Looking at first commercial deal - thoughts?

Question

I do some residential rehabs, looking to get into a some longer term properties as part of diversification.

Property is two buildings side-by-side. One building is 6 residential apartments, other building is 3 retail/office spaces and 3 apartments.

$329,000 purchase price.

$27,900 NOI from 2014 Pro-Forma.

Roughly 8.5% cap rate. If I can finance at 20% down w/ 5% interest, that's approximately a 14.6% ROI on cash outlay. Even higher if there's a little negotiation room available.

I haven't seen 2014 pro-forma, but obvious concerns are that this may not include any sort of capex amounts or maintenance could have been abnormally low.

Any other things to look for, or thoughts on the deal?

ThanksChase

Lee I. · Answer

Check the lease lengths and terms.  Long term retail/office tenants or recently placed?  Maybe talk to tenants to get an idea of if they plan on staying if the lease is ending soon?

Chase Gochnauer · Answer

Yes P&L was -$3000 for the year based on rents. This was fully managed by a larger property management firm. Total rents for the year were $52,000. Fully rented with 0 vacancy my guesstimate would be $70,000 in total rents

Some of the expenses seemed extremely high, and I think there's opportunity to get them reduced but I think it should be closer to purchase price $225k not $330k.

Lee I. · Answer

Losing money before even counting debt service?  Are the buildings partially vacant?  If there was really opportunity for raising rent, you'd think the seller would have by now if (s)he's losing money.

Chase Gochnauer · Answer

Basically I'm not missing anything. Per broker, this would best fit a hands on manager and there is an opportunity for raising rents. AKA, it's not making money now but if you do everything yourself you can make a profit. As it's operating it's essentially a 0% cap rate. The difference between 2014 rents and property taxes/insurance is about a 9% cap rate, assuming zero maintenance or management. Crazy how they can list it at a $27,900 NOI when that's completely bogus. This is an established commercial broker.

Chase Gochnauer · Answer

Received detailed P&L.

NOI for 2014 on their Income statement shows $-3,171.03. Even subtracting out the $3k in professional management fees, that's a $0 NOI for 2014. This does not include any of their financing costs. I might be missing something but I don't think so, other than the fact some of the maintenance costs such as snow and lawn seemed to be a little steep(we could probably cut in half as my other business performs lot maintenance) , but I'm sure that's due to a large property management company handling them.

I'll ask the broker what I'm missing.

Chase Gochnauer · Answer

Makes sense on the interest rate. I have some lower priced investment properties free in clear I can leverage against too. I'll look into this deal further and any others out there and see what I can come up with on more detailed numbers. It just seems to make much more sense for me from a management standpoint to manage one $330k property than say (3) $110k homes if the cap rates are comparable.

Joel Owens · Answer

"I am having trouble deciding at what level to try my first deal in the commercial arena."

Yes that's a tough decision. Larger loans involving non-banks and CMBS debt are typically with loans of 2 million or higher.

If buying multifamily there are some non-bank lenders at smaller amounts.

5 year is the term of the loan usually with a local bank for 20 year term. They do not want to lend out money for 7 or 10 years fixed. The reason is with interest rates rising if you can imagine paying out 3.5% for savings and deposits to get customers in the branch 5 years from now and they have debt fixed in the 4's the spreads do not work to stay in business.

Non bank lenders can hang money out for much longer periods at fixed rates as their business model is different.

Chase Gochnauer · Answer

I will check into that Lee. Thank you.

Chase Gochnauer · Answer

Thanks for the quick response Joel. I am having trouble deciding at what level to try my first deal in the commercial arena. I can go higher, but I'd rather have some of my "learning experiences" on a lower level property.

When you say 5 year, are you referring to a sort of balloon type payment?

Joel Owens · Answer

It will be a local bank with short term finance of likely 5 years and they will want full recourse.

Mom and pop mixed-use properties they will likely want a higher DSCR than 1.20. Probably 30 to 35% down. Low leverage is prudent on non-vanilla type commercial assets.

250k loan in commercial is like a 20k house. Small banks might want it. Likely who holds your deposits now for the relationship would be most comfortable looking at this.

Looking at first commercial deal - thoughts?

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