but I doubt that's accurate.

My hope is that there is someone in this group - hopefully in Maryland - that has done a similar deal and can offer some suggestions. Or has an idea about determining the ARV. Or any creative way to get this deal done.

[Russell Brazil]

Without knowing exactly where it is, my off the cuff price that jumped to mind was $1 million. I would also say prices are higher in that area than they were in 2002.

I would check the zoning and make sure it is legally zoned for commercial use since you don't want the county shutting you down. 

Is this property right on Georgia Ave? There is a building with a dentist office on the east side of Georgia north of Forest Glen Ave about half way to wheaton. If it is that building, I'd say off the cuff $900k for that particular building.

[Account Closed]

In commercial properties you don't calculate ARV. You calculate the value of the property by comparing the current net income with the areas cap rate for similiar properties. As an example you take the current net income (gross rent minus expenses). What are the expenses? To determine the value you take the net income (before loan payment of income taxes) but including property taxes and insurance and divide it by the area cap rate for the that age and type of property.

What is the age of the property? What is the typical rent for the offices and residence in that area?

Here is an example without knowing the additional expenses for the 3rd unit being rented, the age of the property or cap rate: before the 3rd unit is rented: Annual income $75,600 - expenses of $22,104 = Net Income of $53,496. If the age and area cap rate for this type of asset is 8% then the calculations are $53,496 / 0.08 = $668,700. This is the current value of the property.

When the other unit is rented then the numbers are $111,600 gross income minus expenses $22,104 = $89,496. Then take this number and divide it by 8% = $1,118,700. This then becomes the value of the property after the next unit is rented, if the expenses stay the same.

So let me know the age of the property, what is the typical rent for this type of asset in the area, and the area cap rate for this type of asset, then I can give you better numbers to work with. 

I hope this helps. 

Steve Anderson

[Account Closed]

Originally posted by @Account Closed:

Here is an example without knowing the additional expenses for the 3rd unit being rented, the age of the property or cap rate: before the 3rd unit is rented: Annual income $75,600 - expenses of $22,104 = Net Income of $53,496. If the age and area cap rate for this type of asset is 8% then the calculations are $53,496 / 0.08 = $668,700. This is the current value of the property.

When the other unit is rented then the numbers are $111,600 gross income minus expenses $22,104 = $89,496. Then take this number and divide it by 8% = $1,118,700. This then becomes the value of the property after the next unit is rented, if the expenses stay the same.

Steve, that is an incorrect way to calculate value.  By ignoring the PGI potential gross income of the property and only capitalizing actual rents you are grossly under valuing the property.

The correct way would be to take the potential rents of all three units. Subtract a vacancy and collection amount and then operating expenses to get NOI. Then you would take the market cap rate against that NOI and get close to your $1.1M value. But you do not have the property operating at market so you would subtract FROM the capitalized value the costs to get the third unit leases and the lost rents and a risk factor. That may only be $10,000 in a strong market or $100,000+ in a weak market. So the difference in value is not $450,000 as in your incorrect calculation just because one unit is not leased.

[Jason Krick]

Originally posted by @Account Closed:

Originally posted by @Account Closed:

Here is an example without knowing the additional expenses for the 3rd unit being rented, the age of the property or cap rate: before the 3rd unit is rented: Annual income $75,600 - expenses of $22,104 = Net Income of $53,496. If the age and area cap rate for this type of asset is 8% then the calculations are $53,496 / 0.08 = $668,700. This is the current value of the property.

When the other unit is rented then the numbers are $111,600 gross income minus expenses $22,104 = $89,496. Then take this number and divide it by 8% = $1,118,700. This then becomes the value of the property after the next unit is rented, if the expenses stay the same.

Steve, that is an incorrect way to calculate value.  By ignoring the PGI potential gross income of the property and only capitalizing actual rents you are grossly under valuing the property.

The correct way would be to take the potential rents of all three units. Subtract a vacancy and collection amount and then operating expenses to get NOI. Then you would take the market cap rate against that NOI and get close to your $1.1M value. But you do not have the property operating at market so you would subtract FROM the capitalized value the costs to get the third unit leases and the lost rents and a risk factor. That may only be $10,000 in a strong market or $100,000+ in a weak market. So the difference in value is not $450,000 as in your incorrect calculation just because one unit is not leased.

Bob,

This comment is perfect timing for me. I was looking at a property that currently only had three units bringing in income, but another section of the building has renovations started. When complete, I could have between 9-11 units total. Going off of current NOI, I knew that the value would be absurdly low, but I had no idea how to value the rest of the unused space when trying to determine an appropriate offer. Your explanation was extremely helpful. Thanks for the step-by-step!

[Account Closed]

This was a beginners version of the calculations. You are right there is alot more going into the calculations. 

[Russell Brazil]

Not so much for the op, but for those following the discussion....very often a small commercial property rarely will trade based strictly on the numbers, at least in my market which is the market at hand.  Small apartment buildings, think 10 units....will typically trade on price per unit basis to a comparable unit. What they are actually getting in rent or how much they are actually paying in expenses almost never comes into the equation on these types of properties.  Small commercial properties like a corner store will have more of a link to the numbers, but not anywhere the link of say a large commercial office space building. A small mixed use property like the one described is actually probably the hardest to come up with a price for.  Its going to be a combination of value of the land, value of the building, and potential rents. What an appraiser would appraise it at for bank financing would likely have no correlation to market value as something like this would typically be purchased for all cash in this market.