When I first got started with looking for multifamily properties, it took me four hours to answer the question, “What is the most I can offer for this particular deal?” As you probably know, you’ve got to kiss a lot of frogs before you find a good deal and can put it under contract. The time it took to analyze deals was a real issue, and that impacted my ability to get deals done.
I’ve since learned that I was wasting my time. Maybe I can help you learn this lesson sooner than I did and give you some tips on how you can do this in 10 minutes or less.
When you first get a marketing package from one of your commercial real estate brokers, it can be overwhelming. Some of these packages are 20 pages or more! I found myself reading every page, and of course I wanted to be detail-oriented in my analysis. I was examining the financials with a fine-toothed comb, comparing the reported real estate taxes with what’s published online, doing rental comps for the area and comparing them to the reported rents, and performing other research.
Did I mention this was a waste of time?
Your goal at this stage is not to begin due diligence on this property, but to assess the fair market value of the building based on the information you were given.
Many times the marketing packages are not only incomplete, but they’re overly optimistic with the income and expenses. You can use this to your advantage to start the negotiating process. If we get a positive reaction, we can then delve into the deal a bit more. But only if there’s a nibble!
Here is a better way to do this.
The 10-Minute Analysis
Step #1: Adjust the Income—4 minutes
If the marketing package contains actual financials, look for the gross scheduled income and adjustments for vacancies, concessions, and bad debt, etc. If these adjustments are greater than 10%, then use that number; otherwise, use 10% as a vacancy factor.
If you have a rent roll as well, compare the bottom-line income in the rent roll with the financials in the marketing package, and use the lower of the two.
If you only have the ProForma financials, then use those numbers.
Keep track of any adjustments you make to the income because you’re going to be communicating those to the broker later.
Step #2: Adjust the Expenses—3 minutes
This is going to be easy.
If the reported or ProForma expenses are greater than 55%, then use that number; otherwise, use 55%. Often, when the reported expenses are less than 55%, they’re missing something. For example, the expenses may be missing a management fee (because the current owner is managing the property himself), or perhaps it’s missing insurance or some other expense.
Don’t spend a lot of time on this, but see if you can find SOME expense that is missing from the broker’s marketing package. You’re going to use that as an argument that the expenses are unrealistically low.
Now, determine your adjusted net operating income (NOI) by subtracting your adjusted expenses from your adjusted income.
Step #3: Use the Advertised Cap Rate to Come Up With a Revised Fair Market Value—3 minutes
Usually the marketing package advertises a certain cap rate for the property, as in, “Awesome deal at a 8.6% cap!”
If the cap rate is not that obvious, you can quickly deduce it by taking the NOI from the package and dividing it by the asking price.
Make a note of that cap rate because you’re going to use it to your advantage shortly.
Now, determine your adjusted NOI from Steps 1 and 2 and divide it by the advertised cap rate. This will give you the adjusted price for the property.
Typically, this number will be lower than the asking price. That’s because the income and expenses in the marketing package were overly optimistic to begin with!
Make note of the adjusted price. Your offer price should be below that to give you some negotiating room.
Step #4: Get Back to the Broker With Your Analysis and Informal Offer Price
Compose an email to the broker in which you explain your adjustments to the income and expenses. Explain that after applying the broker’s cap rate, the adjusted price is X, and that you’d be happy to make an offer at the price if the seller would be amenable to that.
Something like this:
Hey Rob — I looked over the package you sent me. Everything looks good: it’s what we talked about on the phone. I made a few adjustments to the underwriting in the package, though.
For starters, I don’t have the actual financials, so I had to rely on the ProForma numbers, and we both know those are going to be better than actuals, right? Well, that’s all I have at the moment, except you also sent me the rent roll. The rent roll income is about $30,000 less than what you have in the ProForma, so that’s what I’m using for the underwriting.
WRT the expenses, I don’t have the actuals, but the ProForma expenses in the package only added up to about 35% of income. For example, it looks like the insurance expenses are missing, and there are hardly any repairs in the P&L. Based on experience and looking at actual financials from similar listings in the area, I know those are way low. I normally use 55% of income for the expenses, and that’s what I’m using here.
You’re advertising a 8.5% cap rate for this deal. I’m not 100% sure if that’s fair for this area, but let’s assume it is. If you apply an 8.5% cap rate to the adjusted Net Operating Income, the valuation of the building is $1.75M, quite a bit away from the $2.4M asking price.
If you see something awry with my underwriting, let me know. I could make an offer at asking price, but I don’t want to waste your time if we both know the actual NOI will be lower than what you have in the ProFormas once we get into due diligence. So I’d rather be a bit more realistic upfront.
I’m not sure how set your seller is on the asking price, but I’d be pleased to put in an offer at $1.75M if he would consider it.
Let me know what you think. I look forward to hearing from you.
What Have You Done?
- You’ve spent no more than 10 minutes analyzing the deal to come up with an offer price. You used the information you were given, plus some rules of thumb. But you didn’t launch an investigation to get better numbers—at least not yet.
- You got back to the broker quickly with feedback. Brokers tell me that only 25% of their buyers get back to them with feedback. So if you do, you’ve elevated yourself to the top 25% of that broker’s list of buyers. A good place to be, no?
- You’ve started the negotiation process. Yes, you have. It starts informally, but it started. The broker may not respond, or he may say that the seller wants asking or that there are multiple offers at a higher price. Or you may get a counter. And now you’re in the game!
So, don’t waste your life away analyzing deals. Work smarter, not harder. If you do, you’ll be able to look at more deals and increase your chances of finding a deal that will actually work.
Will you use my analysis method? Any tips to add?
Leave me a comment below!