how much can I "Afford"? :-)

Question

I'm new to Commercial and finding it challenging to figure out how much sales price I can afford. Having bought and sold 5 SFRs over the last 15 years I'm not new to RE. I am new to commercial. I see properties I like (4 unit bldgs.) yet when I run the numbers with what I intend to put down ($50k) the CashFlow/ROI is either negative or a few dollars at years end. There's a 4 unit I really like, it listing price is in the ballpark of fair ($1 mil) and I like everything about it. While I am firm in the reality of "its worth what it's generating Now", the upside is that rents can be raised and I'm confident even with a fair rental rate increase, the units will get rented should the cheaper tenants leave. Where I'm at a road block is

A. making it work with $50k down and B. Can I even expect to get a loan with such a small down payment for $1 million? At the moment all 4 units are rented but quite below market rates.

Thank you for your input!

Steve

A. making it work with $50k down and B. Can I even expect to get a loan with such a small down payment for $1 million?   At the moment all 4 units are rented but quite below market rates.

Thank you for your input!

Steve

Dan C. · Answer

@Radhika M. Sorry. Guess my verbiage of "assuming" and "estimates" weren't clear. My analysis was not wrong. It was just estimated as the original post gave us no concrete information to the PITI calculation. I appreciate the feedback though.

Brent Coombs · Answer

@Steve Miller, why would any Investor consider accepting a cap rate that is lower than their loan interest rate? And, when "house hacking", its income becomes even worse! Cheers...

Brandon Hall · Answer

Why are you only interested in $1MM buildings (not that there is anything wrong with that!)? There are many places in the US where a $300k property will be an excellent performer and generate 15%+ IRR.

You said your minimum cap is 4%, personally I wouldn't go below 8%. I feel like the guys buying at 4-6% caps are going to get burned pretty badly in the future. Being in DC, we've seen buildings go regularly for 4-6% cap, and I don't understand it. IRR is too tight at that level, for me at least.

Dan C. · Answer

Hi Steve - I found this post very intriguing so I spent some time doing a quick analysis.

Ball park for commercial loans I've always read about is anywhere between 20-35% -- typically on the higher end. But let's say you find some lender willing to give you a 95% LTV loan -- On the $1MM 4-plex property.. you'd have payments of (ballpark estimates):

950k loan @ a commercial rate of 6% = $5,695/mo towards principal / interest

+Maintenance / Vacancy of 15% = $14,400/year ($1,200/mo) (this is 7.5% for maintenance, 7.5% vacancy -- possibly not high enough -- but a quick estimate nonetheless)

+Insurance (assuming 1% of loan) = $9,500/year ($791/mo -- just under $200/mo/unit -- might be a bit high..)

+Taxes (assuming 2% of property value) = $20,000/year ($1,666/mo)

= a total of $9,354/month to own the property because you're so leveraged

Thus, you need each of those 4 units to pull $2,338/mo to break even --  You said gross annual rent currently is $49,200/year -- that's $4,100 / month (or $1,025/mo/unit) -- you need to more than double each units rent to be profitable. Is this realistic, regardless of what upgrades you can make?

Additionally, I don't know your financial situation, but do you have enough financial income to cover multiple vacancies on top of all your other obligations. I would just hate to see yourself so over-leveraged that a 2-3 month blip on 1-2 units could potentially lose you the property and send you into foreclosure.

All-in-all I'd personally rather see you put the $50,000 in a safer investment. You can find many duplexes, or even triplexes in the $175k-300k range. A $300,000 tri-plex pulling $1,200/unit would result in a 9.41% cap rate -- using the same percentages for criteria in my PITI  calculations above (exception -- interest rate lowered to 4.25%) and yield a 26.92% CoC return. You'd achieve an IRR of 5.38% and have an NOI of $13,461/year.

