All Forum Posts by: Darin A. Scavella Jr

Hello BP community!

So I currently have yet to purchase my first property, and I wanted to hear some opinions on my preferential strategy. After researching quite a bit, I have come across the niche in which investors seek out 5-20 unit commercial properties for a variety of reasons. First, this market is less concentrated than others. From what I've heard, the vast majority of investors are scared to enter the commercial industry because they feel overwhelmed by its "complexity". On top of this, I've heard that most experienced commercial investors are not looking for such small properties, and would prefer to invest in large multifamily (80-100+ units) to increase their return. This leaves the smaller, 5-20 unit commercial space with less concentration and more opportunity for deals (especially in particular markets around the country).

Beyond this, I also am attracted to the fact that commercial value is based upon NOI and cap rate, rather than on comps, so the value is more in control of the investor and less based on the surrounding properties. From what I've heard, this allows investors to add value without as much rehab to the property (through raising rents, adding in additional revenue-building assets, decreasing expenses, etc.).

However, I do know that is is harder to find quality property management for these sizes of properties, and it is also harder to sell them (due to less demand). Also, commercial loans are also a bit more complicated (at least to me) than residential loans, so I would need to learn much more about how these work before ultimately cracking down on the strategy.

I am curious as to what are your guys' thoughts are on skipping the residential realm and hopping directly into small, multifamily commercial properties? Also if anyone has any advice, tips, or resources, I'd love to hear them if you'd be willing to share.

Thanks everyone!

The formula for the cap rate of a property is Cap Rate = NOI / Value. Algebraically you can reshuffle the formula into Value = NOI / Cap Rate which is what you have done... so yes, algebraically it works. That's why you come back to the value of $3.4M.

But note that there is a lot of confusion about cap rate. Cap rate is a valuation metric in that it's only useful when a valuation of a property is needed. For example, valuation is needed when you are considering buying a property, or when you are trying to refinance a property that you already own, or when you're planning to sell a property that you already own. Another thing about cap rate as a valuation metric is that it is determined by the market, it is not a rate that you calculate from your property. While owning and operating a property, you can certainly calculate the cap rate but it's not all that useful. Many investors do calculate cap rate of their properties and use it as a performance metric which again is not very useful. Cap rate is not a performance metric.

So how then do you calculate value? Well... you would use "comps" (i.e. comparisons to other similar properties that have sold recently in the area). You would need the average cap rate of the recently sold similar properties in the area and divide it INTO the NOI of the property you're interested in buying. This would give you the probable value of the property. Note that the cap rate in this case is determined by the market, it's not a rate that you calculate.

Again, there is a lot of confusion surrounding cap rate. I might have opened a can of worms, but if you do a search on "cap rate", you will see lively discussions about cap rate :-)

Cheers... Immanuel

@Darin A. Scavella Jr

Cap rate is an annual metric, so it calls for annualized NOI. Your NOI of $18,936.25 is for a month. I believe your cap rate should be (18,936.25 x 12) / (2,000,000 + 1,000,000 + 400,000) = 6.68%.

The general rule is CoC should be higher than Cap Rate on a leveraged deal because without leverage CoC approximates Cap Rate. So, one of the primary reasons to use leverage (i.e. debt) is to, well... leverage (i.e. jack up) CoC, otherwise what's the point?

So when I see a leveraged deal where CoC is the same as Cap rate (i.e. as in your case), either it's a bad leverage (i.e. interest rate is too high) or there is an error in the calculations (i.e. as in your case).

Cheers... Immanuel

Greatly appreciated Immanuel.

You broke this down for me that a 2 year old could follow.

It is good that my calculations were wrong. I would recalculate things and then go from there.

To say I am great full for the feedback is a gross understatement!

Thanks again, and God bless you all. 

@Darin A. Scavella Jr Props to wanting to fully understand. 

in: Value =Noi÷cap rate. So should these figures be 18936÷.00946? 9.46% would be .0946 you had one to many zeros.

For cash on cash return just count the cash you are putting in the deal. If you are financing the reno then that would not be included. However, if you were on financing the purchase price and paying out of pocket the reno cost then the reno cost would go into cash on cash return. 

For the cap rate I would include the reno cost to get to 3mil since you wouldn't have the NOI of 18936.25 if you didn't complete the 1mil reno.

These are all just ways tools for analysis to help see if a deal is good or bad and if works for you.