12 Unit Apartment deal - Seller wants to sell with assumed Mtg

8 Replies

Hi All,

I wanted to lay out a deal I am looking at and get others opinions on quality of the deal and of options to finance considering the assumed mortgage.

Asking Price: $1,425,000
Mtg to be assumed: $720,000; 4.68%; 5 yrs remaining on 10 yr term; $140,000 payout penalty (which is why seller wants mortgage to be assumed)
2014 
Revenue: $119,926
Expenses: $78,294 ($37,593 in repairs/maintenance)
NOI: $41,632

2015
Revenue: $129,727
Expenses: $127,815 ($83,181 in repairs/maintenance)
NOI: $1,912
2014/2015 maintenance and expenses are inflated due to renovations (windows, metal roof, flooring in common area, some upgrades to suites)

I am very new to buying buildings and have only been the money partner in the past.  
Any comments or feedback would be appreciated.
What am I not seeing?
How would you approach financing?
Anything else I don't even know to ask.

Thanks!
Derrick

opps started in the wrong forum, thanks for re-posting Mindy!

@Derrick Jordan the price seems way too high. Even if you add all the renovations back into the NOI it's only about a 5.5 cap. The reality is that renovations and repairs will likely continue. If this is an older building that will continue to need ongoing maintainence, than a 10 cap would be more appropriate. Assuming an ongoing $20k in renovations and repairs, that would put the price at about $650k.

You're looking at about $65k NOI on this property, give or take, assuming the heavy lifting on renovations is done. For reference, I have a building that produces around $45k NOI, including the ongoing renovations and I paid $335k for it. To me, that's what a good deal looks like.

Without a significant concession on price, I wouldn't dig into this one any more.

Good luck!

@Derrick Jordan

Valuation for commercial property is Value = Net Operating Income / Capitalization Rate. 

Basically, the higher the NOI, the higher the property value. Only makes sense, right? And generally sellers/brokers will try to fudge numbers to get that NOI as high as possible. They'll do this by using pro forma rent numbers that shows what they think the units could rent out for and at 100% occupancy, where in reality they might be at 80% occupancy and $100 under market rent. You don't want to pay based on pro forma because you'd not be paying for reality, you'd be paying for future potential. And if you get that property up to future potential, you should be the one reaping the benefit of that value add turnaround. Also, generally, NOI does not include capital expenses such as roof, windows, etc. Looks like the above numbers are lumping repairs (lightbulbs, paint, etc) with Cap Ex. It's good that they're not trying to move those items below the line to try to make the NOI larger. But at the same time you don't want to include them which will cause you to undervalue the property (and possibly pass up on good deals). So you need to break out those items carefully.

The Cap Rate is specific to type of property in a sub-market. A newer property in a good area will have lower cap rates. An older property in a high crime area will have higher cap rates because investors will expect a higher return on their money due to the increased risks. You will have to get with a commercial broker in that area to see what the going cap rate is. When you are buying you want a higher cap rate since it makes the property cheaper (dividing by a larger number).
Using the numbers you provided above, you get a very low cap rate based on asking price. Even using 2014 numbers, which has much higher NOI of $42k, the cap rate they're wanting to sell at is only 2.9%. Right now cap rates usually range from around 6% to 10%, so that number looks too low, which means the asking price is likely too high.

So basically you have to go and make sure both the revenue and expense numbers are correct. Get the cap rate from a broker. And you should be able to come up with proper value.

Originally posted by @Wade Sikkink :

@Derrick Jordan the price seems way too high. Even if you add all the renovations back into the NOI it's only about a 5.5 cap. The reality is that renovations and repairs will likely continue. If this is an older building that will continue to need ongoing maintainence, than a 10 cap would be more appropriate. Assuming an ongoing $20k in renovations and repairs, that would put the price at about $650k.

You're looking at about $65k NOI on this property, give or take, assuming the heavy lifting on renovations is done. For reference, I have a building that produces around $45k NOI, including the ongoing renovations and I paid $335k for it. To me, that's what a good deal looks like.

Without a significant concession on price, I wouldn't dig into this one any more.

Good luck!

