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REAL ESTATE I feel like I'm spinning in circles!

yveskleinsky

Bronze Contributor
Speedway Pass
Jul 26, 2007
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Okay- I am straddling the divide between residential/commercial real estate, as well as employee/business owner. Something's gotta give! My intention is to get into mult-unit vacation rentals- and it would be great to be in a position to increase the value and refi out (that was my understanding of a post by AroundtheWorld. Increase NOI=increase cap rate=increase income. Right?). Based on this strategy (increasing NOI and cap) I could buy these 5 cabins, fix up, increase cap and refi out. Am I on track here? The owner is asking $550 for the whole complex (9 units and the owner's quarters (jail cell) ). He is willing to split into into 2- $275k for each. The income he has listed is around (don't have numbers in front of me) $45k. Total expense with my new debt service would eat that up. However, I think under my mgmt I could increase income as all 9 cabins are vacation rentals...and I would rent out 1-2 as long term rentals. The owner's quarters could be used for something else as well. Laundry room? Game room? Snack bar? All of the above?

So...would it be wise for me to buy these (or buy half) and increase income and then refi money out? Am I even close to being on track here? ...How do you guys make money when you buy properties with low occupancy?
 

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AroundTheWorld

Be in the Moment
Speedway Pass
Jul 24, 2007
2,909
1,865
550
.
Okay- I am straddling the divide between residential/commercial real estate, as well as employee/business owner. Something's gotta give! My intention is to get into mult-unit vacation rentals- and it would be great to be in a position to increase the value and refi out (that was my understanding of a post by AroundtheWorld. Increase NOI=increase cap rate=increase income. Right?).
Your cap rate may not change much.... but because of the cap rate, your VALUE will go up exponentially as your INCOME goes up.

And, cap rates actually have an inverse relationship to value. The LOWER the CAP the HIGHER the value.

Example: Property brings in a net income of $50,000.
Assume a 10% cap: $50,000/.10 = $500,000
This property is worth $500,000

Now lets assume a 7% cap: $50,000/.07 = $714,285


Based on this strategy (increasing NOI and cap) I could buy these 5 cabins, fix up, increase cap and refi out. Am I on track here? The owner is asking $550 for the whole complex (9 units and the owner's quarters (jail cell) ). He is willing to split into into 2- $275k for each. The income he has listed is around (don't have numbers in front of me) $45k. Total expense with my new debt service would eat that up. However, I think under my mgmt I could increase income as all 9 cabins are vacation rentals...and I would rent out 1-2 as long term rentals. The owner's quarters could be used for something else as well. Laundry room? Game room? Snack bar? All of the above?
If the owner is asking $550,000 and his stated income is $45,000 then the cap rate he is offering this property at is.... 8.1%

45,000/550,000 = 8.1

Is this the going cap rate for an investment such as this in your area?

If it is, that would be your first indication that it is an okay buy.... all due diligence required :smxB: I think the cap seems a little low, but it can be different in different areas. The way to CREATE value now is to increase your net income. Let's say you increase it by $10,000 a year with yor ideas.

Your new value (assuming 8.1 cap is going rate in your area for this type of property) is

55,000/.081 = $679,000.
 
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yveskleinsky

yveskleinsky

Bronze Contributor
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Jul 26, 2007
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This property does have a cap of 8.2%. I don't know what the going cap rate is- would I ask an appraiser? ...Is the same "if a property sits on the market for longer than 3 months it's overpriced" rule still applicable in commercial? This property has been on the market about a year- maybe longer. The owner said that it took the owner of another cabin operation 12 years (!!!!) to sell his!

How are Steve O and AroundtheWorld (or others) making money off of rundown or commercial properties that need improvements?
 
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yveskleinsky

yveskleinsky

Bronze Contributor
Speedway Pass
Jul 26, 2007
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Thanks AroundtheWorld! I have ideas on increasing income, but how are you and Steve O then using the increased NOI to make money ? Are you making money when you sell or are you refi-ing and holding?
 

