1st time looking at commercial ... advice?

homebrew · January 5, 2013, 1:56pm

Hello,

I came to this forum because of some of your articles. We are looking at a 4-unit rental (apartments) and trying to determine if it makes sense. Our philosophy is to lever the downpayment (presumably <25%) and generate decent positive cash flow.

The longer term idea is that the C/F would be a source of income when we retire – potentially in about 4-5 years.

I read about “NOI” but I can’t figure out the NOI on this property because I don’t know the period over which I should calculate NOI. Is NOI over the life of the mortgage (i.e. 30 years?). I can’t imagine it is just a single year’s income…?. What’s the time period to calculate NOI?

Below are some of the details. An opinion or feedback would be greatly appreciated.!.

Property is in San Diego county.
4-plex in a residential area – good midclass subdivision.
Few other rentals/apartments in the area – so limited rent competition.
Very good condition.
All units separately metered.
Separate garage per unit.
Close to schools and major freeway.

All units rented with long-term renters. Rent is low for the area – probably
because the renters have been there awhile.

Asking price is $700K – pretty firm. Priced to sell…
Total RENT/mo = $4375/mo plus $50/mo laundry.

Expenses:
Water/Trash/Elec ~$310/mo
General maintenance & pest control ~$200/mo
Property insurance ~$1600/yr
Property taxes ~$7200/yr ---- but would change based on our price

Mortgage:
Assume 4.5% (is this realistic ??), 25% down === $2700/mo

We also have a difficult time guessing at the land value vs the building value. Here in CA land value is at a premium. However we suspect that for a 4-plex, the building value should be a larger percentage of the total value. We know this is important to calculate depreciation (for taxes) which should make the investment more interesting – but we can’t figure out how to guesstimate this with reasonable accuracy…?.

Can you tell us:

do we have all the needed info to calculate NOI? What is it?
what other info do we need to get?
is depreciation a significant factor which we should further study?
based on the above, what’s your guy on this investment?

Thank you very VERY much for any inputs and advice!!

“homebrew” in San Diego, CA.

rrwolfpack · January 7, 2013, 6:53am

Hi homebrew, I know for a fact the San Diego multifamily market is a strong performer. In that sense this 4plex is probably a good investment. As far as calculating NOI and what your mortgage might be, that depends on your financial history and what the bank figures out for your loan. Have you calculated in future repairs to the building due to wear and tear or unforeseen events?

I feel this is probably a great fit but the borrowing numbers need to be defined by a banker who is going to give you the loan instead of just estimating it.

JeremyCyrierCCIM · January 7, 2013, 7:05am

You’re off the right start because you know what you want to the property to do for you financially. If you’re planning to retire in 4-5 years, start with the amount of income you’re looking to supplement/replace and then back that down to how much you’ll need the property to provide you on an annual basis.

NOI or net operating income, is measured on a 12 month cycle. It’s an annual figure. To arrive at it, calculate your gross income less vacancy loss less annual operating expenses. Once you determine your net income, you’ll be in a position to calculate how much debt service you should carry on the property in order to generate the cash flow you’re looking for to cover your retirement.

Brantley · January 9, 2013, 10:03pm

The key measure, contrary to popular belief, is not ROI (return on investment); it’s ROE (return on equity)
EXPENSES…
PI/ Mortgage 2700/mo (NOT OPERATING EXPENSE)
Property Tax 600/mo (operating expense)
Insurance 133/mo (operating expense)
Gen/Maint 200/mo (operating expense)
Utilities 310/mo (operating expense)

TOTAL 3943/mo (this is w/ no deferred maint fund or mgt.fee)
Deferred maintenance at 10% of rents= 43.75/mo 525/yr
Management fee at 10% of gross rents= 44.25/mo 531/yr

INCOME…
Rents 4375/mo
Misc 50/mo

TOTAL 4425/mo (this is no vacancy/collection factor)
Vacancy/Collection factor at 5% of rents 22.12/mo 265.44/yr

CASH FLOW 482/mo 5784/yr

Down Payment 125,000
Closing Cost 10,925 @ 1.9% of loan amt. **

Cash invested payback: 23.5 yrs
Cash on Cash Return: 4.26%

A very important factors is the debt service coverage ratio (DSCR)
DSCR is 3071.88/2700 = 1.137 [Banker may not like this less than 1.2 or 1.3]

DSCR Formula: NOI/LOAN PAYMENT
(NOI= Effective Gross Income - “Operating” Expenses)
NOI is 4402.88 (EGI) – 1331 (OE) = 3071.88

PS. GET 2-3 years of the IRS Form Schedule E they filed, get Lease Agreement & Verify Rents. Last, 4Plex property is usually based on comps, not income method so figure the return desirable for your money/effort and weight all decisions on current cash-flow. “Buyer beware….Figures lie & liars figure”….Do Due Diligence!!!

homebrew · January 15, 2013, 1:50pm

thx for info on ROE

Hello Brantley,

Thanks for the detailed info — but what would be a “good” ROE?

Thanks again!

rrwolfpack · January 16, 2013, 6:57am

That would be up to Homebrew. You also have to take into consideration about random expenses that you can’t account for which are the worst ones because they can come out of nowhere.

midlifeman · January 17, 2013, 12:49pm

cap rate vs. return on equity

So what factor do you look at. Return on equity or cap rate when evaluating this property? …and what is it?

MsJow · February 25, 2013, 9:53am

[QUOTE=Brantley;888652]The key measure, contrary to popular belief, is not ROI (return on investment); it’s ROE (return on equity)
EXPENSES…
PI/ Mortgage 2700/mo (NOT OPERATING EXPENSE)
Property Tax 600/mo (operating expense)
Insurance 133/mo (operating expense)
Gen/Maint 200/mo (operating expense)
Utilities 310/mo (operating expense)