What are we missing?

[Brian McCabe]

I am an agent in NJ. Here are the basics of a deal that I recently discussed with a client.

The asking price for a 9 unit, mixed use property in good condition is about $1,500,000. Gross income is approximately $150,000. A broker-provided offering memorandum, which was unusually thorough, included a broad array of expense items the net of which was an NOI of approximately $110,000, a cap of just under 7%, and cash-on-cash of about 8.4%. Not bad at all.

However, the offering memorandum was incomplete in the following ways. There were no vacancy allowances assumed for any of the 9 units, 4 of which are commercial, with 3 of the 4 having leases expiring in 2023. There is also a vacant office space. The NJ Mansion Tax, which is 1% of the contract price, was not taken into consideration. Neither were closing costs, which represent a very sizable cash expense.

So, when underwriting the property, we applied a 5% vacancy allowance to all units and added nearly $58,000 to cash (which included the Mansion Tax) to account for closing costs.

The results. NOI dropped from $110,000 to about $95,000, the cap rate fell from nearly 7% to 5.8%, and cash-on-cash collapsed from 8.4% to 4.8%. My client passed on the deal.

However, THIS PROPERTY WILL SELL AT OR ABOUT ASKING. What are we missing? Is this a market where an investor should be content with a 4.8% return on cash and an overall 5% return on investment?