Posted by Penny on May 23, 2007 at 12:24:24:
Others on this forum may have additional ideas and suggestions for you.
The offering price needs to reflect what the property is worth to you. See Ray’s article below:
There’s a couple of other numbers that are helpful to understand. My calculations are based on assuming that the numbers are valid. If the actual income is actually lower or expenses higher, then you would adjust your offering price accordingly.
Capitalization Rate or Cap rate. This is the Net Operating Income divided by the purchase price and expressed as a percentage. It represents the rate of return an investor would receive if the property were purchased with 100% cash outright.
So for this property, the asking cap is $60,015 / $799,000 = 7.5%
Your offering price gives a cap of $60,015 / $720,000 = 8.33%
Gross Rent Multiplier or GRM. If you divide the purchase price by the gross income, you get a real number as follows. It is an indicator of price to total revenue. That said, the expenses could be high, resulting in a lower NOI and lower Cap.
Asking GRM: $ 799k / $82.5k = 9.68
Offering GRM $ 720k / 82.5k = 8.73
To me, the asking GRM is marginal, I look for those 9 or less, so your offering price isn’t out of line.
These aren’t bad numbers. To me, they reflect reasonable returns on a stable property assuming there is no significant deferred maintenance. Stable properties with no major problems do not deliver the big returns, but also have less risk. A stable property delivering reasonable returns is less likely to be discounted significantly on price unless the seller has other motivations for selling.
But this may be very acceptable returns, particularly if you are able to take advantage of the restaurant upside and generate additional income through another business. The property could be stable with positive cash flow and provide reduced start up costs for a restaurant venture. I would suggest looking at the combination and lay out a multi-year operating plan to determine what your returns would be.
Your 10% discount is in the ballpark. You can offer less and they can say no. You never know until you make the offer.
But on commercial properties, it is pretty common to put down 20-25%, so the 25% I calculated for your asking price doesn’t seem out of line. That said, the challenge is in coming up with the 25% or $180k.
So I don’t think the property is necessarily overpriced, I think that the expectations of putting only 10% may be unrealistic for this property and that is what will make financing this deal a challenge.
I would recommend searching the archives both here and on the lenders forum for seller carryback terms and other down payment sources to see what others have done, then run the numbers.
Whether the deal is workable depends on what you desire for a return on your money and the resources you can come up with for the down payment.
I am also going to point you to another of Ray’s articles to provide additional insight on high LTV financing:
Hope this helps.