Southern California multifamily deal. Advice greatly appreciated.
4.5% cap rate on a brand spanking new 28 unit complex. The annual NOI is negative ~$200k when you factor in the debt service of 80% DSCR loan at 6%. 

I'm not versed in commercial rental sales. Is this a normal / attractive structure? 

Why would someone buy a property that operates at a loss? 

Is it uncommon to have debt service on a deal like this? 


Thanks
[{"id": "hqd8xqn", "text": "Debt service is common.\n\nPeople that buy properties that are cashflow negative do so because they are situated to provide value-add to the property in a way that can turn that around.", "replies": [{"id": "hqda42z", "text": "You don\u2019t pay a 4.5% for a new property to turn it around.\n\nThe property can\u2019t support debt at 80%.", "replies": [{"id": "hqee0v1", "text": "You definitely can.  I had friends in Virginia that bought a 120 SFR portfolio that was cash-flowing negative $70,000/yr because they had the systems and structure in place to turn it into a cashflow-positive portfolio in 2 years.", "replies": [{"id": "hqewvw0", "text": "That's not the same as new construction.", "replies": [{"id": "hqf0r6p", "text": "It\u2019s not, no.  But I bought a new warehouse for $194,000 that was being rented out for $2,000/m NNN, thew 67k into building out the inside for my specialized niche market, and now it grosses $8,300/m and cashflows $7,200/m.  \n\nIf you have special skills or operate in a unique niche, if you can leverage those on a deal, it doesn\u2019t matter if the property is brand new or a hundred years old.  \n\nThis property that the OP is asking about needs a buyer that can do for this property what I did for my warehouse.", "replies": [{"id": "hqf60e5", "text": "It\u2019s a brand new construction. Presumably, the builder maximized the utility of the property already\u2026", "replies": [], "depth": 6}], "depth": 5}], "depth": 4}], "depth": 3}], "depth": 2}, {"id": "hqdd2ml", "text": "That's the thing. It's brand new. The rents are fmv. \n\nThe NPV at 6% rate, 3% annual rent increases and 15 year duration is $14M. \n\nI'm the dev. I was thinking about keeping it but not if it's at a loss. I'm not sure if there is a buyer for this either. \n\nThe average 2022 employer housing COLA for the area is 20%. I'm using current fmv rents. If they increase a proportional amount, it's a small winner at $60k annum.", "replies": [{"id": "hqeguep", "text": "Just sell it and do it again.", "replies": [], "depth": 3}, {"id": "hqevybx", "text": "I\u2019ll bite. I work for a large Multifamily lender.\n\n6% is an insanely high rate for a loan today. I\u2019m not sure who is offering that, but I can tell you that you should be able to find way better. If you\u2019re looking for longer term debt at more attractive rates you\u2019re going to need to cap at 75% LTV. Rates at that leverage point should be in the low 3s. If you really need the proceeds go bridge for 3 years and then reevaluate. You should be able to get 80-85% out of those guys with a 4 handle on the rate.", "replies": [{"id": "hqf06u1", "text": "Thanks! It's not an actual rate. This is just a rate I'm using for the proforma. I realized my numbers were all kinds of wrong. After I entered in realistic values, it makes a lot more sense.", "replies": [], "depth": 4}], "depth": 3}], "depth": 2}], "depth": 1}, {"id": "hqda962", "text": "What occupancy is the NOI assuming and what is the rent penetration of the property versus its peers?", "replies": [{"id": "hqdey75", "text": "95% occupancy for my projections. Area vacancy is less than 3%. \n\nI do not know the penetration rate but there are 7k commuters daily as a result of a lack of rentals.", "replies": [], "depth": 2}], "depth": 1}, {"id": "hqdiwow", "text": "First, you clearly don\u2019t know what you\u2019re doing so you should not buy this.\n\nSecond, it is not possible for something to sell at a 4.5% cap if the NOI is negative.  Cap rate would not be a relevant measure.\n\nThird, NOI does not account for capital structure.  It is the net operating income of the property, not the net cash flow after debt service to the investor.", "replies": [{"id": "hqdk47m", "text": "Thanks. \n\nFor clarity: \n\nI'm building it not buying it. I was thinking of keeping it or selling it. The NPV is $14.2M, the IRR is 7.09 and the cash on cash is 184%. \n\nThe NOI is only negative with the debt service at 80% of FMV which is substantially more than my build cost. This has a contingency and a maint. reserve factor of $50k per year.\n\nExcluding debt service, it's a positive annual yield of $441k.  Edit positive annual yield over $500k.", "replies": [{"id": "hqdmy8o", "text": "NOI is effective gross income minus operating expenses.\n\nNet cash flow is NOI minus replacement reserves.\n\nNet cash flow after debt service is net cash flow minus debt service.  This is the cash flow available to equity investors.