Can this Residential Commercial Strategy work?

[Chris John]

Rents in my corner of the world have risen rapidly over the past 10 years or so.  I'm finding several smaller commercial, residential properties (5-10 units) that are very below market on the rents.  I apologize for my ignorance on potential rules and verbiage, but I'm wondering how realistic this strategy is in the "Real World"?

I'm vaguely familiar with debt yield and a former student that's now a commercial lender told me that their bank is comfortable at around 8-10% (10-12 multiplier).  My thoughts, for example:

Buy a 1M property with a current noi of 70K for a cap rate of 7%. Based on the debt yield, I'd apparently have to put down somewhere between 150-300k although I'm guessing at least 200 - 250k for a 75-80% LTV. I'll add another 50k in renovation costs and assume 300k (250k + 50k).

Then raise rents (a property we're looking at has rents at around $900/mo, but my property manager feels like he can get them to $1400-1500/mo over a couple of years). So, assuming all of this is accurate and doable, let's assume a new NOI of 100k.

If I assume a 7% cap rate (what I bought at in this fictional scenario), it should sell for around 1.4 million and I'd roughly double my 300k in a couple of years.  What I'd rather do is refinance it for 1M - 1.2M (again the 10-12 multiplier), get my cash out plus a little, having a cashflowing property and money to go do it again.

Is this something that people do?  Is there more to it than this?  Would a lender give cash out like this on residential?  I just don't know enough about commercial, so I'd love feedback.

Thank you!

[Marty Johnston]

@Chris John Sounds like a great deal here! This certainly is something that you could do, and you'd have CRE Loan options assuming that the values are there. Also, with the $50,000 in renovations, how much value do you feel you'd be bringing to the property? You could look at a Rehab loan (short term Interest Only) for the purchase + rehab, and then refinance into a permanent financing loan (30-yr type product) once you've completed the renovations. We have a lender we work with who only has a 1 month seasoning, so you could refinance using the new value of the property after 30 days, get out of your high-interest rehab loan, and refinance again in a few years to pull out your new equity if you believe the appreciation will be there.

Options are there, but it really does all depend on the value of the property. You're correct in your estimates of 75-80% LTV on the acquisition. A cashout refi will usually be 5% LTV < than a Purchase or Rate & Term Refi LTV from the same lender (cashout is simply viewed as higher risk).

Hope this helps! Shoot me a DM if you'd like to chat more on this.