My fellow BP'ers,
I am running into a reoccurring issue lately. For a little background, I am located in the Cincinnati, Ohio market. I am looking for a 2+ multifamily property, the amount of units does not really matter to me, as long as the numbers work and it is in my target area (C to C+ area). I have now sourced 5 off market properties from different owners and have ran into the same issue. On 2-4 unit properties, they want a purchase price that typically results in zero to negative cash flow, and typically the comps in my area are showing a value above where anything makes sense at market rents, based on what sellers expect to sell for. I understand the sellers position somewhat on these 2-4 unit properties, because if others have overpaid and set the market values above what makes sense to buy at, they are hoping for another seller to come along to make the same mistake on their property, and they have the comps to support their position.
However, I am running into the exact same issue on commercial properties, 5+ units. The past two deals I have worked on, the owners set an arbitrary asking price. I run all the numbers, income-minus expenses divided by cap rate = current market value right? Often times the actual valuation is 25-40% lower than their asking price. If someone paid their asking price with standard financing they would be losing money. When you demonstrate why your offer price is what it is, they get offended and say they would never sell for anywhere close to that price. Of course, my valuation is based purely on the financials they are providing. Even when I factor in value add opportunities by renovating units, raising rents, reducing expenses, it still would not make any sense at their asking price.
Is this something everyone is dealing with? Am I approaching these sellers in the wrong manner? Has everyone just lost their mind and we will not be able to buy anything until the market crashes? I am honestly just trying to put myself in their position, and if I understood how real estate math works, and I knew anyone buying at this price would lose money every month, how could I possibly think I would sell the property at this price? Additionally, this particular sub market has very little to no appreciation, so it is not like someone can buy these at zero or negative cash flow and make 10% in appreciation every year.
I would love to hear any suggestions, or from others who have dealt with the same situation.
I have been noticing that a lot myself. Out if state investors are getting into bidding wars for properties and owners are taking notice. I bought a 4 family in 2016 and the one right next door with very similar configuration sold this year for 27% more than I paid!
I have seen multi family building that normally sit for 60+ days on the market now sell within a couple of days.
For the time being it is the new normal in Cincinnati. You might have better luck finding reasonably priced off market deals or buildings in need of work.
Some bigger investors that I know are stock piling cash and have been suggesting others do the same.
2018 may seem some changes in the market.
Welcome to real estate market cycles. We are on an upswing (some say at the top).
Here are a few things that you should know.
1) Your numbers are your numbers. You have a business plan (or should) that defines your parameters under which you will purchase. You find properties that fit that model. Anything outside of that model is a non-purchase. This is what folks mean when they look at the deal funnel, and say it takes 1000 leads to give me 100 properties to look at, which gives me 10 to offer on and 1 to buy. You can adjust your model, but always keep profit as your goal.
2) 1-4's are financed via conventional loans, based on market comps, NOT cashflow. I have yet to meet a single family that cashflows properly. Forced appreciation can work, but if you figure 10% vacancy, 10% CAPX, 10% property management, it's a tough go. 2's can work, but again, they are usually bid up to the point where they don't. Typically, 1's &2's aren't held by investors, but investor wannabes. 3's and 4's tend to cash flow better, since your buyer pool is slightly smaller and more business savvy, but depending on location they might be bid up as well, since the financing is easy.
3) 5+ units are commercial financed. Right now, there is so much money in the system, and interest rates are so low, that to have a 5 or 6 cap is great if you have (or can get) a bunch of cash. Heck, if you are making 1% (1 cap) in the bank, property at 2-3 cap sounds great. If you have a cap rate that approaches the "real" or "average" risk adjusted rate, then you won't be competitive in the market. Junk bonds are only paying 5% or so... FOR JUNK BONDS! The risk has been removed from the system by the government QE programs, and nobody wants that party to end (Actually, I would like to see it end, and it should have never started IMHO). But it will have to end, or we will go the way of Japan, stagnation and deflation, with overpriced assets (i.e. all risk removed from the market) propped up by the central bank. A risk-less market ain't good for anyone.
4) If your one trick pony is not doing it's trick, find another horse to ride, but keep training the pony. Right now, you are focused on MFR rentals. That trick pony is about tricked out. Find another horse to ride; Fix/Flip, wholesale, Air BnB, new construction, affordable housing, or something else. You need to learn how to make those horses do their tricks. Another analogy: right now you have a hammer, and you can't find a nail to save your life. Go figure out how to use a screwdriver, and go find some screws to turn. No screws? Get a drill, and go drill some holes. No holes that need drilling? Get a saw and cut something. You get the point.