\n\nUsing your $441k NOI and applying a 4.5% cap rate gives the property a value of $9.8 million or $350k per unit.\n\nWill an investor buy the asset at a 4.5% cap rate if their net cash flow after debt service is negative?  Likely no.  A lender would not (or should not) make that loan. \n\nIs the buyer going to get an interest rate of 6%?  Likely no.  Since we are talking about a stabilized multifamily asset, they can likely get an agency loan for 70-80% LTV at a 3.5% to 4.5% interest rate.  It is more likely to be constrained by a 1.3x DSCR based on a 30-year amortization schedule though.  So the max leverage might be closer to the 60-70% range.\n\nIs it common to have debt on a deal like this?  It is common to have debt on most investment real estate.", "replies": [{"id": "hqdpnnn", "text": "Thanks!\n\nThe NOI is actually $513,819. I was using net cash flow on core rent income only.  \n\nAt 3.5% with 65% LTV using a $12M sales price, the net cash flow after debt service is $93k annum. \n\nI understand that debt is common. I should have asked if that is a typical raye/ltv structure. My numbers were based on residential rates and LTV. \n\nThis makes a lot more sense!", "replies": [], "depth": 4}], "depth": 3}, {"id": "hqf17p0", "text": "NOI does not include debt service.", "replies": [{"id": "hqf1pho", "text": "This was among the list of errors. I also added a maintenance replacement reserve allocation, ignored the ancillary income and assumed a really high LTV and rate.", "replies": [{"id": "hqf75un", "text": "Have you engaged a broker to put together a BOV package for you? This will probably answer a lot of your questions and help you understand what the property is worth. They can help you determine who to market the property to, what range of prices you can expect, provide comparable sales data, etc\u2026\nThey will market it to prospects buyers with a typical capital structure example.", "replies": [{"id": "hqffw13", "text": "No not yet. This is just preliminary work now to see if it's even worth the effort.", "replies": [], "depth": 6}], "depth": 5}], "depth": 4}], "depth": 3}], "depth": 2}, {"id": "hqdt8jg", "text": "This is all correct. NOI also excludes any brokerage commissions/leasing incentives.", "replies": [], "depth": 2}], "depth": 1}, {"id": "hqdj91s", "text": "People will not buy at a loss unless it is New York real estate. That being said, why would it be operating at a loss? You first need to deliver those units completely vacant, then you can sell with pure pro forma cap. After that you need to market the property correctly, work with a loan broker to give you some estimates in terms of loan. You should aim for 50% down not 20%. If you want to DM me I can give you my 2 cents.", "replies": [{"id": "hqdkdvp", "text": "It's not a loss unless the DSCR is 6% with 80% LTV. The NOI exclusive of the debt service is $441k positive. Edit $500k + positive.", "replies": [{"id": "hqdqmky", "text": "If you don\u2019t mind me asking, what city is this located in and how many bedrooms/bathrooms exist in each unit? Per my rough calculation, especially on a new build, I feel like $441K NOI is on the lower end of what my numbers would come in at.", "replies": [{"id": "hqdrbi3", "text": "The bedrooms and baths range from 2/2, 3/2, and 4/2.5. \n\nIt's not $441. I was excluding ancillary income and including a deduction for replacement reserves of $50k per year. The actual NOI is over $500k. \n\nThe rent is probably going to be higher as well. I am using rental values of class B and class C properties. There aren't many active new build comps.", "replies": [{"id": "hqdt2od", "text": "Wow! Amazing! I wanted to share this with you as I see in other comments that you are considering holding and renting. \n\nMy girlfriend property manages here in the Inland Empire (Ontario, CA) - for one of my properties, she brought in $1,600 for a 400sq foot 1 bed/1 bath, and brings in $2,500 a month renting out 3 beds in our 4 bedroom house. Another one of her clients in Moreno Valley is currently bringing in $4,500 for their 5 bedroom house by renting it out per room.  I say all of this to offer guidance on where the local market is at right now when it comes to rent.