Low Profit Margin on Multi-Unit Properties?

7 Replies

I've been an investor in SFR exclusively, but this past summer, tried to enter the multi dwelling unit market. For each multi family I looked at, whether in a nice tree lined neighborhood in the suburb, or in the city, there was a common theme, whether it was a duplex or an 7 or 8 plex. Each property had massively deferred maintenance. I found in each case, care for things like roof, soffets, exterior decking, interior closet doors, walls, AC units, window rot, long expired heating units, etc, were in generally beat up and run down condition. The best one was a duplex with a big electrical problem. I live in the Minneapolis/St. Paul area, by the way.

What I wonder is, why do owners defer all maintenance on these properties if the cash flow is so good?  Is there a rent compression problem in the Twin Cities?  Are the rents are too low across all units to create needed cap ex or cap imp funds to continually maintain a property?  I just got a 7 plex under contract, and to the naked eye, it looked way better than all the other multi's I saw.  Then my inspector went through it, and my cap ex in acquisition began to expand beyond my ability.  I had to cancel the contract, because the cap ex for deferred maintenance was off the charts.

I am adjusting my strategy on multi's to assume a large cap ex going forward, so I am learning, but I wonder if SFR is just better, because owners tend to maintain their properties way better than investors.

Hey David,

Just wondering, what kind of percentage have you used and what are you upping it to now? I've looked at Multi's in the south metro and have seen a lot of deferred maintenance even on the surface level. I've also seen a lot of SFR that fall into the deferred maintenance category as well. It seems anything (MF or SF) that's well maintained is going to cost enough to destroy my cash flow margins with financing payments. I guess it's you get what you pay for.

My strategy is to buy the building right, to create a cash flow that supports a 5% ongoing YOY maintenance, hopefully with only a 5% vacancy.  I find cap ex is something of a challenge.  I thought I was good at it, until I tried to purchase the 7 unit in St. Paul.  My commercial inspector showed me I have much to learn.  

I'm always looking for a 10 cap, even if the asking price is too high.  I'm looking for minimal initial cap ex, but  I just haven't found it yet.  I keep finding 4, 5 and more units that have interiors with kitchens and bathrooms from the 50's, carpets and walls all beat up, fire exists clogged with stuff, soffets and windows rotting, AC units beat up.  My cash is too limited or I am too inexperienced to know how to buy a building and get financing with a big repair bills factored in.  But I wonder if multi's in general just make no sense in the metro.  Why do owners let these buildings get so beat up and run down?  Is there no money in it?

David,

Always seems the case.  It is difficult to buy a decent apartment property at a true 10 cap.  I find that either capex has been ignored or they are fudging the numbers.  Just my perspective.

Mark

@David Moore

Your observations may speak more about the owners of those properties and why they are now choosing to dispose of them than about the possible cash flow with a well run multi-unit property.  I see just as many "student houses" (single unit, duplex, triplex) now sitting vacant and for sale due to accumulation of years of deferred maintenance.   There are "poor" landlords and slumlords in all sizes of properties.

That said, in our experience, there is the no-mans-land of small multi-unit properties (5 - 20 units, say) where financing will be commercial and, if not a converted house, the property will have the commercial systems one expects to find in larger buildings (fire alarm and suppression, security doors, common boiler, common laundry, etc).  Couple that with the current looniness of money in many multi-unit markets and you will be looking at single digit cash flow returns.

We are not big enough to hunt the 50 - 100 unit properties (there are very few in our area), but are finding you really need to buy right to make the smaller properties work.

I think one thing investors do, especially in "poorer" communities is to buy multis, rent them out to the lowest common denominator, do as little as possible, then sell the buildings for peanuts at the end of 20-30 years. They end up making more money than any of us (exaggerating) but don't contribute much to the well-being of the community. 

Also, when I started buying in 2009, alot of landlords went out of business because they'd bought near the top 3-4 years prior. We were paying 20-25k per unit for buildings that were purchased for 40k per unit 5 years earlier. This might also explain what you're seeing. 

We encountered this and simply bought the distressed buildings at super low rates. we factored in what we would need to spend to bring the buildings up to our standard and wouldn't pay one cent more. We then followed through, brought them up, and now 6 years later, we are very fortunate to have units that are near the top of the "desirability list" for our area. It's alot of work, but it feels good!

Originally posted by @Kenneth LaVoie :

Also, when I started buying in 2009, alot of landlords went out of business because they'd bought near the top 3-4 years prior. We were paying 20-25k per unit for buildings that were purchased for 40k per unit 5 years earlier. This might also explain what you're seeing. 

 Kenneth:

What a difference a 4-hour drive up the 95 makes.  Here if you paid 40K /unit, you would be giddy.   Folks have been buying multies at 75 - 100K /unit ... absolute craziness.

I think it's all in your strategy and what you do with the property.  We use a 10 cap on everything we are buying....but it's our use that gets us there.  If you take a multi-fam and turn it into shared housing, you max income and minimize vacancy.  The higher rents will allow you to fix the places up to your standards.  All we do today is multi-family and are now hunting smaller apartments in metro atlanta for that same purpose.  Most everything we see has deferred maintenance and it's really the mindset of most investors to just suck the property for max income. We have really nice units in higher end properties and lower end stuff.....our lower end stuff is more profitable.  

Most owners we buy from have rarely if ever, walked the property on a regular basis....doing so would catch a ton of repairs while they were still cheap.  We walk ours every quarter to catch the little stuff.