How should I invest in this commercial property?

Question

I am a newbie investor and I need help, I don't want my 1st deal to be a nightmare. I'm looking at purchasing a 12 unit multi-family senior living facility. This business is already fully staffed and up and running But the seller is just too old to keep up with the property. She just wants to get this off her books and she is motivated. I would like to buy and hold and possibly do a 1031 exchange for another income producing property. There are currently no other offers, But here are the specifics:

Sale price - $1,4500,000

2012 net income - $392,280

2012 total expenses - $378,905

Just based on these numbers, it looks like about 96% of the income is going towards expenses. this seems like a bad investment, am i right or wrong?

How much should I offer on this property?

how can i make this property perform? or should i just continue on my search and purchase a property that is already performing with positive cash flow?

Joel Owens · Answer

Senior living is highly specialized and in many cases carries heavy government regulations.

I would not recommend you go after this for your first purchase.

Ned Carey · Answer

How are you defining "net Income:"  is this NOI?

Do you know what Net Operating Income (NOI) is and how it is determined?

Who knows are rents, occupancy or income dramatically below where they should be? Are expenses out of control but have opportunities to reduce?

You don't have enough information to make the determination.

How could anyone possibly comment, given the information you have given us?  Without knowing how it should be performing and exactly how it is performing now it is impossible to say.

Unless you can answer some of the questions I pose above you are not ready for this kind of investment.  You need more education or you risk making some serious mistakes.  Right now you do not even know what you don't know.   My suggestion is you use this deal to practice on.  Use it to learn what you can about evaluating properties.   Good Luck - Ned

Jose Enage · Answer

I would evaluate a commercial property using the typical NOI and CAP analysis..
Capitalization rate= NOI/purchase price
NOI or net operating income= Effective Income - Expenses = $14,000
Cap rate= $14,000/ $1,450,000 = < 1%
Under any market 1% is extremely low
Depending on what the market cap rate is, ie. 8%, you want your investment to be at the least 1% above the market cap rate.
Find out what the market cap rate is first, you've got a possible deal if it is at least 1% above this figure. This is just the preliminary 5 minute analysis.
If it passes this then you look at other things like price per door, potential to do a value play, etc.
To me, this fails on the initial analysis. I would not go any further.

Jose Enage · Answer

At what price would I consider?
You need more info like I previously suggested you get-- market cap rate.
That way you can calculate the value or price of the property below:

Price=NOI/Cap Rate

Education is key.
Suggest you read @JScott blog on commercial analysis: 
http://www.biggerpockets.com/renewsblog/2010/06/30/introduction-to-real-estate-analysis-investing/

Joel Owens · Answer

Hi Raymond,

Sellers want to dump properties all the time for various reasons.

You have to make sure you get it at a price where the work put in will give you a huge upside for taking on problems.

Sellers think my property has a few issues so I will discount it 10%. Buyers see it as I will have to do all this work and get it to cash flow so I will buy with 40% off of retail.

Otherwise a buyer will just buy a fully performing property without any issues for close to full market. For expenses you would have to look at their books and see if they had huge one time CAPEX that year and also retirement plans, family salaries, etc. to reduce taxes on shown profit. Once you take out the not normal expenses from the seller that is customary with that type of property you get the (what should be)regular expenses and numbers.

Roy N. · Answer

Raymond,

Some properties simply do not work from a cashflow perspective; the operating costs are too large a percentage of the revenue (>50%) and there is not (or may not be) sufficient room for upward movement of rent or improvement of the operating efficiency.    We looked at one like this last month.

That said, a horrendously deep discount might make such a property "work" - or at least give you a fighting chance at rehabilitation - but I've yet to find a vendor who sees it that way.

Raymond Ali · Answer

Thank you Joel Owens it seemed like a cash flowing investment if purchased at the right price.. I'm just wondering what that price would be?

Raymond Ali · Answer

Thank you Ned Carey I appreciate your response.
my apologies for the confusion, i should have provided more info, i just wanted a quick analysis.

How are you defining "net Income:" is this NOI? 
- im defining net income as "total income"

Do you know what Net Operating Income (NOI) is and how it is determined?
-yes i do know what NOI is and how its determined

this seems like a bad investment, am i right or wrong?
Who knows are rents, occupancy or income dramatically below where they should be? Are expenses out of control but have opportunities to reduce?

-the rents are $2200 for shared room, $3000 for a private room

How much should I offer on this property
You don't have enough information to make the determination.
-What additional information do i need in order to make a proper determination?

how can i make this property perform?
How could anyone possibly comment, given the information you have given us? Without knowing how it should be performing and exactly how it is performing now it is impossible to say.

Unless you can answer some of the questions I pose above you are not ready for this kind of investment. You need more education or you risk making some serious mistakes. Right now you do not even know what you don't know. My suggestion is you use this deal to practice on. Use it to learn what you can about evaluating properties. Good Luck - Ned

-Thanks again Ned, hopefully with your expertise i can learn something new today

Raymond Ali · Answer

I have evaluated this property using the typical NOI and CAP analysis formula Jose Enage and it just doesn't make sense at this price "$1,450,000"...but the purpose of this msg was to get your expert opinions because i'm still learning.

To me it failed the initial analysis as well but i was wonder at what price would this analysis work?

Thanks again!

Raymond Ali · Answer

Thank you, Tevis Verrett this facility is currently being managed by an experienced management company. i have also done research based on the 50% rule here on BP. but based on the 2012 financials it looks like 96% of this properties income went to expenses.

Thanks again

How should I invest in this commercial property?

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