BiggerPockets

Hey Everyone. My first major deal has come across my plate and although I've read every book under the sun about buying apartments, it is still a big step. I thought if anyone is up for the challenge, they can let me know if this is a good deal or not.

The apartment is 24 units. A friend of mine bought them new 22 years ago, owned them for around 15 years, paid them off, then sold them will seller financing 7 years ago. He is now foreclosing and will take back these apartments in 3 weeks. We have been discussing this for some time, and now I need to decide. He has offered to sell them to me for 580,000, if I can come in with only 25,000 to pay the back-taxes. This is his retirement, and he wants someone he trusts to buy it. The following is the info we have:

24 units (6 4-plexes surrounding a parking lot); average rent 475 per month = gross rent 11400/month, $136,800 per year.

only 17 units are rented (actual rent: 8075/month, $96,900 per year) . the others cannot be yet, due to their condition. The owner stopped caring for the properties 1 year ago, so when tenants moved out, the units were never prepared for new tenants. The exterior needs paint and some small siding repair (which I can do myself) and the parking lot could use some patch work. One unit is gutted to the studs, but the rest just need carpet,paint, etc. If I got this apartment, I would move in for the first year and spend my time fixing the units up one at a time, getting them rented as I go - hoping to have the whole complex online and running smoothly within one year's time. I expect the cost of materials to fix this place up to be around $30,000. So I will need around $55,000 total invested. I plan on borrowing this from either my parents or a partner (if I can find one).

Using 50% rule, expenses (not counting the cost of getting the vacant units rented) will probably end up running around 5500 per month, or 66000 annually. I did a more detailed analysis of expenses, and came up with about the same amount when I include 8% monthly maintenance, 10% property maintenance, and eventual 8% vacancy rate.

So possible NOI could be about 70,000 - so with a 8.5% cap rate (my guess at average in the area for a nice complex) the value could be $833,000 . However, AS IS, with an 8.5% cap and NOI of 30900 the value would be 364,000.

So I know that "they" say never pay for an apartment based on what it "could be" but rather what it is right now. However, my friend who is selling it to me has offered the following option for the 555,000 mortgage payment: first year $2000 per month, second year $3000 per month, and third year and beyond, 7.75% APR which equals out to about $4000 per month. This way, hopefully some of the repair money can be made from the cashflow the first 2 years.

Also to complicate things, the apartments that are renting for 475 would be able to be raised without much trouble to 525. Rents have not been raised in years and 525 is very much market rent - if the complex had the needed repairs and management in place.

So the big question is: Is it worth paying more than its worth because of the relative easy financing, low down payment, and having a step up mortgage for the first few years?

So, that's the situation. From almost every angle, I like it. But maybe someone else has different perspective. I feel like with only needing $55,000 total invested (none of which is my own money), I can own this apartment which cashflows at every step (according to my calculations). Let me know if I left out any vital information!

Uwe, you have to divide NOI by the cap rate, not multiply.

Brandon, I have not gone through your entire post. It looks like you know what you are doing and I am assuming your numbers are right.

As I see it, your main question is whether to buy based on future potential or current income. My view comes from my experience in other businesses and not necessarily the RE business. Here's what I think:

In a perfect world, you should buy based on current income. But a reasonably smart landlord might not be willing to sell it for that price if he knows how to fix the problem and sell it a year later at a much higher price. And even if he cannot sell it at a higher price, he may believe he can get other people to buy it at something in between the current value and its expected value in a year. So unless he is desperate, it is going to be hard for you to get it at exactly the current value.

I think it is entirely reasonable to pay a higher value than what current cash flows will demand if you know your numbers for repairs, future rents, etc. If you pay something between current and future values, you still have good upside potential.

And with your limited experience and perhaps limited resources, your friend's willingness to give you seller-financing at favorable terms might be exactly the opportunity you need to get started in RE.

Having said all this, I must say that I did not actually calculate with your numbers for NOI, cap rate, etc. I am assuming you have read posts about those things and have calculated right and just want to know whether it is OK to pay more than what the current rent will justify. My answer is that it is OK to pay that extra amount if you know your market, the property and your ability to make it happen.

Uwe, cap rate is given by this formula:

CAP RATE = NOI / COST

therefore

COST = NOI / CAP RATE

It is actually easy to think about this. The higher the cap rate, the higher your returns. This obviously means the higher the cap rate, the lower the price you are paying.

If you multiply by the cap rate, the result will be the opposite.

Hey guys, Thanks for the input.

Uwe - I figured value by taking $70,000 NOI and then dividing by .085, which comes out to 823k; I'm pretty sure that's about right.

Vikram -I kinda feel the same way. This seller would never consider selling for what it actually is worth, because he would rather just do the work himself and sell it for much higher. I just wanted to make sure I wasn't crazy in thinking it might be okay to pay more because of this.

Eddie - I've struggled with this a bit too, but I have 5 units rented right now (mix of duplex and sfh) and it doesn't feel like much of a problem. I work for myself doing handyman work, so I've got a flexible schedule. I also think i'll move in and call myself the "live in maintenance guy" while I'm fixing it up which means I can handle landlording much more hands on but can always defer questions to "I'll talk to the owner". And it could be an adventure. If I decide to proceed, I'll definitely be needing lots of support from bigger pockets. I'll live on these forums :)

Thanks! Anything more I'd love to hear!