\n\nAssuming the average is 3 bedrooms/2 bath in your 28 unit complex, you could easily get $2,500 per unit should you choose to hold and rent. That would be $70,000 per month x $840K annually pro forma", "replies": [], "depth": 5}], "depth": 4}], "depth": 3}], "depth": 2}], "depth": 1}, {"id": "hqdkz30", "text": "I\u2019m a socal developer also building multi as well as regularly acquiring. A reasonable buyer in todays market isn\u2019t putting more than 60% LTV. We stay between 40-50% on low cap multi. I would use 65% LTV as the max on your next buyer analysis likely less", "replies": [{"id": "hqdlo69", "text": "Thanks! This is exactly the info I'm looking for! \n\nAt 65% LTV what is the typical annual net surplus buyers want after debt service? \n\nWhat is the rate for a loan of 65% LTV?", "replies": [{"id": "hqdo29n", "text": "We typically use our own credit facility/LOC but last I had quoted was a couple months ago around 3%. \n\nWhat buyers seek is deal dependent. I would say run your numbers with a DSCR between 1.5-1.8 in increments of 0.05", "replies": [{"id": "hqdpsqv", "text": "The concern is the rate hikes. I know it's a pointless endeavor but I want to guess the available long term rate after completion. \n\nDo usually sell or build and hold?", "replies": [{"id": "hqff2t7", "text": "Why not just lock in a fixed rate loan? Brand new property in a decent location will likely get leased up quickly no?", "replies": [{"id": "hqfgp4y", "text": "It should be leased very quickly. It's not built yet so we can't lock in anything. \n\nThis is part of our due diligence / feasibility study.", "replies": [], "depth": 6}], "depth": 5}], "depth": 4}], "depth": 3}], "depth": 2}, {"id": "hqim5jl", "text": "Use DSCR and your best bet on LT rates that align with your exit horizon and that\u2019s about as scientific as you can get", "replies": [], "depth": 2}], "depth": 1}, {"id": "hqdlb8e", "text": "Think about an exchange buyer who needs to place their money and not just putting 20 percent down", "replies": [], "depth": 1}, {"id": "hqdlhs0", "text": "I live in CA but buy multifamily out of state for this exact reason. If you have a 1031 exchange and can defer the interest payments to your 8nevstors then you might be able to get it to cashflow, but if you're FMV is 14M then I'm guessing your purchase price and fees should be around 14.6M. We can talk more if you'd like.", "replies": [], "depth": 1}, {"id": "hqdpdn0", "text": "If you are not going to sell but instead want to refinance once it\u2019s stabilized and get some cash out, feel free to reach out. Happy to help. I am in SoCal and specialize in financing Multifamily properties nationwide.", "replies": [{"id": "hqdqcdz", "text": "Thanks. I have a mortgage bank. I just haven't done any multifamily yet. It's all been single family and condos. I've   branched off into land development (tract homes) but this parcel would be better suited for rentals according to the agents we have there and the city planners.", "replies": [], "depth": 2}], "depth": 1}, {"id": "hqdqn8w", "text": "To summarize, you are building a property with 80% ltc financing and the property produces negative cash flow after debt service once stabilized? Sounds like you are over levered. Also, idk who would finance that non-recourse.", "replies": [{"id": "hqds7zh", "text": "No. I'm building a property but the actual LTC is closer to 50%. I have a large contingency as lumber prices are rising, the supply chain may get worse, inflationary pressure on labor and materials is inevitable, and interest rates will be higher.  \n  \nI want to determine 1) the debt service of permanent financing of a buyer and 2) my debt service should I keep it and cash out some equity once it's complete. \n  \nIt seems that I was using high LTV, high interest rates, lower than actual income.  \n\nI'm used to SFR deal structures and I didn't realize the difference in available commercial terms.", "replies": [{"id": "hqfcbyq", "text": "When you say you are \"building\", what does that mean? How far down the road on this are you?\n\n&amp;#x200B;\n\nYou lack some basic knowledge and understanding in this area. Part of your due diligence before ever starting a project is to figure out all the different component parts, including the back-end valuations and exits. To make sure it makes sense before proceeding.\n\nI think you would be well served to retain a commercial broker to advise you ASAP. They can help you proforma this out and actually come up with a clear strategy moving forward.", "replies": [{"id": "hqfgi9b", "text": "Were in preliminary pre-construction. We have the land, arechectual, rent surveys, vendors (GCs, Subs, Etc) and construction budget. The reason why I'm doing this is to determine if we want to proceed to engineering and CRE broker evaluation.", "replies": [{"id": "hqfi963", "text": "IMO you're doing it backwards. You've spent a lot time, effort, and money before obtaining the necessary knowledge and information.\n\nYou should profoma the project at the outset. Bring the broker in at the very beginning. Before spending all that money on land acquisition and architect fees.\n\nThat ship has sailed. But at this point bring in a broker right now. Before doing anything else. \"Hi Broker Bob, I've got this project. Can you help me run a financial analysis?