The only way I can realistically see that property selling for $1,000,000 is if someone buys it all-cash or close to all-cash. It does not currently pull enough rental income / unit to be worthwhile otherwise. An all cash deal would still only yield a 1.23% cap rate -- assuming $20,000/year is going to taxes, $9,500/year to insurance, and you have $7,380/year in maintenance/vacancy. I'd rather put my $1MM in a money market earning 1.1% and not have to deal with the hassle of tenants! Time is money.

Hope this helps one way or the other!

Best,

Dan

Radhika M. · Answer

@Dan C No need to apologize. I was just trying to show you how assumptions and estimates should not be used unless you have  experience in similar properties in the same area.

Radhika M. · Answer

@Steve Miller I am not an expert in Southern California but in San Jose where we see similar cap rates or lower in some cases where there is potential increase of the the renal income. Based on my experience having 50K or 5% down is going to be very hard unless you are willing to live in one of the units and get a FHA loan or seller financing.

The commercial loan interest here is closer to 5% from what I see here locally. Also for a 4 unit you will not need commercial loan. You need commercial for 5 or more units. So for residential you can get a loan for 4.5% but this is again with higher down.

For doing value add projects like you are planning you need more capital or partners with capital.

@Dan C. I know you had good intentions when you did your analysis and posted but your costs and analysis is wrong. One easy example is the property tax. The property tax is different in every state and even every city so don't generalize this. The property taxes in california are closer to 1.25% and the insurance cost as 1% of property is totally weird. for high cost areas where land is more expensive than the building. What I have seen here is 50 to 40 per unit per month. So for all 4 units you will have 200 per month.

The Vacancy also is totally dependent on the area in the area and can not be generalized.

I am not saying this is a good deal or you should do it. But please put real numbers and do the calculations.

Steve Miller · Answer

The 4% cap rate is what I found to be a local fair market number.   Given the cost of RE in SoCal and my research, that seems accurate.   Would I prefer higher?    yes

This is my first multi unit, so for me, there's some safety in the search being local.  I think instead of out of state, I'll search in other areas here that are not as lofty in price.  They exist, just not ones that will work for owner occupied as planned.  That's ok.  If I can find a profitable bldg. within an hour or so, I'll do that.  I want to buy something that allows me to go through the process and experience. As in experience what's involved, the good and the bad.

Jacqueline Carrington · Answer

I know how California is expensive being from Rancho Cucamonga.

Jacqueline Carrington · Answer

Have you reached out to any local investor friendly agents to see if they have any better deals available? Gross rent of $49k is low for a $1M property....and that's the GROSS income. Doesn't seem worth the investment. I think your $50k could be put to better use working with someone who can help you find better-numbered deals.

Steve Miller · Answer

OK.  I give.  I see now that I'm unrealistic with what I can buy.  I do have more capital.  I want to keep that extra $ for exactly what you mention, vacancy and repair.  First let me say that for this 4 unit I'm referring to, I Am knowledgeable about the area.   It's two 1/1s and two 2/1s.  There's no question that rents for all 4 can be raised $300/mo each and still be very competitive.  I'd even say that if all four current residents walked away, the building would be fully leased within a month at the higher rents. That's $1200 a month more in revenue.  It was built in the '50s and I'm guessing original ownership family.   I haven't looked it up yet but given that the rents are So far below market, I'm expecting the descendants who now hold the title have enjoyed the income while being hands off the management and financials. From the pics I'd say yes, there's some work to do be done though mostly cosmetic.  I'd allocate $1000 per unit, which I think is generous. There could possibly be deffered maintenance but a full inspection would find it. Plus at that point I'd have leverage to push down the price.  GRM and acronyms aside, like I said, this building is in a B + area to be conservative and I would go out of my way to put it together if I had the means.  Since I don't.....   I'll let it go.  Which leads me to my next area of consideration.  I'm in SoCal where the buildings I like are $1 mil.  If you're talking $200 - $300k, those are not geographies I'm interested in.  I'm not opposed to out of state.  Ignorance is bliss.  I've been all over the U.S. and open to where I find what I takes to get the ball rolling.

how much can I "Afford"? :-)

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