The building in which my professional practice has resided since 1990 has just gone up for sale. The owner has given me the first right of refusal to purchase the building. It’s an older building with four residential apartments and two professional suites on the first floor. The yearly income from these and a couple of garage rental spaces comes to around $75K per year. The owner wants $600K. Real estate taxes are around $16K. I haven’t received the profit/loss statement as it is being prepared. I need to start doing some homework on this deal as I am entirely new to this type of purchase. I’ve purchased homes for my family, and assume a commercial loan is a completely different animal. Can anyone with experience help me out with some advice? What are my financing options in a best case scenario? Are there price to income guidelines I should be looking into? How long are loans like this taken out for and are they amortized over time like home loans? Thanks.

Ok here are my thoughts in a random manner:

- You need to deduct a percentage of rents to allow for vacancies. It is usually the percentage of vacancies in the area for that type of property. When in doubt use at least 5%.

- Taxes are not the only expenses. Insurance will be the next big ticket followed by maintenance and utilities. Another thing to take into consideration is the possibility of a big expense coming soon. If you have to replace the roof soon, you might want that expense accounted for on the price.

- I think that on a best case scenario, we are looking at a building with a $50,000 NOI. On a worst case scenario the NOI is around $40,000. It is crucial that you pin down the amount of expenses because the NOI or Net Operating Income will be the number, from which valuation is derived.. Read up on the “income approach” to valuation some.

- Getting a loan for this building requires about 20% of equity/subordinated debt. You can probably get it with as little as 10% down payment if you get the seller to carry a second.

- When negotiating with the lender. You want 25-year amortization instead of 20- year, and you want a ten-year loan instead of five.

- Rates have gone up recently and you are looking at somewhere between 7.25% and mid 8%

- Lenders charge about 1% of the loan total at closing in the form of a fee. Other closing costs include an appraisal {a couple of thousand} and an environmental report. All together, closing costs can easily amount to $10,000 on a deal of this size.

- Talk to a couple of lenders in your area. I would try commercial banks first. I emphasize that you should talk to a couple of lenders, and not just one.

- When making the offer, make it subject to financing and give yourself at least 60 days.

Good luck

Thanks for the insight. I may be too simplistic here, but just looking at the numbers and adjusting them accordingly, I have a rental income of $75K - 5% = $71,250. Assuming I can finance 10% through the seller at the same 8% interest rate, my monthly payment for the entire $600K (25 years) comes to a little over $4600. Yearly, that's $55.5K. Taxes at $16K. So, not taking into account insurance and maintenance, I'm already in the hole! What am I missing here, and how do people make money doing this?

RFH

The simple answer is that the seller may be asking more than the building is worth. Even with a more traditional 25% down the numbers would appear to be tight.

Have you added what you pay in rent into the gross rental income?

One thing to keep in mind. You will not be able to finance 100% of the property. You will need 10% from your own funds not including a seller held second mortgage. The remaining 10% can come from a seller second but you must have your own money in the deal.

They pay less. I did not do the numbers on your situation, but at first glance they appeared tight. This is the reason why I mentioned valuation and knowing exactly how much the property is worth. Nobody should make such a sizeable investment without all the facts, and nothing is more important than pinning down NOI.

Take a look at the spreadsheet located at http://www.loanuniverse.com/sensitivity.html

Use it to calculate debt service coverage. I think my next project will be to improve that spreadsheet and add a quick valuation using cap rates. Saying it on February 2006 means the new version will be ready sometime in 2008

Good luck

Yes, my rent payment is included in the total yearly income the property produces. I see now that owners of rental property must increase the rent regularly to support the eventual selling price. I have a feeling that the low rents being paid have not increased with the market. This evidently hurts the seller when it comes time to cash in on the investment. Am I correct here?

RFH