Finding the Value on a Commercial Property?

Question

Hi All,

This will be my first foray into anything larger than a triplex - so I'm sorry if this is a dumb newbie question!

I'm looking at a 6unit property that had appeared to be marketed to regular residential purchasers (i.e. it was on the mls by a residential realtor who doesn't appear to have sold any commercial properties before)... so they valued the property (based on comps) - again so it would seem.

When I've talked to commercial brokers about a loan for this property, they looked at the current rents, and NOI and they are willing to loan about 350K, leaving about a 300K balance that I'd have to pay out of pocket.

Now I know the rents are below market and I can raise the NOI almost 100% (wish some improvements of course...). So what I was figuring was if we purchased this property at 600K and put in 100K but brought rents up and the NOI up from $4190 a month, or 50280 annually to $6900 a month, or 82800 annually and using the low end of the GRM that I've seen in listings for the near by area of 12... it makes the new value $993,600.   (btw, I'm basing the rents off of what I currently get for my similar units in the same city/area - and using the low end to be conservative)

Should I expect this, (if I accomplish my plans) or am I missing some other key factors when trying to see what I could potentially refinance out of this property at (or resell it at?)

Thanks in advance for the input!!!

Scott Skinger · Answer

Hi Jennifer,

Comps are fine but it is very important that you also know the commercial value of the property using the formula

NOI/Cap Rate = Value

So if the current NOI is $50K and the average cap rate in your market is 7%, the approximate value of the property is $715K. This is a baseline to give you an idea of roughly what the property is worth, the price might be higher or lower for a lot different factors.

Part 2 is plugging these numbers into a investment calculator to see if the numbers make sense for your ROI goals. Raising rents to market, cutting down operational expenses and thus increasing your NOI will exponentially impact the value of your property (using the formula above).

Keep in mind that you should buy the property at a price that is based on current actuals, not what the seller thinks it is going to be worth. If you want some more feedback, post the actual numbers of your deal and I will be happy to give you my opinion.

Andrew Beauchemin · Answer

Hi @Jennifer McElliott,

It sounds like you're on the right track.  Here's a very basic explanation of how to value a commercial property.

You need to figure out two things:  Market CAP Rate, and NOI.  You will get the Market CAP by looking at sold comps (a broker should help you with this), and NOI is easily calculated as "Annual Income minus Annual Expense."

Once you have these two numbers, divide the NOI by your CAP rate to get your value:  i.e. 100k NOI at 8% CAP gives a valuation of $1.25MM.

You can increase your value two ways:  lower your CAP, or increase NOI.  Since CAP is largely market-driven, you don't have much control here.  You can increase NOI by increasing rents (which it sounds like you're planning to do!) and/or reducing expenses.

Hope that helps, and wasn't too broad.

Andrew

Ali Hashemi · Answer

@Jennifer McElliott it sounds to me like it's priced for it's potential. You don't want to buy it for what it can be you want to buy it for what it is.

Where's the debt obligation in the financial calculations? If you're taking a $350k loan the $4,190 in monthly rent isn't going to cover the loan payment and expenses....

You need to take the time and put together a formal proforma and be VERY REALISTIC about the CURRENT STATE. Often I'll actually make 3 proformas.....a) Hihgly Optimistic b) Realistic c) Hightly Conservative. And I'm very honest with myself in doing this.

Fred Heller · Answer

"Keep in mind that you should buy the property at a price that is based on current actuals, not what the seller thinks it is going to be worth. "Double amen to that. The hardest part of my job is dealing with sellers who have priced the property at what they think it will be worth 5-10 years from now.As far as I'm concerned, the main thing I'm looking at is current NOI when determining the value of a property.

Gino Barbaro · Answer

@Jennifer McElliott

The property was on the market for a couple of years. The best thing to do is to run an actual scenario of last 12 months P&L, plug in sales price and debt, and shoot it over to the seller. When they see the actual performance and how the property is overpriced, a motivated seller will begin to negotiate without you having to say a word.

We bought on actual numbers, but their expenses were very high, and some units were not at market. The price did make sense, and the owner financing was a huge bonus.

Five years ago, it was easier to buy on actuals.  Investors now give up some of their profit and pay higher prices. Just where the market is.  It took us almost 18 months to buy our last deal, from March 2016, to December 2017. I have learned the brutal lesson of not overpaying!

Hope that helps

Gino

Jennifer McElliott · Answer

Hi @Gino Barbaro - thanks for commenting - I had to go back and re-watch/listen to your podcast - and was truly inspired!  Sounds like your first deal might be a similar situation (minus the drug den part and weekly renters ;P)... I believe you mentioned that you also purchased that place at or around 600K, did that price make sense w/ the current NOI that the sellers were collecting or were you and your partner purchasing it knowing that the future NOI outweighed the fact that the current numbers weren't good?   Have you guys written out a pro forma to show the sellers that why their ask price is too high and actually have them come down as a result?

Jennifer McElliott · Answer

@Rich Hupper - very true, in this case however, it'd be a relatively small deal for the big players - and it's not a traditional apartment building either - definitely more mom and pop style think large property where there's a 4-plex on one end and some single units in a separate building on the same property... this one also appears to be represented by a residential realtor and was listed on MLS and not loop net ... But I hear you.

Rich Hupper · Answer

Just from my experience Jennifer. The best commercial deals are never found online. Brokers who know all the big players literally pick up the phone as soon as they have a commercial listing and make a few calls to get those sold. I was just dealing with this the other day.

Commercial real estate is few and far between so there are a very very small percentage of brokers dealing with these transactions, and they know all the business owners who may want them.

Jennifer McElliott · Answer

@Ali Hashemi - thanks, yes I see it now, I am embarrassed to admit that I've been basing deals on it's potential as opposed to it's current value (b/c I think it can be worth more than the 600K that I'd be paying right now. and/or I believe I can make the cash flow when I turn the place over.).  In this case, I think beyond the eventual cash flow that I believe I can achieve, I think there is still room for forced appreciation even at the 600K price... but I think you all are saying that's (too) risky and plain, not wise....?

Finding the Value on a Commercial Property?

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