How much is a gutted shell worth?

Question

Hey all,

I'm hoping a more seasoned commercial multi-family investor can help me with this issue:

I found a building that used to be a 10-unit apartment building but the previous owner gutted it completely and now it is just a shell. It has exterior walls, windows, exterior doors, subfloors and a roof. I can do an analysis for how the building should perform once it is built out and rented out but how do I figure out how much this shell is currently worth?

Allyssa McCleery · Answer

Definitely a good strategy. A comp is not a comp until it has sold. I think when you present the offer to the seller in a very reasonable way you will have a better chance of getting to the number you need. You could show him estimates of what the rehab will cost you and very conservative estimates of what you'll be able to rent each unit at. Put this all together on a spreadsheet and show what type of return you would be looking at (be sure to account for closing costs and a full year of vacancy assuming you'll have to pay the mortgage every month during renovation). For taking on a project this large you are taking a big risk and therefore should be reaping a larger reward (the ROI). He is clearly an investor himself and should understand this logic.

Russell Gronsky · Answer

@Allyssa McCleery, thanks for the tip of lenders. I thought about asking for interest-only financing for at least a year (or more if a lender will agree to it) so I can get the place built/rented but defer payments...that's an even better idea.

However, about the CAP rates....the comparable building 2 blocks away is using the market CAP rate (a little fudging of numbers but not as bad as I've seen from other sellers) but it hasn't sold in over a year. Now there might be something very wrong with the building but I'd still like to use it to justify to the seller of this shell that the CAP rate needs to increase since the comp is getting no action at current CAP rate. Now comes the art of the deal that I need to get just right. If I suggest a CAP rate that is too high, the seller will balk but if I suggest too small of a CAP rate adjustment, I'll leave a lot of money on the table so I was hoping for some insights on how to go about coming up with a higher (but not too high) of a CAP rate so I get the seller to agree and stay in the deal.

I'm also still working out several scenarios for the second issue with lost revenues. The potential of deferred mortgage payments is a nice Ace in the hole if I can get a bank to agree to it but I need to work out several scenarios assuming I won't get that kind of deal. I've been buying rentals and I've been flipping for the last 14 years but it's all been residential stuff so not sure if a bank will be enthused at giving me a payment deferment for 12+ months on a shell that needs to be built. It's a tremendous opportunity but I think the only activity in Real Estate that comes with more risk than this, is doing brand new construction so the pool of banks interested in this kind of opportunity will be small, even before asking for all the payment relief.

Matthew Paul · Answer

Now since it is gutted , you have a great opportunity to set the building up correctly .  Submeter the water , update the electric , fire alarms . Soundproofing between units .  And you would see any  framing issues prior to the sale .

Allyssa McCleery · Answer

You should be able to get the market cap rate from a broker. Are you using a broker in this transaction? Secondly, there are lenders who will let your payments accrue while the construction is being completed so you can either make reduced payments during the construction phase or make higher payments once the property is operational again. The best way to find these lenders would be to call the local banks in your area and ask if they offer any programs like this. If not, ask if they have any referrals. You can also check the list of lenders here on BP. I would consult a builder or highly recommended contractor in your area to see what the price per square foot would be to get this project done. You could also drive around your area and look for people rehabbing an apartment building similar to yours and talk to the project manager/GC to get a good idea of what to expect the costs to be. Whatever estimate you come up with add in at least 10% for unknowns.

Russell Gronsky · Answer

So I was playing with some ideas over the weekend on how to accurately evaluate a commercial shell and so far, this is what I came up with:

I can do an analysis on what the building should be producing, based on current market rents in the area, expected expenses and come up with what the NOI should be. Then, I can apply the current CAP rate for the local market and come up with what the building SHOULD be worth. Then, I'd work backwards from that number, subtracting out all the construction expenses to actually build the apartments.

This gets me to a good start but I feel like I'm missing some pieces here.

First off, there is a fully built and rented out comparable building 2 blocks away that is currently for sale. It has been on the market for over a year now so I believe the asking price is too high. While the asking price of that building is a little higher than it should be in my opinion, it isn't too much over what it should be and with the multi-family space being so hot, I'm surprised it hasn't sold. So this is one indicator that despite the decent NOI, the market has not been willing to facilitate an exchange of owners for over a year now. Long story short, I think I need to apply a higher CAP rate to the NOI I came up with on my analysis to get a more accurate  (lower) property value once it is built out and rented out. But if the market CAP rate isn't accurate, how to determine the accurate CAP rate to use?

Second, while I have the numbers for how much each apartment would cost to build, my mortgage on the shell would be due each month and I will have 0 income until I can build out and rent at least 1 apartment (assuming the city would be willing to grant me a CO for each apartment completed, instead of making me build out the entire building before issuing me one CO for the whole property) and find renters willing to move in at a discounted rate until the construction is over and they won't have to deal with the daily noise. So I would be paying for construction out of pocket and for the mortgage out of pocket so I believe I need to factor in lost rent due to construction into the price I'm willing to offer for the shell. But how best to calculate that? Should I take the monthly gross rental income for every unit, multiply that by the time it would take to complete the entire project and deduct from my offer price? What if the city is willing to give me individual CO's for each apartment as it completes? Factor that into the price reduction on the offer, even if I can get partial rent from tenants that are willing to deal with construction noise? I'm guessing the answer here is, whatever the seller and I can agree to is how to do it but is there an industry standard for how to do this I can reference?

Are there other costs/lost revenues I need to account for in my analysis before making an offer?

Russell Gronsky · Answer

@Davy Singleton, it is 8,076 sq ft. The unit mix (prior to the full gut) was 9 units that are 2-bed 1-bath at approximately 750 sq ft and 1 unit that is 3-bed 1-bath at 1,194 sq ft.

Davy Singleton · Answer

How many sqft is the building.

How much is a gutted shell worth?

Most Popular Reply