Financing 8 unit with cash and equity |
| Posted by: Mark Mar 27 2004, 10:38 PM |
| Hi. This is a great site. I’m learning and will donate to the March of Dimes. Sorry this will be very revealing but after reading your discussions I know you will need this info to help me. I would like to know what you think would be wisest for me to do. My wife and I are 48 and we have found a ten year old 8 unit appartment complex (two 4 plex modulars with coin washer and dryer in each.) in a very good area. The building and grounds are excellent as well as the location. It’s 100% occupied by good tenants and all have been credit checked. Six tenants on yearly leases and two on month by month leases. The gross rent is $79,535.00 with an additional $1,170.00 from the coin laundry for a total gross income of $80,705.00. All expenses for 2003 were $23,820.00 and the purchase price of our accepted binder offer is $770,000.00. We have been landlords since 1980 and our credit rating from the big three are about 710, 730, and 771. We own our residence that would sell for 200K easily and a two family that would sell for 100K easily. The two family nets about 6K. (rents below market with our long term tenants.) Our salaries total 50K and we have a whole life policy cash value that we are willing to use of 26K, a 401K savings plan with 44K that we prefer to not use, 40K cash, and our total debt is 5K on our master card. The card has 11K still available as an emergency buffer. We calculate our net worth minus the 5K debt on the card to be about 405K. I would like to borrow 150K from our home equity and add the 26K from the insurance plus 40K cash and get commercial financing of $553,000.00 to make the $770,000.00 purchase price. I thought it might be best to get 30 yr fixed hopefully at about 6% so that in the future we might sell providing financing at what I suspect would be higher rates to collect the difference between my fixed rate and the rates about ten years down the road. When I work the numbers I come up with a 1.09 debt repayment ratio. Owner is going to do a 1031 exchange and I said I would try to help him succeed and if the appraisal comes in low he might accept holding a note. If you were in my shoes, how would you make this fly. Max out the equity to keep the commercial loan small? Then my equity moves to the 8 unit and if I need some I’ll have to borrow at the higer commercial rate. (Maybe I shouldn’t worry about that.) I am scheduled for a building inspection March 30th, ($1300.00 & all tenants notified.) and am wondering if I should pull the plug and try to re-negotiate but don’t want the seller to feel jerked around. Also maybe the inspection will bring up something allowing us to re-negotiate. Although 3 loan applications are out I have no firm commitment and am having a hard time telling what rates I would get and with the numbers this close it matters. Thanking you in advance for you opinion on this, Mark |
| Posted by: loanuniverse Mar 27 2004, 11:04 PM |
| Mark: I like your post. Lots of nice information to digest. Unfortunately, it is too late for me to star doing math A couple of quick questions/comments… 1_ Am I correct in guessing that your house is paid for? “that is what I understood from the getting $150K in equity from it” comment. 2_ If the appraisal comes in lower don’t think “getting the seller to finance a portion of it” as your out. If the appraisal comes in lower request a price break, and think about letting the seller carry a note as a second option. Will probably do the math tomorrow. Got to go away from the pc for a while. |
| Posted by: loanuniverse Mar 28 2004, 09:14 AM |
| Mark: I had a chance to go over the numbers and the following is my feedback: 1- The property seems to be overvalued at $770,000. A good commercial appraisal would value a property based on three types of valuation methods {sales comparison, cost and income approach }. For income producing properties, the income approach is the best and most reliable. In order to come up with a $770,000 valuation, you would need to use a capitalization rate that seems far too low to make good sense. {You get the cap rate by dividing Net Operating Income by the sales value or ” NOI / Sales Value = Cap Rate” } In this case the Net Operating income is $56,885 after deducting the operating expenses. And this number is with me being nice and not deducting vacancies or setting aside a reserve for the big ticket expenses such as the roof. If you take the NOI and divide it by the sales value of $770,000 you get a cap rate of about 7.4%. Frankly this is too low, for a long time the cap rate was around 10%, if the market is really hot an 8% cap rate could be defended, but 7.4% is pretty low. Of course the last thing I am is an appraiser, but I would not be surprised if the appraisal comes in at about $700K give or take a few thousand. 