What rules of thumb do you use to buy apartments and why?

Question

Hey guys,

I'm reviewing apartment complexes left and right looking to pick up my first one in the next 60-90 days and was curious to know what rules of thumb other folks on BP use to filter properties effectively?

Any input is appreciated - thanks!

Joel Owens · Answer

Tony the 50% mark is simply a quick screening tool.

When you have a candidate you perform a much more intense due diligence looking at tons of different factors.

Example if you buy at a current 10 CAP going in but you didn't estimate a proper  increase in utilities,underestimated improvements needed and deferred maintenance,and didn't count on renewal lease rental rates dropping or counted on rising to equal a certain return.

In that instance what looked like a 10% cap going in is now a 7 to 8% for a B to C product for the next few years.If you have a 2 to 3 year exit planned you have really hurt yourself.

As a big apartment investor put it bluntly to me one time.

"I buy at a 12 CAP because if I hit problems I still have a ten but if I buy at 10 then I could have an 8 with expenses crushing my cash flow"

Also do the tenants pay on time or not pay at all?? What is the vacancy rate as well as the turnover rate??

Is occupancy increasing,decreasing,or staying the same over time?? Are rents increasing or decreasing and do they include utilities the landlord pays??

What kind of specials have been given to drive occupancy that the landlord trying to sell is hiding?? Example low to zero security deposits,unfavorable leases to land a tenant,rent concessions etc.

The seller is selling for a reason and there is usually  a problem attached.That is fine you just need to know the true story so you don't overpay going in.

Joel Owens · Answer

Tony there are general factors to consider and specialized ones.

What SIZE of apartment complexes are you talking about??

Are you going after Class B or C that is fully stabilized or are you going after B or C that is distressed with a value add component??

How would you finance the deal??

-Hard Money
-conventional  bank with 20 to 25% down of your own cash
-Part of an investor group purchasing
-asking the seller to hold back a second

All of these things will factor in to the viability of a deal.

As a fast guideline I do this.Most B and C stuff I calculate as an exit of a 10 CAP.

Might be able to resale at a lower CAP if the market improves  but I play it safe with margins.

Example:

100 unit at 50% occupancy. Rent all 2 beds at 700 a week.

700 X 50 = 35,000 month X 12= 420,000 gross income

420k divided by 2 = 210,000 NOI

50% costs is
5% property management
15% vacancy loss turnover
30% operating and expenses

So based on the quick formula buying at a 10CAP going in the most I could pay is 2,100,000.

Now this doesn't look at deferred CAPEX and a bunch of other items.This is a down and dirty 10 second calculation I do in my head to see if it's a possible or not to look into further.

You have to really know the markets.Example current income is based off of 700 with many leases fixing to expire.A current investigation of the market shows competitor rents have decreased from 8 months ago and are now  675 a month.

To retain many of the tenants on renewal all things being equal your rent rates will most likely go down along with cash flow.

I could go on and on but this is how I do my quick calculation.

Bryan Hancock · Answer

I don't use rules of thumb to buy apartments.  I use rules of thumb to SCREEN apartment deals and then I use actual data to bid on them.  The 50% rule is good for the former activity, not the latter.

Jon Holdman · Answer

Assume that vacancy plus expenses plus capital will work out to about 50% of the gross scheduled rents, at best.  If the seller if showing these items at 30% of gross scheduled rents, you know something is being left out.  In general, you should just assume that whatever the listing agent or seller gives you for vacancy, expenses, and capital is understated.

If rents are around $500, you can't pay more than about $25K for the unit plus rehab.  If rents are up around $1000, you can pay more like $70K (sorry, gotta run, not exactly the correct number).

Shayne F. · Answer

When reviewing the financial data make certain to figure out if Units are individually metered or billed.

Bryan Hancock · Answer

The 50% rule of thumb is based on AVERAGES and thus it doesn't work in all scenarios.  I don't want to start another thread where we all argue about this incessantly.  Look back through the forums.  There are probably 10 or so threads about this already with very strong opinions on either side.

Our LOI asks for a ton of due diligence items so that we can see ACTUAL operations data and bid based on that.  Some of the old BP threads cite national surveys where expense data is categorized.  This is a nice sanity check for you and it will help to account for ALL expenses instead of the few that folks normally account for.  Use that as a guide, but don't scrap the real data in favor of some arbitrary "rule" when you are figuring out what to pay for the cash flow stream.

You should also realize that the data supplied by the seller isn't always accurate and you will need to make adjustments to it.

Tony Nguyen · Answer

Bryan - good thing to point that out! I would prefer to use rules of thumb to SCREEN apt deals as well. What do you mean about 50% rule for the fomer activity and not the latter?

Jeffrey K. · Answer

Most people agree with that.  In big buildings you often pay for some of the utilities.  You will be running closer to 55% in a large building.

Tony Nguyen · Answer

it would be a B/C property btw...

Tony Nguyen · Answer

Joel and Jon - do you guys both agree that when analyzing, I should always calculate 50% towards operating expense and then whatever is left of that, I take away for debt service = cash flow?

What rules of thumb do you use to buy apartments and why?

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