Case Study 11 unit Midwest property. Is this a good deal? advice?

Question

Hi All,

I wanted to get your professional opinion on this property that I'm thinking about putting in an offer on. This quite possibly may be my first commercial property deal, and I'm just a bit nervous about pulling the trigger on it. Any comments or words of advice will be truly appreciated!

Here is the info:

C-class property in a C-class location

seller will take 350k

11 units total: 10 units 1br/1bath , 1 unit 2/1

all 1br are occupied, 2br is vacant

$50/month for coin-op laundry

average rents for the 1br $455, 2br vacant but can rent for $550

room to increase rent of 1br to $500-550, possible to increase 2br rent to $600-650

current monthly income $5150

tenants pay own electric

landlord pays $70/month community electric

landlord pays water $450/month

insurance $170/month

loan: 5 year balloon, 20% down, 5.25%, 25 year amortization= $1677.89/month

NOI: $29,900

Annual taxes $9411

closing costs: ~$8000?

setting aside 5% vacancy, 5% cap ex, 5% repairs, 8% property mgmt leaving a monthly cashflow of $813.36 and 12.51% cash on cash return on investment.

What do you guys think?

What type of commercial loan structure can you suggest that may work well for this situation?

-Thanks!

Matthew Olszak · Answer

Your 5% estimates are too low for class C, especially low-c earning only $550/mo for a 2BR. I would normally use 10, 15, 10, 10 as a minimum unless there were unique factors (like newly renovated/constructed), and go up from there. 5% of 550/mo is only $330/year/unit - that could get swallowed up in a single service call for a malfunctioning furnace. Also for managing $550/mo units, you'll be hard-pressed to find a PM that will charge less than 10% who won't nickle and dime to you make that up otherwise.

The proforma rents are only slightly higher, but percentage-wise its 10% higher. Why are rents not at that level right now? When you turn over the units to get that extra $600/yr/unit, how much will you spend in repairs/improvements and vacancy to get the units up to $600/mo quality?

Jay Hinrichs · Answer

As @Matthew Olszak stated your reality of expenses is way off..   your projecting best case.

I would take 60% of gross for back of napkin and if it still works then do a deeper dive.

those type of C class properties are going to have lots of turnover.. and your probably not going to turn a unit for 300 bucks.  not to mention your probably not going to move one out and one in..

I like these for locals who self manage and can really stay on top of them.. could be pretty risky from Burlingame

Always take into consideration that the market prices for risk.. and your risk here is tenant stability and how they treat the units.

Alex Bekeza · Answer

@Joel Florek Sounds like you've got a good system figured out.

-I asked because I was hoping @Darius Falahkhir would share the name of the bank.  I like to make note of local banks terms when I come across them in case it made sense to reach out to them for a client in that area at some point.  The terms are good, especially for an out of state investor who presumably doesn't already have accounts there.

-As far as small balance commercial loans go those are great terms.  Like @Jay Hinrichs pointed out.  Rates tend to be a little higher on average.  Small Balance Commercial floor rates tend to start in the 6% range and go into the 8% range.  However, the class of loan programs I'm talking about don't balloon.  They're 30  year terms, fully amortized.  For all of the reasons Jay mentioned short term balloon products aren't my first target for clients.

-If you're really only paying $1,500 for a $550k loan and the interest rate isn't swollen with YSP then I have to assume those bankers have pretty sweet salaries.  Considering that is around 1/3 of a point.  Its unheard of.  I keep my origination fees flexible to compete but that's not even in the ballpark of industry standards.  99% of us work on commission alone.  Not a penny until the loan closes.  That being said, if your looking at motivations, we obviously have a way higher incentive to get the loan closed charging a reasonable fee.

-Allowing some subordinated debt via seller financing is somewhat common in small amounts (10% or so) but I'm always impressed when an investor pulls it off!

-I can only assume that you are one awesome borrower to work for and must make it easy for them to  get these loans closed.

Happy New Year!  I'd be happy to sharpen my pencil to present a loan scenario in 2019!

Brian Ploszay · Answer

You leave out an important piece of information - the location.  Some smaller towns are in deep decline in the Midwest.  And the depth of the tenant base isn't particularly good.  I stay away from these tertiary cities, even though they are in my backyard.  Your rents are very low, so I suspect your potential acquisition lies within a declining economic area.

Jay Hinrichs · Answer

you have a honey hole keep dipping your bucket into those banks.. APR is when you add in all the up front costs.. so for most folks

they pay 4 to 6k in closing cost from mortgage brokers etc.. so when you add those fee's in that's the APR which is slightly higher than the note rate.. so the fact that you paid some fee's your apr is SLIGHTLY higher than your note rate..   the only thing to be cautious about with smaller commercial banks is if you have 5 year calls.. those can bite you.. now I am not predicting this in any manner. but that was one of the main drivers of the last credit crisis was that the banks would not roll over the loans at the 5 year call. and then other banks were not loaning that lead to perfectly performing assets being foreclosed on .. especially if said small bank failed and a hedgefund bought all the notes.. they proceeded to foreclose on them like no tomorrow.   AGAIN not saying this will happen in the next recession but investors should be mindful that not all 5 year call notes will get rolled over and there may not be aggressive lenders out there or the rates will be significantly higher.

Account Closed · Answer

@Darius Falahkhir Congrats !! .

I would suggest using 45% of gross income as operating exp in this scenario. I also suggest to take the new property tax (which might incr based on the purchase price) into account while calculating operating exp. If it's 100% occupied then considering 5% vacancy is standard (I usually prefer using 10% as vacancy). If not please use the actual economic vacancy while calculating NOI.  Did you get a chance to check what are the prop mgr charges in that area ?.  if you haven't, consider using 10% as prop mgr fees.

In order to incr the NOI after purchase, if possible may be you can start with passing back the water expenses to tenants.  It will make tenants more responsible both in using water as well as promptly reporting water leakages if any.

Henri Meli · Answer

@Darius Falahkhir The market price of a commercial asset is generally dependent on two numbers. The NOI (Net Operating Income) and the CAP Rate. (CAP).

Price = NOI / CAP .

If CAP Rates go down (compress), assets become more expensive.

Let's look at an example: An asset that produces $100k in NOI will be priced at $1,250,000 when CAP rates are 8. ($100k / .08) . The same asset will be priced at $1,666,666, if CAP rates were to go down to 6.

So, if the CAP Rates in your area go down, your asset becomes more expensive.

How do you know cap rates? Talk to a broker in the area and get a feel for what assets are selling at.

Hope that helps.

Good Luck.

Darius Falahkhir · Answer

@Alex Bekeza Yes! It is a local bank.

Darius Falahkhir · Answer

Hi @Todd Dexheimer the property is located near white oak off blue rock rd and the 27.

Todd Dexheimer · Answer

I would say your NOI is around $25-30k, which makes the deal look ok, but you did not mention the market you're looking at, so it is hard to determine if you are over paying or getting a great deal.

Also, your profile says San Francisco, but you are looking to buy in the midwest with a local bank. Are you sure you can get a loan from a local bank?

Case Study 11 unit Midwest property. Is this a good deal? advice?

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