2- You said: ” I thought it might be best to get 30 yr fixed hopefully at about 6% …. Are you talking about the commercial loan? This is not going to happen, not with this kind of property. You are talking about a clearly commercial property, and the industry standard is five-year maturity. Some negotiation will get you a ten year maturity with a repricing event at the end of the fifth year. Some better negotiation might get you a fixed rate for ten years with a twenty-five year amortization. On the good side, a loan of the size that you are going to need starts to get appetizing for the lenders. You might be able to get a better rate than the 6%. I do not want to get your hopes up because I don’t know your market, but with what I have read and some shopping around a 5.5% rate for the first five years is possible, and one around 5% is within your grasps with a lot of shopping around and making a good case with the lenders. 3- You said: ” get commercial financing of $553,000.00”. Personally, I would go up to the maximum loan-to-value available for that type of property. Most banks that I know will have an 80% cap for these type of properties. Or better yet get the loan for the maximum amount that the property cash flows for $590K under my estimate {remember that the actual lender might come up with a different debt service coverage ratio and maximum loan amount} 4- You said: ”When I work the numbers I come up with a 1.09 debt repayment ratio. ”. I hope you are using only the debt service for the commercial loan to calculate this. The only way that the cash flow from the property can make the debt service and result in the 1.20X coverage that you will need is to use your personal income as the source of repayment for your personal residence mortgage of $150K. That is get the mortgage on your residence based on your income. 5- You said: ”If you were in my shoes, how would you make this fly. Max out the equity to keep the commercial loan small? Then my equity moves to the 8 unit and if I need some I’ll have to borrow at the higer commercial rate.” I think the general idea of how you are going to fund the whole thing makes some sense. I would probably get a slightly higher commercial loan. Keeping the equity in your house makes it more readily accessible. I also think that you are going to have to juggle a couple of closings at the same time. This might prove difficult since the purchase contract probably has a deadline. I also think that you forgot to take into account about $10,000 in fees that you will need at closing. 6- You said: ”….and am wondering if I should pull the plug and try to re-negotiate…..”. How did you word the purchase contract? Does it have a “subject to financing clause”? I think that you are going to get a chance to renegotiate once the appraisal comes around. I am not saying it is a bad deal, but the pricing is a little too tight for my liking. 7- You said: ”…. Although 3 loan applications are out I have no firm commitment and am having a hard time telling what rates I would get and with the numbers this close it matters. …..”. Hmmmm loan broker? I think you will be pleasantly surprised and could be looking at a rate at 6% or a little less. In all honestly, the worse loans that have ever crossed my desk in terms of quality are usually coming from a lender that gets his referrals from brokers. I am not a big fan of commercial loan brokers, but I understand the usefulness of their business when it comes to helping people shop around. I think that is it for now, please let me know how everything works out. Hope this helps. |
| Posted by: Mark Mar 28 2004, 01:30 PM |
| Hi. First off, thanks for your prompt response. Second, your information and insight is greatly appreciated and helpful. Third, you are correct, I am working with brokers as the banks I have contacted thus far do not seem to be able to offer what I am hearing from the brokers. I have one broker who tells me he has a source for a 5.75% fixed with 30yr amortization and a ten year balloon with no closing cost, no points and no application fee and can finance 84.9% of appraisal value. This broker has a $90.00 fee to prepare the package and if it flies will have a charge of 1 point at which I balked a bit and he said he could negotiate a bit on the point and would still come in cheaper than average closing costs. I have another broker that believes he can set up (with 20% down) a fixed 5.99% with a ten year balloon and a 25 year amortization. I thank you for your comment of “I like your post”. I didn’t want the tone to sound bragging and would be the first to admit I’m not even a small fish but more like a fish embryo peeking out through it’s egg shell. I will respond to your posts in the order of your numbered comments or questions. Your first post: 1. Yes you are correct. Both My house and the 2 family rental building are fully paid for with no debt of any form attached. 