Advice about deal/financing - Posted by InNJ

Posted by InNJ on April 18, 2006 at 21:26:31:

Ray,

Thanks for the wonderful reply. You confirm my doubt that it is way over price for cash flow investment. Listing is about 3 months old. They already had contract on it twice with above asking price but for some reason it did not close.

I think I will wait for another month and offer based on the derived cap rate for 15% return.

Advice about deal/financing - Posted by InNJ

Posted by InNJ on April 14, 2006 at 09:47:15:

Hi,
I am looking at the retail strip with following details:

Asking price: 800,000
NOI: 57,000
CapRate: 7.1
Size: 6500 sq ft.
No. of stores: 6
Paking: none, street parking and there is muncipal parking lot across the street.

It is completely leased with about 3% increase per year. Two of the leases are expiring in 2008 rest are longer term. Area is good and looks like it is growing. I spoke to one mortgage broker about it and he offered me the following. Nothing is on paper yet just verbal.

Terms

10 year fixed
25 year amortization
6.5-6.7%
25% down

Cost

$1500 non-refundable application fees when he gets me the LOI from bank.
Bank charges (no points, appraisal, environmental, inspection, engineering, attorney). approximately $6000
1% to broker at closing. approximately $6000
I am estimating the total cost to be $15000 to be safe.

At asking price following are my calculations:
Total price: Asking + closing = 800,000 + 15,000 = 815000
Down payment: 25% of asking + closing = 200,000 + 15,000 = 215,000
Loan: 75% of asking = 600,000
yearly Debt service (600,000, 6.7%, 25 year amortization) = 4126*12 = 49,512
NOI: 57,000
Cash flow: 7488
cash on cash return: 7488/215000 = 3.48% (Not very pretty)

Questions

  1. What would be reasonable offer for this.
  2. Loan terms sound right or it is off. I am little concerned about $1500 non-refunable. What are the possible ways to structure this. Ask owner for some financing etc.
  3. Any other comments as I am new to commercial and do not own any retail.

Re: Advice about deal/financing - Posted by Paul

Posted by Paul on April 26, 2006 at 17:28:43:

I see that the LTV is 75% on this property. Is it possible to get into this with 0 down if you brought a partner on for the other 25%? Also, would the lender consider a longer ammort. period?

Re: Advice about deal/financing 2 - Posted by ray@lcorn

Posted by ray@lcorn on April 18, 2006 at 20:26:37:

InNJ,

(note: I reposted this to correct a number of typos in the previous post)

To determine your reasonable offer, you need to determine your minimum acceptable rate of return, the loan terms, and the NOI.

You’ve got the loan terms (which sound about average, and the fees are in line with the norms), you know how much cash you will put in the deal, and you have a starting point for the NOI (subject to verification).

So the only missing factor is your minimum acceptable return. That’s up to you, but I would point out that you can get 5% with a 10-year T-bond, with no risk and no effort. You can buy investment grade corporate bonds with 7%-8% yields, with very little risk and no effort. So think about that before accepting returns below that level for real estate that carries more risk and requires more effort than a bond.

Once you set your minimum return, use the derivative cap rate formula to give you the minimum cap rate to apply to the NOI.

(LTV debt ratio x mortgage constant) + (LTV equity ratio x equity constant) = Derived Cap Rate

*note: the equity constant = ROI

For example, if your minimum acceptable return on investment is say 15% and the loan terms are as you’ve quoted (6.5%, 25 yr)), then the minimum derived cap rate would be 9.83%.

The numbers would be:

(.75 x .08102) + (.25 x .15) = .0983 = 9.83%

Change the ROI to 10% and the minimum cap rate would be 8.58%.

Then you can calculate the maximum price that can be paid and meet that criteria. (NOI / Cap Rate = Price)

In this case, if you want the 15% ROI, the maximum price would be ~$580,000 (assuming no deferred maintenance). With a 10% ROI, the maximum price would be ~$664,000.

See http://www.real-estate-online.com/articles/art-216.html for a full explanation.

ray

p.s. the state of retail property types is still hot. From what you describe, the property is a local small-shop strip with 33% of the tenants on short-term leases with uncertain futures. In my opinion, that puts it in the upper ranges of the risk curve, and I would be looking for at least a 15% going-in return. However, because it’s a hot market that offer will likely not be accepted, especially if it is a new listing. As the price increases, the return decreases. So you have to decide (a) how much you want to make and, (b) how much risk and effort you will undertake to get it.

Re: Advice about deal/financing - Posted by ray@lcorn

Posted by ray@lcorn on April 18, 2006 at 17:43:55:

InNJ,

To determine your reasonable offer, you need to 79determine your minimum acceptable rate of return, the loan terms, and the NOI.

You’ve got the loan terms (which sound about average, and the fees are in line with the norms), you know how much cash you will put in the deal, and you have a starting point for the NOI (subject to verification).

So the only missing factor is your minimum acceptable return. That’s up to you, but I sould submit that you can get 5% with a 10-year T-bond, with no risk and no effort. You can buy investment grade corporate bonds with 7%-8% yields, with very little risk and no effort. So think about that before accepting returns below that level for real estate that carries more risk and requires more effort than a bond.

Once you set your minimum return, use the derivative cap rate formula to give you the minimum cap rate to apply to the NOI.

(LTV debt ratio x mortgage constant) + (LTV equity ratio x equity constant) = Derived Cap Rate

*note: the equity constant = ROI

For example, if your minimum acceptable return on investment is say 15% and the loan terms are as you’ve quoted (6.5%, 25 yr)), then the minimum derived cap rate would be 9.83%.

The numbers would be:

(.75 x .08102) + (.25 x .15) = .0983 = 9.83%

The maximum price you could pay and provide that return and service the loan on the stated terms

Change the ROI to 10% and the minimum cap rate would be 8.58%.

Then you can calculate the maximum price that can be paid and meet that criteria. (NOI / Cap Rate = Price)

In this case, if you want the 15% ROI, the maximum price would be ~$580,000 (assuming no deferred maintenance). With a 10% ROI, the maximum price would be ~$664,000.

See http://www.real-estate-online.com/articles/art-216.html for a full explanation.

ray

p.s. the state of the retail property markets right now are still hot. From what you describe, the property is a local small-shop strip with 33% of the tenants on short-term leases with uncertain futures. In my opinion, that puts it in the upper ranges of the risk curve, and I would be looking for at least a 15% return. However, that offer probably wouldn’t be accepted either. So you have to decide (a) how much you want to make and, (b) how much risk and effort you will undertake to get it.