Priced the two halves separately, which is what got it funded

Closed a 14 over 3 in a mid-size midwest city last month. 14 apartments, 6,200 square feet of ground floor split into three bays, one of them dark at contract.

The listing was marketed at a 6.9 blended cap on in-place income, which I think is a lazy way to price these. I underwrote the residential and the commercial as two separate income streams and then added them back. Residential: 14 units, $1,050 average, $176k gross, 7 percent vacancy and credit loss, $78k of operating expense against it. Retail: 4,800 leased square feet at $14 modified gross with a partial recovery, 1,400 vacant, and I carried the vacant bay at zero for 14 months plus $22 a foot of TI and free rent on the re-lease. Combined NOI to me was $144k. I paid $1.95m.

The part that nearly killed it was the appraisal. The appraiser ran one blended cap across the whole building and came in $80k under contract, because his comps were suburban strip and my retail is a walkable neighborhood block where the leased bays are a barber and a small grocer. We got a second review with the residential and commercial income schedules broken out and it came in $15k over.

The whole thing depends on one assumption: that I recover about 60 percent of the ground floor operating expense from the retail leases as written. If that number is really 30, my NOI is $135k and the debt sizing changes. I read all three leases before I put a number on paper and I would keep that step over anything else I did.

Answer

1angela_burkeServicePRO6

The $78k of residential operating expense is where I would push. On a 14 unit with three commercial bays, my crews spend more time on the ground floor than the unit count suggests. The grocer generates trash volume that a 14 unit residential building never would, and if your dumpster is shared and your leases only recover a flat CAM stub, you eat the overage every month. We bill one owner separately for commercial pulls now because the first year we did not, and it was about $4,100 out of pocket.

Also ask who is responsible for the ground floor HVAC units. On the buildings I service, the retail rooftop packages are the single largest unbudgeted line, and half the leases I read put replacement on the landlord even where the tenant maintains. If your 60 percent recovery number holds and the roof units are tenant responsibility, your $144k is real. If either one moves, you are at $130k and your coverage is a different conversation.

4 replies

1stephen_ok9CO2CPRO6

The separate-cap approach makes sense to me on the way in. What I keep getting stuck on is the exit. If the buyer behind you is a residential buyer with a blended cap in his head, you built value the market may not pay you for. Did you underwrite an exit on component caps or did you haircut yourself back to a blended number for the sale?

1jordan_ellis2ActivePRO6

Carrying the dark bay at zero for 14 months is the part I would never have had the nerve to write down.

3sonia_alvarez Get yoursPRO6

The appraisal fight is the one I see most often on these. Lenders differ a lot on how much commercial income they will tolerate before the file stops being a residential product and becomes a commercial one, and some size the loan off the whole NOI while others discount the retail portion. Ask your lender in writing, before you order anything, how they treat the ground floor income and whether they want a residential appraiser or a commercial one on it. Getting that answer after the report is written is expensive. Did yours tell you up front or did you find out at review?