SteveO

Legendary Contributor
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This property does have a cap of 8.2%
The issue could be that this is what the seller is telling you. You need to verify all the numbers. Small changes in income or expenses can change the cap rate significantly. The seller will not err in your favor.

I like to find properties that have upside that is obvious to me. It is easy when it comes to apartments because there are rent comps everywhere. We actually visit local properties and get as much information as we can from each one.

My plan was buy, improve operations, and sell for many years. Now that I have increased my holdigs substantially, this is harder to manage. I hold most and occasionally sell and trade up.
 

AroundTheWorld

Be in the Moment
Speedway Pass
Jul 24, 2007
2,909
1,865
550
.
This property does have a cap of 8.2%. I don't know what the going cap rate is- would I ask an appraiser? ...
Ask several different people. Is there a local REI group? Also, ask an appraiser, a banker, a commercial realtor. Is there some sort of trade association for vacation rentals? You may find something there as well.... and Steve O is absolutely right.... DON'T TRUST THE SELLER OR HIS AGENT about what the going cap rate is!!!

Is the same "if a property sits on the market for longer than 3 months it's overpriced" rule still applicable in commercial? This property has been on the market about a year- maybe longer. The owner said that it took the owner of another cabin operation 12 years (!!!!) to sell his!
It can take much longer for commercial to sell.


How are Steve O and AroundtheWorld (or others) making money off of rundown or commercial properties that need improvements?
Either one can be a vaible option... and your exit strategy could be influenced by interest rates.

Selling means you get MORE CASH to leverage into another (or two or three) deals.
Re-fi means you get some cash (not as much) but you are keeping your origional property and still cashflowing.

Interest rates influence my decision here. If I can re-fi, get some cash out, and still keep my payments low because the interest rate is now LOWER then my current rate... I'd rather keep the property. If rates are the same, or have gone up, then I'd probably rather sell. It is really a matter of personal preference... and what your goals are. If you do sell - and take ALL THE CASH - and are not adverse to being highly leveraged, this is probably the faster route to wealth.
 
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yveskleinsky

yveskleinsky

Bronze Contributor
Speedway Pass
Jul 26, 2007
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Is the benefit to increasing NOI only to increase the income coming in, or does increasing the NOI allow me to refi and pull equity out? ...Is equity figured the same in commercial and residential property? Or does increasing NOI increase equity in commercial? ...Does this question even make sense?
 

JesseO

Contributor
Jul 25, 2007
548
31
33
Phoenix, AZ
Is the benefit to increasing NOI only to increase the income coming in, or does increasing the NOI allow me to refi and pull equity out? ...Is equity figured the same in commercial and residential property? Or does increasing NOI increase equity in commercial? ...Does this question even make sense?
Increasing your NOI will create more cashflow, assuming your debt service stays the same. Yes, with commercial properties, it will also increase the value of a property, and therefore give an increase in equity. Yes, you can get the numbers up, get a new appraisal, and refinance to pull out money. Yes, your questions made perfect sense. This is a great way to generate cashflow and equity/appreciation at the same time. The two generally go hand in hand when dealing with commercial properties.
 

andviv

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My intention is to get into mult-unit vacation rentals- and it would be great to be in a position to increase the value and refi out.
...

The owner's quarters could be used for something else as well. Laundry room? Game room? Snack bar? All of the above?

So...would it be wise for me to buy these (or buy half) and increase income and then refi money out? Am I even close to being on track here? ...How do you guys make money when you buy properties with low occupancy?

Just some observations....
your business is the multi-unit vacation rentals.
The property is not performing at a point where you think it could --you see potential and have confidence in your mgmt skill to improve this
Your plan is to buy-and-hold and after improving the property's performance then refi and use the money for other deal --this is combining Velocity and Leverage, great idea.
This plan is for the long term, as you said selling this property will probably take long time, thus tying your money until you can re-fi

A small concern with this is the financing, as I don't know how financial institutions react to this type of properties where the income is not constant (not long term leases) so maybe you will need higher down payment. Have you checked this already with some banks or mortgage brokers?

