How much would you pay for this deal?

Question

What would you pay for this deal? I primarily invest in SFHs but an opportunity has come up to purchase a commercial property with rental units and the owner wants me to come up with a price...

The property has three retail/business spaces and 7 apartment units. The financials are as follows:

Monthly rental income: $7835

Taxes: $954/month

Utilities: $416/month

Insurance: $329/month

I'm projecting 7% vacancy, 5% repairs, and 10% cap ex. Are these reasonable estimates?

I would say it's a class C rental, on the lower end for the area and will probably see more frequent turn of tenants.

I will likely finance the property at 80% LTV and the property will need to cash flow...

The price that the owner thinks it is worth is much higher than I feel I can pay. I'd like to be able to cash flow $1000/month and have 12% cash on cash return. Here are my numbers:

Income

Rent

7,835.00

Expenses

Taxes

954.00

Utilities

416.00

Insurance

329.00

Vacancy

548.45

Repairs

391.75

CapEx

783.50

Mortgage

3,151.10

Total Expenses

6,573.80

How much would you pay for this property based on these numbers?

Steve Shaffer · Answer

Net Operating Income/Cap Rate = Value

Using your current numbers, you're looking at a 43% expense ratio.  I would humbly submit that for class-C that may be a little low.  Often when commercial appraisers come in, they're just going to assign you a 50% expense ratio unless you can show them cause for it to be much lower or higher.  The value of the property then comes down to the capitalization rate from the area which you should be able to get from a reputable broker or by doing your homework on similar properties that have sold.

$7835 x 12 = $94,020 (Make sure the only income is rent.  Laundry, vending machines, etc need to be in the top line)

$94,020 x .5 (50% expense ratio) = $47,010 NOI

$47,010/0.08 (8% Cap Rate) = $587,625

$47,010/0.07 (7% Cap Rate) = $671,571

The real opportunities with these properties is in increasing the NOI and keeping good records to pass to the appraiser and future potential buyers that you did so.  Make the units nicer than they need to be.  Charge fair rents.  Reduce turnover.  Cut expenses relentlessly and increase income in a fair way as you're able.  Good luck!