Submitted my first letter of intent on Master lease with option
Investor · Chicago, IL · Member since 2013 · 227 posts · 31 votes
Submitted my first letter of intent on Master lease with option
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Landlord and Rehabber · Newton, MA · Member since 2010 · 2k+ posts · 877 votes
12yMaybe I'm reading something wrong but I can't see how this could work.
If the current NOI is really $55,000 then the guy is looking for like a 5.2% Cap in an area you are saying is 12-14%. First crazy thing!
However if you see that great opportunity to get more value out of it and can get the NOI to that projected $108,405 that is a pretty tremendous turnaround, but you still can't really win.
Unless the Cap rates go way down over that timeframe you are still only looking at like 10.3% which gives you negative equity and you will just let the option expire.
Seems like even if you want to roll the dice on getting the NOI up you still need to get him down to like $900K which is where your projected NOI would get you a ~12% Cap. I mean even that is a zero equity position but at least then if Cap rates do come down for some reason you at least have a shot.
Am I missing something?
22 Replies
- Joplin, MO · Member since 2013 · 32 posts · 0 votes12y
Keep updating with progress I'd like to track you to see how it goes. I have something very similar in my pipeline. Any learning experiences you can share from your experience would be great!
- Real Estate Professional · West Palm Beach, FL · Member since 2012 · 23k+ posts · 13k+ votes12y
Sorry, but the "I want to lose actual money to save money on taxes" is delusional. If I lose $100k cash, I save about $30k on income taxes(maybe), which means I Still lose $70k net.
- 12yJean BolgerPro MemberAurora, CO · Member since 2012 · 2k+ posts · 1k+ votes
Congrats! I don't know much about Master leases and will be interested to learn more about this as you go forward. I agree asking price seems high- what are you going to try to get it for?
- Investor · Chicago, IL · Member since 2013 · 227 posts · 31 votes12y
I think its another case of absentee landlordism. The owner is in Australia, and perhaps has just lost interest.
I walk through the property and every unit is in tremendously good shape Just a little dated. But He is basically getting 60% of market rent of each unit.
I've asked the question " WHy not just raise rents to market?" The response was he doesn't want to rock the boat. The tenants are all long term. And are immigrants mostly. From speaking with the property manager it seems like he just has a soft spot for Immigrants.
I don't know. he just seems kind of like a flakey person who got into real estate because the market was down and didnt know how to manage the property or drama that comes with landlording.
- Rental Property Investor · Brookline, MA · Member since 2013 · 1k+ posts · 777 votes12y
@Samson Kay How much money do you expect to make on this deal?
How do you expect to make it? (flip, hold, etc)
- Investor · Chicago, IL · Member since 2013 · 227 posts · 31 votes12y
The majority of my money will come in cash flow I think. I will gross rough 4-5k per month after raising rents to market. The terms would be over 30 months.
Where the market ends up in the next 30 months would determine my exit strategy. One of the following:
- Market rents achieve enough profitability to exceed the 1.05M asking price for a 65% LTV. At which point I will acquire commercial financing and close the deal. And officially take title.
- NOI achieves less than desired but enough to achieve higher than Market value of the property after 30 months. At which point I sell my option to purchase at 1.05M to another investor for a small profit.
- I'm completely wrong and can't achieve the NOI I want. So I allow my option to expire.
- Investor · Sherman Oaks, CA · Member since 2008 · 6k+ posts · 3k+ votes12y
Originally posted by @Samson Kay:
I'm excited. The seller has already stated that he would entertain a Master lease.
After walking down the property and neighborhood I decided that this was the perfect storm for this strategy! A subrenting building (23 units) with room for rent increases. A motivated out of country investor. A Negatively cash flowing building. A building with only minor cosmetics needed on the interior.
Here are some of the numbers:
Current NOI/Projected NOI = 55000/108405
Expenses = 95,648
Asking Price = 1.05 Million
Market Cap Rate for the area = 12-14%
The asking price is really high considering the negative NOI. But I believe that the seller was using the building to report a loss on his more profitable investments. Which is why he decided to keep the rents so low.
Wish me luck!
@ what are the intangibles here?
neighborhood, rent growth, amenities for building,
where is this? Im from boston, ma, I know Lowell, blue collar alot of it. What supports higher rents? Who is your projected new higher paying tenant?
Would you want to live in the building?
- Landlord and Rehabber · Newton, MA · Member since 2010 · 2k+ posts · 877 votes12y
Maybe I'm reading something wrong but I can't see how this could work.
If the current NOI is really $55,000 then the guy is looking for like a 5.2% Cap in an area you are saying is 12-14%. First crazy thing!
However if you see that great opportunity to get more value out of it and can get the NOI to that projected $108,405 that is a pretty tremendous turnaround, but you still can't really win.
Unless the Cap rates go way down over that timeframe you are still only looking at like 10.3% which gives you negative equity and you will just let the option expire.
Seems like even if you want to roll the dice on getting the NOI up you still need to get him down to like $900K which is where your projected NOI would get you a ~12% Cap. I mean even that is a zero equity position but at least then if Cap rates do come down for some reason you at least have a shot.
Am I missing something?
- Real Estate Broker · Canton, GA · Member since 2010 · 15k+ posts · 11k+ votes12y
These techniques are taught generally for investors with little money to try to get into a property.
Owner finance or other options are great but NOT at the expense of a very inflated sales price. You can pay a little above market or market but still need a big spread to be compensated for turning around such a property.