Now, my suggestion about the owner's quarters is to use it as a laundry room. When I go on week-long vacationing I usually spend some time doing laundry --usually mid week when I am really tired and need a break, so I don't have to pack too much. Also one or two vending machines could be a good idea.

--great post, rep++
 
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yveskleinsky

yveskleinsky

Bronze Contributor
Speedway Pass
Jul 26, 2007
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Great feedback! So, let me see if I have this straight. One way to increase income (for a commercial property) in the immediate future is to get the rents up. This would benefit me in two ways: 1. More cash every month. 2. More cash everymonth=higher NOI which I can then turn around and refi the money out. Ex: I purchase for $550k and I increase rents by $1000/month ($12k a year) then my new cap rate would be 10.4% and the new value would be $57k (New NOI) x .081 (old Cap)= $703k. Am I on track so far? ...and the bank will let me refi the difference between the original loan and $703k out?!

Is this what you guys are doing? ...I understand that the refi'd money would come at a price, but man would it be cool to have my cabins going and have that spin off more cash for more cabins!
 

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AroundTheWorld

Be in the Moment
Speedway Pass
Jul 24, 2007
2,909
1,865
550
.
One way to increase income (for a commercial property) in the immediate future is to get the rents up. This would benefit me in two ways: 1. More cash every month.
Yup.

2. More cash everymonth=higher NOI which I can then turn around and refi the money out. Ex: I purchase for $550k and I increase rents by $1000/month ($12k a year) then my new cap rate would be 10.4% and the new value would be $57k (New NOI) x .081 (old Cap)= $703k. Am I on track so far? ...and the bank will let me refi the difference between the original loan and $703k out?!
Almost...

your cap rate is unlikely to change. What will change is the Value of your property, and therefore the equity in your property as your income goes up. Let's assume the cap for vacation rentals is 8.1% (have you checked around on this yet?)

If you increase your net income by 1,000 a month - or 12,000 a year, this is what would happen...

VALUE NOW:

Income/cap = value

45,000/.081 = 555,555

VALUE AFTER YOU HAVE INCREASED INCOME:

Income/cap = value

57,000/.081 = 703,703:banana:

The value has increased by about 150K. You could then theoretically pull some of that cash out..... however with the tightening lending market - it is getting harder to do. Will be interesting to see how long this tightening of credit lasts. Having a solid business and solid credit score is becomming more and more important.
 
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yveskleinsky

yveskleinsky

Bronze Contributor
Speedway Pass
Jul 26, 2007
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I just got an email from my dad who is recently into rehabbing apartments. The lead investor mentioned that they financed one through Fannie May at a fixed rate under 7%! How was this done and does anyone using Fannie to finance commercial?

...Also, I met with my local SBA guy, and spoke with my neighbor who is a president of a local bank. She was saying that they only do SBA loans, and that they are generally variable and around 8.25% (for now).

I will find out more tomorrow about what the going cap rate is for those cabins. If the numebr is different, how would I go about presenting it to the seller? (Wouldn't his appraisal be done using the income approach which would figure in cap rate/NOI?)

Thanks everyone- I have seriously learned so much today. I can't wait to apply it!
 

SteveO

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I don't really like to do rehabs. They take a lot of time and energy to complete. There is definitely an easier way but it does take some experience. Properties that are mismanaged to the extent of operating below market are my prime targets. This can lead to motivation for the sellers, especially if they are losing money.

Before anything, I decide on a location to purchase by researching the market fundamentals in the metro area. Then the actual search for a property can begin.

If you have the ability to manage better than the last owner, then there is upside. I like to increase the NOI through more efficient operations. Sometimes this means cleaning up a couple of years of neglect (carpets, appliances, landscape cleanup, etc...) but I will stop well short of something considered a rehab.

