How not to overpay for a value add multi

Question

I've heard time and time again that value add multi-families are one of the best vehicles to build wealth. Look for properties with tired landlords who are losing money if possible.

How are you valuing a property with negative NOI and what do you consider a "deep" discount? What criteria do you use to determine if you are overpaying or not?

Ivan Barratt · Answer

(ARV x .65) - repair costs, holding costs, etc = Max Offer

Started my career with this formula and if you can stay disciplined enough not to violate it there's plenty of readily available capital to borrow.

Go get it dawg!

Brian Garrett · Answer

@Ivan Barratt Curious why 65% instead of the typical 70% rule commonly discussed here? I can't even find deals in my area that I can be all-in on for under 70-75% ARV so there's no way I'd ever find something at 65% at least in my market.

John Warren · Answer

@Ken Domond this is definitely a challenge as most of the value add apartments I look at now have literally hundreds of thousands of dollars in deferred maintenance, and are being sold at a 4 or 5 cap. I am actually buying a 19 unit value add deal in Berwyn, IL now, and it will need a substantial renovation. The deal looked interesting from the surface, but has gotten better the further into it I have gone. Sometimes it is like pealing the layer off an onion with these types of deals. On the surface, these deals just wouldn't look that attractive.

I would join some local REIA groups and get to know other people in the apartment space so you can start understanding the local market and dynamics. It is nice to network and get mentoring from folks who have owned apartments in your target area for decades, not years.

Keith Weigand · Answer

@Ivan Barratt is great advice. I do same thing. Be creative and you can find ways to increase the income.

John Warren · Answer

@Ken D. I wouldn't take a mediocre deal. Even if you pass on solid deals because of inexperience, as long as you are analyzing them and walking them you will eventually get the experience to know what you are doing.

Keep in mind that the 4-5 cap dogs are being purchased by operators like me who are expecting to drive the cap rate to a 10-12 cap within the first year. That kind of gain comes with a cost though. You need capital up front (not from cash flow) and you need to know how to run the construction and management as you turn the asset around. Its not rocket science, but it does take a certain type of person to be able deal with evictions, leaky pipes and roaches all the time!

Ken D. · Answer

This is an interesting distinction. I'll have to think about how the two categories affect my investment strategy. These also don't have to be mutually exclusive which I'm sure complicated valuations and analyses. And to my earlier comment about experience, quantifying higher returns to offset the risks is where I'm struggling. I suppose no one said it'd be easy. (note to other new investors that come across this thread).

Ken D. · Answer

I am in total agreement on the experience comment. I am painfully aware of my inexperience right now in a property I have under contract. It is difficult for me to gauge how accurate my assumptions are and lack other data points to make quick decisions. If the market is able to support the sale of 4-5 cap dogs and time is limited for digging deeper, since experience is what I need what would you recommend? Purchase anyway and learn from a mediocre deal (not loosing money of course)? The alternative is finding a partner who can bring experience to the table, but it sounds like everyone is having trouble finding great deals these days.

Ken D. · Answer

@Ivan Barratt and @Brian Garrett thank you for this rule of thumb. This helps me a large amount in figuring out at least a reference point to work from as I figure things out. I hope others find this post and are able to use this info as well.

Ken D. · Answer

Are you moving on these 4-5 caps? Interesting that you're finding deals that turn out better than listed. Many of the properties I've looked at in my market of interest are largely listed at higher caps than they actually are. I am actually in contract for one right now that I thought was an 8 Cap and turns out will likely be a 5 cap after renovations and stabilization. Full disclosure, it's one of the motivation behind this post.

I should attend a local REIA meeting. The reason I haven't so far is I'm inviting OOS and wasn't sure how productive it'd be. But I guess if I don't go I won't know. Thanks for the tips.

Mike Dymski · Answer

These are "opportunistic" rather than "value add" real estate investments.  Value add investments typically have in-place cash flow and that cash flow can be increased over time by re-positioning the property and through operational improvements.  Opportunistic investments typically do not have in-place positive cash flow, need a lot of rehab, are higher risk, are financed differently, and typically command a higher return to offset that risk.

How not to overpay for a value add multi

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