 Thanks @Wade Sikkink, I appreciate you taking the time to have a look and sharing an example of something you have done which provides good reference on what good looks like.

Originally posted by @Michael Le :

@Derrick Jordan

Valuation for commercial property is Value = Net Operating Income / Capitalization Rate. 

Basically, the higher the NOI, the higher the property value. Only makes sense, right? And generally sellers/brokers will try to fudge numbers to get that NOI as high as possible. They'll do this by using pro forma rent numbers that shows what they think the units could rent out for and at 100% occupancy, where in reality they might be at 80% occupancy and $100 under market rent. You don't want to pay based on pro forma because you'd not be paying for reality, you'd be paying for future potential. And if you get that property up to future potential, you should be the one reaping the benefit of that value add turnaround. Also, generally, NOI does not include capital expenses such as roof, windows, etc. Looks like the above numbers are lumping repairs (lightbulbs, paint, etc) with Cap Ex. It's good that they're not trying to move those items below the line to try to make the NOI larger. But at the same time you don't want to include them which will cause you to undervalue the property (and possibly pass up on good deals). So you need to break out those items carefully.

The Cap Rate is specific to type of property in a sub-market. A newer property in a good area will have lower cap rates. An older property in a high crime area will have higher cap rates because investors will expect a higher return on their money due to the increased risks. You will have to get with a commercial broker in that area to see what the going cap rate is. When you are buying you want a higher cap rate since it makes the property cheaper (dividing by a larger number).
Using the numbers you provided above, you get a very low cap rate based on asking price. Even using 2014 numbers, which has much higher NOI of $42k, the cap rate they're wanting to sell at is only 2.9%. Right now cap rates usually range from around 6% to 10%, so that number looks too low, which means the asking price is likely too high.

So basically you have to go and make sure both the revenue and expense numbers are correct. Get the cap rate from a broker. And you should be able to come up with proper value.

 Thanks @Michael Le, the typical CAP rate for the buildings area is said to be 7 - 7.5. I was trying to figure out how someone could cover all operating costs and financing based on the numbers that were provided. Unless I am missing something this one will sit on the market until the seller is prepared to adjust the price especially with the requirement of assuming the mortgage.

@Derrick Jordan , I didn't dive into the financial underwriting because I don't have enough information to render a useful opinion, but I will say that this deal has a major challenge from the outset.

The underlying financing is at a really low LTV (50.5%) relative to the asking price. That kills your cash-on-cash return and your IRR because you have really low leverage from the outset. The only way to combat this is with a much lower purchase price, where your high cap rate and low basis can overpower the financing disadvantage, or with some type of supplemental financing.

If the existing loan is Fannie or Freddie you might be able to get supplemental financing to get the leverage up to 75-80% LTV. If the loan is with a lender that doesn't prohibit subordinate financing you might be able to get the seller to carry back the difference between 75-80% LTV and the existing loan balance.

If none of those scenarios are feasible the property will likely either sit on the market or the seller will have to eat that prepay to get the property sold.

Originally posted by @Brian Burke :

@Derrick Jordan, I didn't dive into the financial underwriting because I don't have enough information to render a useful opinion, but I will say that this deal has a major challenge from the outset.

The underlying financing is at a really low LTV (50.5%) relative to the asking price. That kills your cash-on-cash return and your IRR because you have really low leverage from the outset. The only way to combat this is with a much lower purchase price, where your high cap rate and low basis can overpower the financing disadvantage, or with some type of supplemental financing.

If the existing loan is Fannie or Freddie you might be able to get supplemental financing to get the leverage up to 75-80% LTV. If the loan is with a lender that doesn't prohibit subordinate financing you might be able to get the seller to carry back the difference between 75-80% LTV and the existing loan balance.

If none of those scenarios are feasible the property will likely either sit on the market or the seller will have to eat that prepay to get the property sold.

 Thanks Brian!  I appreciate your insight.  I have received a little more information about the seller and they have no interest in seller financing.  So, with that said I believe they are going to have a real tough time selling at this point.  I will keep my eye on it for now and if nothing has changed for a few months might follow up and see if they have softened their position at all on the mortgage assumption or vendor financing.  

Agree with Michael Le, Price sounds way too high.

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