There it is the investment property you've been looking for. A freestanding two storey commercial building with 3 residential units on the second floor and it happens to be for sale. Do you buy it or look for something else? You want to buy it, but you don't know whether it's a good deal or not. The price seems steep but the listing agent says you can get good money for the 3 residential units on top. Before you buy you may want to consider the following points.
Type of rents being offered
This is a very important as you want to know as an investor whether the tenants are paying the taxes, maintenance and insurance separately or in their rent or do the tenants pay some of the taxes, maintenance and insurance. The answer to this question affects the amount of cashflow the property generates.
Rate of return
The rate of return is also important as there are different investment vehicles with competing rates of return. Generally the higher the rate of return the better. Its also a good idea to look around at similar investment properties to get an idea of the rates of return being offered. In this instance you want to look for other 2 storey commercial buildings with 3 residential units on top. Apples to apples comparison. This is the nice thing about real estate, you can compare rates of returns for similar type of properties in the area easily. You may see a small fluctuation in rates of return and that's okay too. This will give you the investor a range of returns to be expected. Generally the subject property should fall within this range. If not, ask questions like how well is the property managed? What are the tenants like in paying? Are the rents market value or not. Sometimes rents are a little bit below market value to retain tenants. Tenant retention is also important because it takes time to find a new tenant who will take over the space. In the case of the residential units, not only does it take time to find a new tenant, but also any repairs,maintenance,cleaning, painting to the apartment to make it marketable. The more repairs and maintenance a unit requires the more it comes out of the cashflow of the property. So budget carefully for events like this.
How is the return calculated?
Is the seller basing the sale price on the gross income the property generates or net income. Net income is better because the investor knows how much their going to pocket from this investment. Gross income is okay, however, typically investors want to know the bottom line after deductions. That is why net income is better indicator of value than gross income. This is known as the recapture rate. The rate of return the investor can expect from the property on their initial investment. It is also the length of time required to 'recapture' their investment back.
Condition of the property
Condition of the property is also important. A well kept building will command a premium over one that is poorly maintained. Two income producing properties are for sale and are listed for sale at the same price. Building A is poorly maintained and has a rate of return of say 5% while building B is well maintained and has a rate of return of say 6%. Building B looks like it were built just yesterday. In the market place, investors would flock to building B as it is in superior condition and a superior rate of return. If building A wants to sell quicker, than a price adjustment is needed otherwise it will just stay on the market for a long time before the seller decides to drop the price. Worse still, they may be few if any offers coming in which means more carrying costs like utilities, maintenance, taxes, mortgage payments. The longer the property is on the market the more likely that new competing listings come on to the market vying for investors attention. This makes it more difficult to stand out in a field of competing listings.
On the other hand, if the investor has the resources of money, time and manpower, then building A is a better deal if the investor can get that price down. The discount in the price is the factor of the cost to bring the property up to building A's condition. This would impact the cashflow positively because the property is in better condition and is able to attract more potential tenants and possibly higher rents.
Get a second opinion
If you are unsure about the income the property produces get a second opinion from a local real estate appraiser specializing in commercial properties. The real estate appraiser is independent of the sale and their fees are not based upon achieving a certain value of the property. Make an appointment with the appraiser and bring in the listing and ask their opinion. Granted the appraiser really can't say too much but as an investor you can get more information out of the appraiser than the seller. The appraiser would be able to tell you if the rents are either too high or too low or may hint that you should look at alternatives. This would be just a cursory look based on the listing that you have given them. If you really want to know if its a good deal or not, put a clause in the offer that states approval upon financing and hire the appraiser to appraise the property. Depending on the outcome, the appraisal report will tell you if the purchase price is market value or above market value. Worst case scenario all you have lost is the cost of the appraisal, some time of say 2 weeks and then onto the next deal.
Look at other properties
It's a good idea to look at a number of investment properties that suit the rate of return your looking for. Then you can always compare them and refer to your notes, then make offers as you see fit. Go back and re-visit its amazing what one can miss on the initial inspection.
Shop for best rates
Now that you have signed the bottom line its time to get financing. You can save yourself a lot of time and money if you get your financing in order first. That would mean a visit to your mortgage broker or bank. Generally speaking a mortgage broker is better as they have access to more financial institutions than just your mortgage specialist at your local bank. In fact it doesn't cost you a dime as they are paid by the lender themselves.
Once you have your financing in place, now go ahead and put in those offers. Just look carefully at the condition of the building, re-check all figures in the agreement of purchase and sale including all rents and expenses, get a second opinion from a real estate appraiser if unsure and then sign the deal.
About Author / Additional Info:
Mathew is the President of MRJ Financial Solutions and is dedicated to improving YOUR bottom line. Questions/comments; firstname.lastname@example.org or visit us at http://mrjfinancialsolutions.ca