\" Ask for to stabilization and 5 year horizon to exit.", "replies": [{"id": "hqfvk94", "text": "Understood. \n\nI've sent about 3 hours on this so far. 3.5 including reddit. \n\nThis question applies to the proforma.", "replies": [], "depth": 6}], "depth": 5}], "depth": 4}], "depth": 3}], "depth": 2}], "depth": 1}, {"id": "hqduijl", "text": "I asset manage and service properties with negative DSCR\u2019s. A standard \u201cgood\u201d DSCR is at least 1.10x. Just take that into consideration", "replies": [{"id": "hqf3a12", "text": "Thanks!", "replies": [{"id": "i39jz09", "text": "Most agency loans in good areas are 1.2 to 1.25, generally 1.25 minimum DSCR. Reach out to me and we could analyze the numbers. Your exit value will be largely dependent on NOI and exit cap. I wrote a reverse cap calculation &amp; do math modeling of cash flowing assets for my clients. I\u2019m in So Cal. BTW, with cap rate compression a new build asset in a good area in So Cal would likely be under a 4 cap at this point. I love leverage like you clearly do  and I know markets where 80% LTV is feasible, but not So Cal. On a new build  you\u2019ll likely need to account for high vacancies and long term lease ups to launch the building. This is because rents in class 4 &amp; 5 buildings are high to offset ever increasing development costs. And, unless you\u2019re buying RTI, and I mean true RTI please consider that the entitlement process in Cali can be very costly, very political &amp; open the project to significant holding costs. So, if you\u2019re still in the market, feel free to reach out &amp; we can toss some ideas around! Best, Julie Boyd", "replies": [{"id": "i39mm18", "text": "Hi Julie. I'm not a buyer. I'm a developer.", "replies": [], "depth": 4}], "depth": 3}], "depth": 2}], "depth": 1}, {"id": "hqejrps", "text": "*\"Why would someone buy a property that operates at a loss?\"*\n\nBecause they have excess cash and feel their money would be better served in a hard asset (such as a 28 unit apartment complex), as opposed to a bank, bond or other investment.\n\nBecause they feel the asset value will rise, based on information they possess, and don't care at all about cash flows.\n\nBecause they don't like to sit on their butts and a 28 unit asset possibly could be maintained in house with their current staffing or family members, perhaps even by themselves.\n\nPerhaps because they have other investments that produce income and they need some write offs.\n\nThere are myriad reasons someone would buy an asset that doesn't cash flow...with debt.", "replies": [], "depth": 1}, {"id": "hqemla6", "text": "6% rate is terrible. You should be getting 2.75-3.50% rates at 80% ltv. A 4.5% cap rate is at least 150 bps wide of the market. The asset is either in a terrible sub market or you\u2019re not underwriting it properly.", "replies": [], "depth": 1}, {"id": "hqf4j2r", "text": "Calculate you\u2019re loan payment and divide it by the loan amount. That\u2019s your constant. If this number is higher than your cap rate then you should not buy it unless you are projecting some incremental income", "replies": [], "depth": 1}, {"id": "hqi3nz4", "text": "Run", "replies": [], "depth": 1}, {"id": "i39o21m", "text": "Yes, I understand you\u2019re a builder, and I\u2019ve repped major builders for most of my career. Just trying to help familiarize you with some of the line items that need to be considered so you step into a successful project that a buyer will want to buy. Also, on the DSCR, find out the underwriting guidelines of the lender you\u2019d plan on using, or that a buyer would use upon their purchase/your exit, so you run your operating expenses &amp; reserve requirements &amp; vacancy projections in alignment with real loans. I do this automatically for my clients. Are you using CoStar for market rents? I prepare a full underwriting report on the Submarket so I can use the vacancy factor of the asset class of the subject property. There is no single market rent or market vacancy. Apples &amp; apples. :-) So, it\u2019s been about 3 months since you first wrote about the asset. We\u2019re all curious, having sat with it for a while, what are your current perspectives &amp; constraining factors of the proposed project?", "replies": [{"id": "i39sk86", "text": "The project is a multifamily. Most likely, we're going to build to rent. The structure above is for a contingency plan. Im not very familiar with commercial and wanted feedback in case we want to sell.\n\nI'll pm you at a later point. We have several thousand acres under development. Quite a few of the projects will be commercial.", "replies": [{"id": "i39tk07", "text": "WOW! That\u2019s a lot of ground! Yes, I got that it\u2019s Multifamily. If you\u2019re still early in the planning stage, this would be the ideal time to connect, so you can maximize the value &amp; unit mix! You\u2019ll recognize the names of my developer clients. Just like with you, it all starts with that 1st conversation. Covid has brought so many changes to what tenants are looking for, and It would be great for you to get a leg up, so you can incorporate while it\u2019s still easy to do! \nHave an amazing weekend, talk then!", "replies": [], "depth": 3}], "depth": 2}], "depth": 1}]