You aren't insane. What you are seeing is normal for the market we are in. Could you use some polish on your approach? Yep, we all can. Get better at what you are doing, and find some different things to do, it will come.
Also, you aren't putting yourself in the sellers shoes, you are putting your shoes on the seller. You are approaching an "irrational" market where "anything goes" in a very logical, rational (and correct, I would submit) way. If a seller can ask for and get a 3 cap, a seller will ask for 2.5 cap (and probably get it.) Stick to your model, modify as needed, and see if you can find another way to make some cash in this market.
Hope that helps,
Joseph, you are finding what every other multifamily investor in America is finding. The commercial MF market is overheated and good luck finding one that is distressed. Our firm was in best and final and eventually ended up the brides maid on 3 large deals in the past year because we hit the ceiling on what we believed was a reasonable price based on the numbers. We could not sleep at night if we overpaid using our investors $$.
One thing you can do, and you may have already thought about this, is focus on properties that have either significant management, value-add, or utility opportunities. We recently acquired a 125 unit townhome complex in Lexington, KY and did so because the prior owners were upside down on utility costs by $80k per year. We are in the process of individually metering the entire complex and will switch to tenants shouldering that burden upon renewals. When fully implemented the utility costs added back to our bottom line creates $1.33 million in "added" value ($80k/6 CAP) . We also found other inefficiencies and missed opportunities which will add to the bottom line.
We bought our asset in the upper 5 CAP range, which is low compared to other properties in that market, but it will work out to a mid 6 CAP or better range, once the inefficiencies are fully corrected. I talk about the price buffering effect of value-add and management inefficiencies in my book. I agree with James, dont get caught up with the dumb money guys and overbid on properties. Stick to your model and be willing to look under every rock for a gem!
Great question Joseph and thanks for responding Paul and James.
These are some EXCELLENT comments by @James C. and should eliminate any anxiety in the process for you, no better advice here – Your numbers have to be the guide you use!!
I would say that Cincinnati has always had a very strong local Real estate interest which is increasing with out of state investors – it’s on the circuit for many seminars and events (Great Wolf Lodge last November) and has Vena Jones Cox on WMKV and the OREIA organization etc. etc. And of course I would agree this is now an irrational market as @Brian Robbins mentions.
However I suggest you stick to your plan, the best success I had there were in the outlying areas where prices remained unaffected by what happens in Greater Cincinnati (inside the 275 loop). Try place like Clermont, Brown and Highland counties - Eastside. You could make a whole business in smaller locations places like Hillsboro, Wilmington etc. where there is value, less regulation, less investors, greater community, where word of mouth will work for your next and then next deal.
Hope this Helps & Good Luck @Joseph Cornwell .
I appreciate all of your feedback.
I do understand completely that the comps dictate the market value on the 2-4 family properties, not how the numbers work for me and what would make sense to purchase the property at. I am just saying that if I were a seller, I would fully understand what the market rents are, and I would know that if anyone did buy at my asking price with any financing, they would be losing money each month in negative cash flow. Therefore, I do not understand how most sellers expect anyone to buy with financing at these prices.
As for the commercial properties, in my current negotiation, the seller is asking around 260k, and the current market value is 182k. Hopefully, I can explain to him that if he wants to kick out every tenant, renovate each unit for approximately 5k+, raise the rents $200 per door, and then try to sell it for around 260k it would be closer to the market value. Because that is exactly what I would have to do for the value add component, and for the deal to cash flow. Which would take 12-24 months to complete.
I will keep on working each lead I can, but yes as you all stated, I am sticking to my numbers, and I will not buy a bad deal. I would rather just stock pile cash until we crash.
This is typical in my area as well, for multi family. It is considerably more competitive for multi family than for SFR’s.
I guess my advice would be to try and pivot to where there is less competition - multis that need a ton of work, or SFRs. Or both - SFRs that need a ton of work.
Or maybe try B class if everyone else is going after C’s. Or vice versa. (You probably don’t want to drop down to D’s)
Less competition = better deals = higher yield
@Joseph Cornwell from a sellers perspective they don’t really care about buyers financials and whether it makes sense or not. They care about getting the most money out of the sale and with so many chasing the same deals it is easy for them to do that. If people are willing to pay then they will sell at the higher prices.
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