12 Unit Apartment deal - Seller wants to sell with assumed Mtg

[Derrick Jordan]

Hi All,

I wanted to lay out a deal I am looking at and get others opinions on quality of the deal and of options to finance considering the assumed mortgage.

Asking Price: $1,425,000
Mtg to be assumed: $720,000; 4.68%; 5 yrs remaining on 10 yr term; $140,000 payout penalty (which is why seller wants mortgage to be assumed)
2014 
Revenue: $119,926
Expenses: $78,294 ($37,593 in repairs/maintenance)
NOI: $41,632

2015
Revenue: $129,727
Expenses: $127,815 ($83,181 in repairs/maintenance)
NOI: $1,912
2014/2015 maintenance and expenses are inflated due to renovations (windows, metal roof, flooring in common area, some upgrades to suites)

I am very new to buying buildings and have only been the money partner in the past.  
Any comments or feedback would be appreciated.
What am I not seeing?
How would you approach financing?
Anything else I don't even know to ask.

Thanks!
Derrick

[Michael Le]

@Derrick Jordan

Valuation for commercial property is Value = Net Operating Income / Capitalization Rate. 

Basically, the higher the NOI, the higher the property value. Only makes sense, right? And generally sellers/brokers will try to fudge numbers to get that NOI as high as possible. They'll do this by using pro forma rent numbers that shows what they think the units could rent out for and at 100% occupancy, where in reality they might be at 80% occupancy and $100 under market rent. You don't want to pay based on pro forma because you'd not be paying for reality, you'd be paying for future potential. And if you get that property up to future potential, you should be the one reaping the benefit of that value add turnaround. Also, generally, NOI does not include capital expenses such as roof, windows, etc. Looks like the above numbers are lumping repairs (lightbulbs, paint, etc) with Cap Ex. It's good that they're not trying to move those items below the line to try to make the NOI larger. But at the same time you don't want to include them which will cause you to undervalue the property (and possibly pass up on good deals). So you need to break out those items carefully.

The Cap Rate is specific to type of property in a sub-market. A newer property in a good area will have lower cap rates. An older property in a high crime area will have higher cap rates because investors will expect a higher return on their money due to the increased risks. You will have to get with a commercial broker in that area to see what the going cap rate is. When you are buying you want a higher cap rate since it makes the property cheaper (dividing by a larger number).
Using the numbers you provided above, you get a very low cap rate based on asking price. Even using 2014 numbers, which has much higher NOI of $42k, the cap rate they're wanting to sell at is only 2.9%. Right now cap rates usually range from around 6% to 10%, so that number looks too low, which means the asking price is likely too high.

So basically you have to go and make sure both the revenue and expense numbers are correct. Get the cap rate from a broker. And you should be able to come up with proper value.