As far as financing goes, there are excellent options available for apartment buildings. There are minimum loans out there for most of the main players but I have not followed this for a while. You need to check and see what those are. Once you get below their minimums, you will be stuck with higher rates.

Once you get to the 4M+ loans, there are plenty of options. I refinanced 3 properties last year at fixed rates at or below 5.85% for 10 years. They would be more like 6.5% nowadays. Fannie apartment loans are great. They allow for loans to be assumed and for more money to be added to the loans if the value goes up.
 
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yveskleinsky

yveskleinsky

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Do Fannie Apartment loans have a minimum amount? ...Do you think a commercial cabin operation would qualify for an apartment loan?
 

SteveO

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Not sure on the minimums. The cabins would probably be treated like a motel. I am not sure about the programs for these.

There has been some interesting issues around immigration and their abilities to work here in Arizona. I am suspecting that they may begin flowing to New Mexico and Nevada for jobs as they leave this state.

There may be some near term opportunities in apartments as a result.
 

Diane Kennedy

Bronze Contributor
Aug 31, 2007
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I'm late joining this conversation and I went quickly through the comments, but one thing I think was missing was verification on the income.

Sorry to say - sellers don't always tell the truth. We have a lot predicated on the gross income number, so I would look for independent verification. I always ask for a copy of their tax return to see what they told the government. They can blank out SS#s and only show the pages applicable to the venture we're looking at, but I want to see what they told others. It's also amazing how quickly they "get honest" and will often soften the price even more.
 

SteveO

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The issue could be that this is what the seller is telling you. You need to verify all the numbers. Small changes in income or expenses can change the cap rate significantly. The seller will not err in your favor.
Good advice Diane. The fact that the sellers are not telling the truth was brought up a couple of times though.
 

Russ H

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Read Millionaire Fastlane
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Weird-- I'm reading through this thread and keep saying to myself "45K is probably closer to the gross, not the net".

And then I come to Diane's post. :)

yveskleinsky- what verification has the seller given you to show that this is, indeed, net income?

All of the discussion of CAP rates is pointless if the expenses are fudged.

When we looked at buying a B&B, the sellers never showed us net income (just gross, and expenses), since the practice in this industry is to show gross numbers, not net (don't ask me why, it's goofy).

Those reading this may say. "Well, if you have gross income and expenses, you can get net income."

Only if you have 100% of the actual expenses, and you never do.

We developed our own estimated costs and debt service, and subtracted them from the gross income, and presented these numbers to the SBA for a loan. They were happy with that.

yveskleinsky, have you seen the actual gross and expenses on this place? Like on a tax return?

That was part of our due dilegence, and purchase agreement when we bought the B&B-- we got to see what the owner actually declared as income and expenses on his tax returns.

Unbeknownst to us, he had been renting out 2 rooms as vacation rentals in his house and mixing in that revenue in w/the gross from the B&B. We didn't figure that out until about 2 years after we bought the B&B.

And we know (based on a secret stash of cards we found a year later) that he had pocketed a number of the cash B&B transacations, and never recorded them.

Perhaps he figured the totals were a wash, since he was subtracting the cash, and adding in the 2 illegal rentals?

We'll never know-- he passed away a few months after we bought the place.

In any case, you have some potentially large unknowns here-- esp unknown expenses, and the possibility that the owner is pocketing cash and not recording it (pocketing the cash would throw the overall gross and income down, in your favor, but it's still a huge problem).

So have you seen tax returns? Or do you have access to his books/bills?

If not, chances are you might be missing some enormous expenses-- and the seller will be *banking* on this (that you're too much of a newbie to catch what he's not telling you).

That's part of the reason that resort properties stay on the market for as long as they do-- the sales either go to newbies (the vast majority of these props are under $1 million), or experienced owners w/previous experience who have to sort through the 90-95% BS listings to find the 5-10% of the properties that actually present reasonably accurate numbers.

-Russ H.
 
