New to the Board, first deal...Need advice please - Posted by Mark M.

Posted by B.L.Renfrow on April 21, 2001 at 14:12:55:

First, understand I’m no expert on multi-unit properties. And I haven’t seen anyone talk about using zero coupon bonds in a RE deal since the early 80s! But one thing caught my eye while reading your post.

This is no deal at all, with the numbers you’ve posted. There’s something wrong here…and it’s either that the property is WAY overpriced, the rents are too low, or the seller is under-stating the expenses – or all three. With the asking price, that’s a cap rate of 7.5%! That’s a terrible cap. More on that in a minute.

Also, the standard figure to use for expenses is around 40%. If the expense figure you are given is significantly less, it probably means there’s deferred maintenence somewhere, which will catch up with you sooner or later. Your seller is claiming expenses of only 27%. Unlikely, unless he just did a major rehab.

Cap rates (short for capitalization rate) are determined by a property’s sale price divided by NOI (net operating income).

NOI is gross rents minus expenses (the 40% figure I mentioned above).

So in your proposed purchase:

Gross rents: $41,100
minus expenses: (40% of $41,100) = $16,440

Net Operating Income: $24,660

Cap rate: $24,660/$327,000 = 7.5%

The people who do these deals refer to acceptable cap rates of 13% or greater, from what I’ve read. Obviously, the higher the better.

So if your purchase price was, say, $175,000, that would give you a cap of 14% – much more acceptable.

You might want to post this over on the commercial board also, since people there do these deals every day. The participants on this group do mostly SFRs.

Brian (NY)

New to the Board, first deal…Need advice please - Posted by Mark M.

Posted by Mark M. on April 21, 2001 at 09:33:18:

We found a seller of an 8-plex. Here is the general info:

-seller owns outright, wanting to travel, retirement
-asking $327,000
-yearly rents $41,100
-expenses approx $11,000
-willing to finance, wants $100,000 down, remainder at 8% over 20 yrs, balloon at 10
-we may be able to pull $100,000 equity from our home.

This is what we thought. We would ask the seller to deed the property to us securing part of his equity with equity in our home (value $120,000, this is about all we have to work with)–I understand we could protect the seller’s interest by giving back a “quit claim deed” to the property with this deed being held in escrow by a title company, but we are not exactly sure what this means. Once owners, we would obtain a new mortgage on the property worth $245,250 (75% of asking price). Next we would provide the seller with the $100,000 down payment, and use the remainder ($145,250) to purchase AAA insured zero coupon bonds due in 12 years (there may be one worth 57 cents on the dollor). $145,250/0.57 = $254,824. This plus the $100,000 down = $354,824 our total offer.

We’re not sure if the seller will want interest for this time period, or how to negotiate zero interest. Also, what are the advantages to the seller? By working it out this way, we don’t involve our home and purchase the property at a discount (producing a better cash flow).

This is our first offer. The concepts are still a little fuzzy. If you could elucidate or provide additional insight we would appreciate it!!

Thank you.