2. I agree in what you say here. I don’t want to pay more than the property is worth and I really don’t want to pay less than what the seller should get. (I believe in win win without taking advantage.) I would or might consider giving him a note for some amount due secured by the two family so that the property can catch up or grow in value to match the final price, which may allow or assist him in performing his exchange. (What do you think?) Your second post: 1. I agree again and also came up with 7.4 as the cap rate. The original price was listed at 795K. I wasn’t aware of the 10% and 8% cap rates but the 7.4 was lower than what I prefer. In this area I do see better and worse available in smaller units but an apartment complex obtainable in this size is a rarity. I’ve seen this complex and was looking at a 15 unit last year and those were the only appealing and possible targets that I came across in many many years. There is just not much existing of this type in this area (unless I would consider a slum type modified building that packs low income people into small divided spaces, which I prefer to stay away from.) as compared to what you find if you were to search loopnet.com on Fort Lauderdale. I’m in the Mid Hudson Valley. I did stop by a modular dealer and for two new buildings of the same size and features come up with a 580K cost to build this complex without the cost of land and any glitches. I am waiting on a price of what a comparable lot would cost in the complex’s location and suspect at least 60K for the .675 acres. This will give me a feel for the cost difference in price for the complex being turnkey. However, in reality, in it’s convenient location there would be no lots available, and if there was land, it would probably be impossible to get an OK to build. I believe this is the only complex in this village and resistance to more development of this type would be intense. 2. I hear what you’re saying and mentioned what I’m being told above. The 5.5% and 5% that you mention is encouraging and I will do more shopping with increased enthusiasm. 3. Hmmm.. Not sure I understand. Did you use the Purchase Price of 770K or 700K and how much cash flow floweth? Using 770K as a Purchase Price, 154K as a 20% down payment, 27K from my policy proceeds, 40K cash and a loan on my residence of 150K, I came up with 553K to finance and a cash pre tax cash flow of $8,299.00. If I also add 80K financing out of the two family I get $8,730.00 pre tax cash flow. (P.S. I conservatively estamate I could pull a max of 180K out of my residence and 80K from the two family residence but am not sure if the savings by a smaller commercial loan with a higher interest rate would be washed away by the closing costs to borrow from both my current properties at a lower than commercial rate. What do you think?) 4. HERE IS WHERE YOU REALLY REJUVINATED MY HOPES. I came up with the 1.09 debt repayment ratio using the commercial loan debt service AND my residential debt service. Following as a guide your discussion of “Analying the debt repayment ability of Income Producing Property” using only the commercial properties debt service I come up with 1.36%. 5. The signing of the purchase contract is to occure two weeks after inspections / the binder. I haven’t forgotten about the closing costs but just haven’t figured out how I’ll cover them yet. With brokers and loan programs mentioning no closing cost I get hopeful and if worst comes to worst I might need to roll them into the financing or possibly try for some broker help. (This property has two other interested parties that both came through other brokers. I went direct to the listing agent without a broker which means the broker makes twice as much if the property sells to me. I hope if push comes to shove, that the broker would prefer a cut in price of 25% back to the seller who passes the savings to me as apposed to a 50% cut in commission if another party buys with another brokerage causing them to share the commision.) 6.The actual purchase contract is not completed by sellers Lawyer yet. The “purchase offer and acceptance” on which my binder was given on has contingencies to apply of: *mortgage contingency *satisfactory radon test *woodboring insect inspection *satisfactory building inspection *satisfactory septic dye test *ability to obtain home equity or mortgage on my personal home. The terms to apply *amount of mortgage 80% *amount at contract $31,036.00 *contract signing date: two weeks after inspections *tentative closing date on or about June 11, 2004. The broker has verbally informed me that the seller wants me to have a commitment for the mortgage on my property at the time of signing the contract and I said I would try to comply. I am considering the satisfactory building inspection to not only be the one that I am paying for but mine and my wife’s as well as we have not seen every apartment as of yet. This will be our first true inspection of the entire complex and believe this to be my ability to pull the plug and re negotiate. 7. Yes, you are correct on the loan broker. I will be contacting a bank refered to me yesterday by the modular dealer that I stopped by. I’m looking forward to your responce on all this. I will keep you posted on what happens from here. I really do not feel I have anyone of your experience that I can talk to and I can’t express my greatfullness enough. Thank you again, Mark |
