Is my analysis of this multi-family property correct?

Question

Asking Price: $325,000

6 Units

Unit Type: 4 two bedrooms, 2 three bedrooms. Monthly gross $3945.00. Which seems low but I got off the phone with the realtor and this is what he tells me.

Asking price: $325,000

Down payment 25%: $81,250.00

Capital Improvements: $20,000.00 (this is an arbitrary dollar amount I put in the equation)

Loan Amount: $263,750.00

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Loan Information:

Loan Amount: $263,750.00

Loan Period: (Amortization over 30 years but this is considered commercial property so I'm not sure how the loan amount would be structured?)

Interest Rate: 6.5%

Annual Taxes: $8552.00

Annual Insurance: $2500.00

Monthly Payment: $2588.07 (with insurance and taxes)

>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>

Monthly Income:

6 Units: $3945.00 monthly gross (6 Units * 657.5 = $3945.00 monthly gross)

50% Rule: $3945.00 / 2 = $1972.00

$1972.00 - $2588.07 = $616.07 Negative cash flow

My question is, did I evaluate this property correctly? I know running the numbers this investment def. isn't a good deal but my question is did I look at this investment properly? Did I run the numbers correctly? What did I do wrong?

Thanks

Joseph Weisenbloom · Answer

@Rico Saldana Your projections should be close to the actual numbers unless you messed up your research. The taxes and insurance you will get the exact numbers from county records and bids provided. Be prepared for your taxes to go up though if you bought above the county appraised value. In the state of Texas, taxes and insurance are absurdly high making it hard to hit the 50% rule. A good reason not to follow rules of thumb. For vacancy rate research your local areas specific vacancy rate. Type "city" vacancy rate into google and snoop around or call a local prop management company. For management cost same thing just call around local prop management companies for rates. Usually its around 10% of gross rent in my area. For maintenance I allocate 10% to 15% of gross rent depending on age and condition of the property. After that add in utilities like water, electric and gas. You can use the last few months of bills from seller to determine what an average will look like. Or you could make one time investment and separate out utilities.

@Shane Mcc Yes your expenses could be higher. That's why you need to do the research to figure out what the actual expenses are. Like I mentioned above in my state, taxes and insurance are higher that normal so it wouldn't fit the 50% rule of thumb.

Shane Mcc · Answer

Based on the above statement my expenses could be more than the $1972.00 I'm calculating? @Joseph Weisenbloom

Also, expenses include taxes, insurance, HOA, WSG etc...?

This is something I wasn't aware of. Thanks for help.

Isn't there an APR rate hike risk when financing commercial property? Is there anyway to limit risk on this front? @Jon Gluckman

I went on CL and did a search for this area of the city. Median rents are approx. $50.00 more per-unit. It seems to me the current owner has unusually low rental rates. I'm assuming this is something a good investor would look for in a property? This would be considered potentially "under performing"?

Yes, thanks John. I understand the above data I provided was inconclusive on many fronts. @John Cohen

I mentioned this above, how does a good investor try and limit there risk to an APR shock when it comes to commercial property? I ask because interest rates are projected to go up in the coming months/years ahead. NA Beard

Jeff B. · Answer

• "I mentioned this above, how does a good investor try and limit there  risk to an APR shock when it comes to commercial property? I ask because  interest rates are projected to go up in the coming months/years ahead. "

Yep, that's right - - so how does one project the impact of an ARM changing rate?

In engineering, we hold all other variables constant, change the value of one variable (the fixed rate) and rerun the analysis until you hit "your limit".  ??LIMIT?? that value of cash flow beyond which you want to throw-in the towel. eg: if you set your cash/cash rate minimum to be 10%, then you're done when it becomes < 10%.  The fixed rate that causes this threshold to be crossed is your ARM max rate you can tolerate.

Terms of each ARM differ, but you can take the worst case set of rate changes and determine how many years before your toleration rate can possibly be reached.  Now you have the max rate you 'want' to tolerate and a projected date as to when you might wish to look to trade.  Don't go ape on this, it's harder to explain in words than it is to wire-up in Excel and get the answers :whew:

Personally, I was driving down the LTV with additional principle payments so the outstanding balance was diving at the same time as the ARM changes were climbing, and that was close enough to be a push (aka card game '21' term).

Jeff B. · Answer

@Shane Mcc  let me be clear, by "fixed, one time closing costs" I mean ALL costs occurring due to the COE.  Of course Taxes and Insurance reoccur, impact cash flow, and are included :)

Costs from COE can be written off in the year of purchase.

Rico S. · Answer

When analyzing a deal, How accurate will it be when the property is purchased?

@John Casmon

@Jon Gluckman

@Joseph Weisenbloom

@Shane Mcc

Jeff B. · Answer

hmm;

Excel says: PP of 325,000 less down payment of 81,250 has a loan amount of 243,750

common expenses missing: water, trash, yard care, management expense

Rents(GSI) less 30% expense assumption (I don't go by that 50% guess), gives NOI of 33,138, I get a cash/cash of 32.27%, cap rate of 10.20% and a cash flow of $1,713/mo

using a 50% guess, NOI becomes 23,670 and c/c would be 20.62%, cap rate of 7.28% and a cash flow of $924/mo

The commercial loan will be an ARM and those are difficult to project over the life of the loan, so I project as a fixed loan 6.5% over 20 yrs: payment would be $1,047/mo.

I also ignored the fixed, one time closing costs, as they are not part of the cash/cash evaluation.

John Cohen · Answer

@Shane Mcc so looking at this high level its very difficult to analyze. since I don't know what the potential rents could be, utilities (paid by tenant or owner), and vacancy. Its difficult to give you good guidance. What you should do is get a rent roll, find out if there is any rent push.

Verify the utilities, make sure you know what taxes will be reassessed at (when and how), also try and get a list of capx the owner has done. Roof, plumbing, electrical, and structural are the high ticket items you want to know about.

Hope this helps.

John Casmon · Answer

You need to use real numbers, either current actuals or your projected costs (expenses tend to go up, so I add a little more to each expense line item). Confirm utility costs and what utilities are paid by owner. Also, what's the market rent if you don't think the figures from your agent are accurate? As @Jon Gluckman and @Joseph Weisenbloom mentioned, commercial financing varies, so you'll need to weigh these options. Do you want a 5 year loan amortized over 25 years with a balloon payment or a straight 15 year note. This will drastically change your cash flow.  I like to look at cost per unit and cash flow per unit to help compare deals, but you need to get all of the other info to properly assess the property.

Joseph Weisenbloom · Answer

You made a few mistakes. You double counted tax and insurance. Tax and insurance is a component of the 50% rule that you used. You double counted that in the monthly payment.

More importantly you need to get the actual numbers for expenses and use those. The 50% rule is just a quick tool to evaluate properties. If you are taking a deal seriously you need to get numbers for Vacancy, Maintenance, management, taxes, insurance and utilities. Your actual expenses are most likely over 50% because this is a multiunit property.

The second component is the assumptions for commercial financing. Terms for commercial vary but they usually include shorter amortization periods like 20 years and loan term for 5 to 10. That means that the loan needs to be refinanced every 5-10 years as its called due which is additional cost. Again I would call some local banks to get real numbers for this.

Is my analysis of this multi-family property correct?

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