All Forum Posts by: Michael Worley

Almost all commercial loans are assumable if you talk to the bank directly. You'll have to qualify through their underwriting process, but most banks are willing to talk to you about it.

And renewable probably means it matures (balloon note), but it could mean there is a built in option to renew at either the lender or the borrower's option. Just ask to see the note and/or loan agreement from closing. And most banks will gladly renew a performing loan at maturity, the reason for the 5 year term is to offset interest rate risk primarily.

The only way the cap rate works at the PP you're considering is if there is substantial appreciation in rents in the area. At the numbers you presented, even at a 7 cap rate the property isn't worth 360k until year 7 (if you assume rents grow at 3% a year and expenses grow at 2% a year) and you have negative cash flow for the first 2 years.

Since it's a 1980 property, I'm assuming it's not on the bleeding edge of the path of progress and I'm assuming it's not a A class property (a 5 cap is usually reserved for high demand areas and A class properties).

Unless you're very certain the rental rate growth is substantial, I wouldn't buy this property for anywhere near what they are asking for it.

Here's my $.02

Let's compare a business, such as the software business you mentioned, to a Real Estate Investor's business.

With a software business, the business owner has to do the following to generate a successful business organization. (Not necessarily in order) The Software Business (I'll use SB as an abbreviation from here on) has to design a product. That product has to A) fill a need B) The need has to be large enough that the target market can generate sufficient scale to generate profits and C) has to be either difficult to replicate by competitors or protected by intellectual property rights. The SB then has to spend human capital to develop the product, test the product, then distribute the product. Before the SB can do that, they have to decide how to price the product, how to source the manufacture of the product, hire employees to handle product enhancements/bug fixes, hire employees to distribute the product, hire attorneys to protect the IP. The SB has to determine additional product lines and markets to enter to prevent the inevitable obsolescence that comes with software, etc. You get the idea, you could go on and on for days talking about the things they have to do.

Contrast that to Real Estate Investors. RE is the product. Compared to another business, REI has much lower thresholds for product development and marketing. Whereas a SB has to do their own market research for their product, there is ample market data for real estate in any market. Not only that, but there is no need to hire a sales force to market your widget with REI because RE Agents already exist in every market. As for market data on the need for your product as a REI vs. SB that information is also readily available. Due to the nature of the sales, product development, etc of REI a RE investor can have a very small (often times zero) need for additional employees even with a large dollar volume of business. Capital is readily available for REI at known leverage ratios. SB or other businesses will be on a case by case basis so funding is unknown.

What a REI does is develop a process, what most businesses do is develop a process AND a product.

Now, let's look at the numbers because I think you'll find that the numbers you posted understate the returns of REI as well.

So, let's take a pretty generic case study. We'll use 7% cap rate on a $500,000 multi family property with 10 units. It would be completely reasonable for the buyer to assume (based on naahq.org's 2014 numbers) that expenses would run about 40% of revenue, and CapEx would run 8% of revenue. So a 7% Cap gives you $35,000 of NOI on a $500,000 property. Using naahq.org averages that means you have a gross rent of $58,333, $23,333 of normal operating expenses including vacancy $4,666 of CapEx reserve and a total net revenue of $30,333 at the end of the year. Assuming a 20 year amortization on a 5 year maturity mortgage of 5% interest and 80% LTV (so $400,000 initial balance) your yearly payment is $31,677. (It's obvious at this point the debt service is greater than your net, but again, capex is a reserve not an actual expense YoY, and this example is deliberately a very mediocre set of numbers to illustrate the point). So, let's just go with these numbers. Each year you come OUT OF POCKET $1,344 AND you put $100,000 into the project to begin with. We'll also need to make some assumptions about rent growth etc. Let's assume rent growth at the historical rate of inflation of approximately 3%. After 5 years here's how the numbers look:

Rental Income $65,654

Expenses (40% of RI): $25,496

NOI $40,157

Estimated value at 7% Cap Rate 573,678

Estimated Cash flow net of debt service $30,362

Approximate CapEx Reserve $24,000

Amortized Loan Balance 333,819

So final numbers are 100k invested, equity at 5 years $239,859 with a positive cash flow of $6000 during the 5 year span. If you just average the cash flow over the five years at $1200 (again just making this example simple, it's a bit more complex than this) you get an average annual return of 20%. NOT a bad return on a VERY average set of numbers, especially considering the limited barrier to entry to 'owning' a business.

 To the OP be very wary if responses like this one. The person who responded to this either doesn't understand lender's loan policies or is being deliberately misleading. Every lender has their own loan policy, which can always be more strict but not less strict than the aggregator. Put another way, even if you sell directly to a GSE like Fannie Mae you can (and most likely will) have stricter underwriting standards. Those loan standards are based on the risk weighted pricing your bank is trying to achieve, the current performance of your banks portfolio with the aggregator, the individual underwriter's portfolio performance, etc. The bottom line is that the Checkbox Monkeys don't just go by some alleged Fannie Mae standard.

It is preferable for the tenants to pay their own utilities because you can't control the usage and  you have to pay the bill if they don't on a mastered metered property. Look at the income statements for any mastered metered property and that always have an uncollected utility expense.

We underwrite SBA loans and are a SBA preferred lender. We would not give any value to a purchase of a business without either tax returns or audited financials. 2 years would be sufficient if the business was only in business for that time. It would be a red flag if the business existed but tax returns were unavailable. The best guideline for submitting to a lender is to remember that lenders are naturally skeptical so any red flags need very good explanations.

Austin cap rates in the 5's are very typical at the moment. High 4's in the most desirable areas. You are buying Austin proprties based on an expectation of significant NOI growth due to rental increases if you are buying in Austin. Whether that materializes or not is unknown but that is what the CAP rate compression is telling you.

more likely than not the underwriter will not allow it. The one caveat is that if you have an executed lease you may be able to wash the payment but you won't get any positive credit for the rental income.

Yes, Property Management should be a line item normal operating expense. As for the amount, historically PM for MF properties is in the 3-5% range. On smaller properties it runs a little higher, but should not exceed 7-8% (or else you're getting a bad deal from the property manager).

You'll have to get the tax returns for the business if you plan on giving any value to the business upon purchase. Otherwise just do an asset purchase from the business with either a 7a or a 504 SBA loan (depends on the assets). A 504 loan for just the real estate pretty straight forward. The 504 is for real estate only. You can do two loans, a 504 for the real estate and a 7a for the business assets that are non real estate (FF&E).

In general, as a banker, I'd rather see a client buy the assets and NOT the business or to give the blue sky valuation of the business an extremely low valuation.

Also, a general question would be, what is the value of the business if it's being foreclosed upon? It sounds like the assets are what you're buying anyway because the cash flow is deficient to support the liabilities.