How Financial Analysis Changed A Multifamily Transaction
It's not uncommon in commercial real estate to see a property languish on the open market for months. It may be less common for investment properties given the national, even global, pool of investors for any specific asset class. It may be even less common during the last eighteen to twenty-four months. Rents have increased, capitalization rates have decreased, investors are cash flush, historically low interest rates and sales prices have skyrocketed in many markets. But it still happens.
Why?
There may be several reasons for why an investment property doesn't sell during the listing period. Most common are unreasonably high seller expectations. Sellers have become enboldened by the market and are seeking ever higher prices for investment properties. As I've already noted, the market is ripe for this kind of seller.
So why didn't it sell.
One likely reason is the available financial information. Many of today's real estate agents are using proforma data to validate every increasing prices and seller expectations.
In the case of this scenario, it was not needed. Accurate financial analyis was required!
Fulton Apartments is a twenty-four unit apartment property that's been on and off the market multiple times over the last two years. A local real estate agent familiar with the area, but not necessarily the asset class, and a national brand name firm familiar with the asset class, but not the area, both took turns trying to sell this property. Neither succeeded.
When I began this assignment, the first items I requested from the owners were the most recent twelve month profit & loss statement and prior marketing materials. I've made this standard practice in order to review the real numbers, not proforma, as well as to see the avenue prior agencies have taken to sell the property.
I began with the offering memorandum (OM). It was well formatted, contained vast amounts of inforation, and honestly the aerial photos were great. Truly well done. However, as I scrolled through the entire document two items jumped out at me besides the photos. First, the comparable sales provided didn't support the asking price (15% less than asking). Secondly, the in place capitalization rate was 5.84%! Even the year three proforma was 6.90% not factoring in any escalation in real estate taxes. And when have we ever known any government entity to not raise taxes whenever possible.
We have found the reason the property has yet to sell!
Even for a Class A, brand new, large metropolitan area property this may be a tough pill for many investors to swallow as interest rates rise. This was decidedly not the case I was dealing with in Fulton Apartments.
Total Rents | $163,000 |
Real Estate Taxes | $15,000 |
Property Insurance | $7600 |
Property Management | $26,000 |
Other Operating Costs | $44,000 |
Net Operating Income | $70,000 |
Cap Rate | 5.84% |
To be clear, I've altered and combined this from the actual. But it's not far off from the OM.
The first of ten questions (yes, ten) was why does property management represent 16% of rents? That's high for most markets. I contacted several property managers in the area and determined the average rate in the market was closer to 8%. I also found out that due to timing of payment there was a third property insurance payment in these financials.
Without getting into much more of the minutia, here is my analysis.....
Total Rents | $163,000 |
Real Estate Taxes | $15,000 |
Property Insurance | $6,000 |
Property Management | $13,000 |
Other Operating Costs | $44,000 |
Net Operating Income | $85,000 |
Cap Rate | 7.10% |
Without any changes to the property or capex dollars spent, we were able to take the same property at the same asking price and make it significantly more attractive to investors. Ultimately, we received five offers within ten days of marketing. The property is currently (as of 5/19/22) under contract.
As you can see, having a full understanding of financial reporting can make a huge impact on the sale of investment real estate. It takes time, questions, and clear communication which can often be overlooked during an already complex, time consuming process. But it's vital to maximizing the value of investment real estate in any market.
Wes Purvis
Director & Founder
Purvis Commercial Group
Coldwell Banker Schmidt Realty
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