| Posted by: loanuniverse Mar 28 2004, 02:38 PM |
| Ok let me address some points brought up by your follow up post. ” I don’t want to pay more than the property is worth and I really don’t want to pay less than what the seller should get. (I believe in win win without taking advantage.) I would or might consider giving him a note for some amount due secured by the two family so that the property can catch up or grow in value to match the final price,” I think that you must be very strong in your position of not paying more than the property is worth. The fact that he is doing a tax exchange and you might want to be helpful in getting him his desired sales value is very nice of you, but really there is nothing more important that the sales price. Everything in finance is about cash flows and bringing those cash flows to the present value. “It does not get anymore present value than the money that you are going to pay at closing”. By the way, I know next to nothing about the tax exchange provisions. Fair price definition = “The estimate of value than an appraiser with no vested interest in the final value comes up with” ” cap rates but the 7.4 was lower than what I prefer. In this area I do see better and worse available in smaller units but an appartment complex obtainable in this size is a rarety……………I did stop by a modular dealer and for two new buildings of the same size and features come up with a 580K cost to build this complex without the cost of land and any glitches. I am waiting on a price of what a comparable lot would cost in the complex’s location and suspect at leat 60K…… Well, I actually work in one of the hottest real estate markets in the nation. My office is in Coral Gables and yes I have seen buildings listed at horrible 6% cap rates, but as you found out with your inquiries about possible value from the point of view of cost… The property sounds more and more like is worth less than $700K. ” I hear what you’re saying and mentioned what I’m being told above. The 5.5% and 5% that you mention is encouraging and I will do more shopping with increased enthusiasm.” Do not get too excited, I am quoting 5-year rates here, which means that even if you get a ten-year loan, your rate would change at the end of the fifth. It would also be kind of hard to get the 5% one, but the 5.5% would only take some good negotiating. ” Not sure I understand. Did you use the Purchase Price of 770K” I used $770K, but what I was trying to say is that if it were me, I would take a $590K commercial loan not a $553K ” HERE IS WHERE YOU REALLY REJUVINATED MY HOPES. I came up with the 1.09 debt repayment ratio using the commercial loan debt service AND my residential debt service.” Well, the property would not be able to repay both loans and still provide the cushion that the lender will require. This means that you have to take out the residential loan if you want to qualify. This means that the mortgage on your personal residence most be repaid from your personal income. The problem that I see is that the best deal would be one that would allow you to repay both from the property and leave you a little extra. I hate to keep harping on this, but I don’t like that sales price. I also feel a bit guilty because maybe I just gave you an idea on how to present the deal to a lender to get approved, but that the deal might not be that good to begin with…. This is a good time to point you in the direction of my disclaimer. Also when I mention closing costs, I mean the fees that the lender charges, the appraisal fee, the environmental fee, the documentary stamps…. Do not worry about the broker selling the property, his fees come from the sellers pocket. Believe it or not your closing fees could amount to $10,000 easily. ” The actual purchase contract is not completed by sellers Lawyer yet.” I am not a lawyer, but I would consult one before signing this. The fact that the seller has his attorney prepare a contract does not mean that you can not have your own review, modify and resubmit. Always look for ways out and ways that will improve your leverage if unforeseen situations happen. By the way those 5.75% and 5.99% rates fixed for ten years are very competitive. The thirty-year amortization is very nice. Hope this helps |