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yveskleinsky

yveskleinsky

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So I just picked up the fax today that was suppossed to have the numbers for the cabin operation. lol. It is a fax of the seller's disclosure statement! WTF?! I think/know that the agent that is representing the seller is giving me the runaround because I had my cabins with her for property mgmt then left her and started my own thing. She said that she will not release info with a letter of intent. I suppose I could write a letter of intent stating, but I know then she is going to want to see a pre-qual letter....which I don't have because the property is commercial and I need the property to qualifty. So frustrating! Maybe I should just move on.
 

Russ H

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yveskleinsky-

All of these agents have their own letter of intent/non-disclosure letters.

Just call her, ask her to fax it to you, tell her you'll sign it right away and fax it back, and tell her you "expect to see some numbers by . . . when can you send them to me?"

If she stalls, ask her if the seller has given her the numbers. As a realtor, she has to say yes or no (or explain). If she's stalling, you'll find out.

-Russ H.
 

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yveskleinsky

yveskleinsky

Bronze Contributor
Speedway Pass
Jul 26, 2007
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What would I say in the letter of intent? ...I mean, I would intend to purchase the property if the numbers jived. ...I don't have a pre-qual. Can they refuse to give me numbers based on a lack of pre-qual?
 

JesseO

Contributor
Jul 25, 2007
548
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33
Phoenix, AZ
It does seem like they're giving you the runaround...but if the numbers are really good, then you should continue to try for the purchase. If you can't get any sort of verification of the NOI, I would pass. They might be hiding things that would only be a headache and/or disaster down the road. I think Russ has been spot-on in terms of seeing through this whole deal.
 

Diane Kennedy

Bronze Contributor
Aug 31, 2007
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yveskleinsky, I've signed those disclosure statements before. And I've written letters of intents with LOTS of conditions. This is something you dont' want to do unless you really know what you're doing or have the advice of an attorney. (We always write it up ourselves and then just run it by the attorney.)

On the prequal, we've gotten our mortgage broker (who knows us really well) to write a prequal letter subject to appraisal of the property and review of the numbers. Basically the prequal doesn't mean a thing, but it's enough to get them to release the figures.

Otherwise you're in a Catch-22 and just chasing around.

Even if the property doesn't pan out, you might want to continue (with plenty of contingencies so you don't lose anything) through the process just to get the learning. That way next time you'll be better prepared for the next deal.
 
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yveskleinsky

yveskleinsky

Bronze Contributor
Speedway Pass
Jul 26, 2007
2,233
495
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Great idea Diane- I think I will see how far I can go- if for nothing else, the experience. I was thinking that before I do a letter or intent, that maybe we could practice with some numbers- that way I can see if my thinking is on track. Granted, these aren't the actual numbers- but hypothetically speaking here is how I am looking at the cabins.

(Again, hypothetical numbers)
5 Cabins. Owner asking $275k.
Gross Rents $30k ...which breaks down to about $85/night for 5.5 nights for 5 cabins a month.
Expenses:$10k
Utilities,firewood, snow plowing, insurance, cleaning, internet, credit card fees, taxes, repair, vacancy (roughly 60%) ...although I don't really know how to account for vacancy as it fluctuates as they are nightly rentals
NOI: $20k
New Debt service would be on $220k @ 9% over 15 years: $2239/month or $26,868
So I would be -$6,868/year.
...So this deal wouldn't work based on the hypothetical numbers...but it could work if I increased rents, and negotiated down on price.

...Russ, when you mentioned before about "knowing your financials like the back of you hand" what does your financial set up look like? ...Where do you plug your numbers after a guest leaves? Or a major repair occurs? Do you keep a personal financial statement and one for your B&B?

Diane- how would you recommend a budding business get their financials in order? What does it look like to you?

Again, I really appreciate all the help and the time you guys spend with me. I know my questions revolve around "small potatoes" type deals, but it's big potatoes for me! :)
 

elballer

PARKED
Jul 2, 2010
20
0
9
Thank you for the lesson.It did take me a while to understand.But I learned something today that is priceless.You guys are good at what you do.:thankyousign:
 

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