I have been there before it is very easy talking about the theory on here but actually doing it in real life is a whole other reality. You are basically buying a job with the hope that you are getting a bonus at the end of it. If not you gain experience but nothing else monetary. If the cash flow is so low now how will you be compensated for your time while you turn this around??
If an area has 12 to 14 caps then it is a rough area and you are dealing with types of tenants that will come with many, many issues to collect the rent.
I think this is going to be much harder than you think to do. Why not start with a quad instead and rehab it and rent out and create equity?? Gain experience on a small scale with limited risk.
- Investor · Chicago, IL · Member since 2013 · 227 posts · 31 votes12y
The property is in Manchester. I don't really understand the logic from the sellers perspective, but you are right at the existing purchase price and noi, the cap is in the 6% range which is more in line with the 50+ buildings in Manchester. The 12-14% cap is more for 10+ units. Perhaps he is using the lower cap rate number.
I believe Manchester has reached a bottom and has better growth opportunities than closer to our area of Massachusetts. So I figured if the market stabilizes there in the next 3 to 5 years caps may come down to the 8 range.
Even if it doesn't, the monthly cashflow I'm looking to make in the deal is more than enough to make this a deal, if I pick it up with little to no money down on a lease option.
He's literally getting 500 for a 1 bedroom and 600-700 for a 2 bedroom. When it's worth 750 and 900 for a mid quality apartment in that area. All at will.
I'm not saying I think it's worth the 1.05m, but to make 4k extra a month, I don't mind this strategy
- Real Estate Broker · Canton, GA · Member since 2010 · 15k+ posts · 11k+ votes12y
You really need to drill down on the rent discrepancy. Is the area with the higher rents EXACTLY like where your property is located? Is the tenant demographic and work force different?
What amenities are close by for the higher rent location or located at the complex itself.
You have to drill down for external reasons why the rents are where they are at. Upon further examination you might find it has nothing to do with the building but the tenant base and location. You could have found a gem at the right price but you need more research as more often than not it's the opposite case.
- Landlord and Rehabber · Newton, MA · Member since 2010 · 2k+ posts · 877 votes12y
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The property is in Manchester. I don't really understand the logic from the sellers perspective, but you are right at the existing purchase price and noi, the cap is in the 6% range which is more in line with the 50+ buildings in Manchester. The 12-14% cap is more for 10+ units. Perhaps he is using the lower cap rate number.
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Is it normal for that kind of discrepancy in cap rates in a city (It isn't a giant city)? I have not done any commercial but would not have expected a variance like that.
- Investor · Chicago, IL · Member since 2013 · 227 posts · 31 votes12y
Originally posted by @Joel Owens:
You really need to drill down on the rent discrepancy. Is the area with the higher rents EXACTLY like where your property is located? Is the tenant demographic and work force different?
What amenities are close by for the higher rent location or located at the complex itself.
You have to drill down for external reasons why the rents are where they are at. Upon further examination you might find it has nothing to do with the building but the tenant base and location. You could have found a gem at the right price but you need more research as more often than not it's the opposite case.
I would probably verify all this during the "due diligence" phase, but the demographic are low to middleclass immigrants that were placed at the apartment over the past 2 years under the existing managment. Every single tenant is participating in the placement program which puts new immigrants in affordable housing and helps them find some sort of work. Everyone on who currently lives there was either a direct participant in the program or is some how related to someone who currently lives there.
I've spoken with the current property managment company, they recieved strict instructions to keep rents suppressed. Why? The only reason I recieved was what I stated originally, that the owner was using the property to report a loss for tax purposes.
As far as market rents, I use rentometer, and looked at rents in the area which are basically in 1 square block of the building. Honestly every building is getting around 750 for a 1 bedroom and anywhere between 800-900 for a 2. I also confirm these numbers with the existing property manager by asking him what he thought he could get if he were to rent the unit as-is at market rents.
I walk through the units and they're pretty big! Not humugous. But 700-850 sqft per unit. I would say the only downside is that the apartments are dated and gas heat is not seperately metered. But the roof is good, theres off street parking, and onsite laundry. Electrical and water heaters are newer.
- Real Estate Broker · Canton, GA · Member since 2010 · 15k+ posts · 11k+ votes12y
As far as basing it on the number of units that is a very large discrepancy. As for being in a different part of a city that is definitely possible.
In urban core areas changing a few blocks can drastically change even in suburban in a city they can change.
The nicer areas to end to go for lower caps and the tenant base has more stable income in general terms. You really have to study the micro market there to see what is happening and why.
In city parts of Atlanta here in GA you can have a war zone a few blocks away and then a really upscale nice area that Is booming.
- Investor · Chicago, IL · Member since 2013 · 227 posts · 31 votes12y
Originally posted by @Joel Owens:
These techniques are taught generally for investors with little money to try to get into a property.
Owner finance or other options are great but NOT at the expense of a very inflated sales price. You can pay a little above market or market but still need a big spread to be compensated for turning around such a property.
I have been there before it is very easy talking about the theory on here but actually doing it in real life is a whole other reality. You are basically buying a job with the hope that you are getting a bonus at the end of it. If not you gain experience but nothing else monetary. If the cash flow is so low now how will you be compensated for your time while you turn this around??
If an area has 12 to 14 caps then it is a rough area and you are dealing with types of tenants that will come with many, many issues to collect the rent.
I think this is going to be much harder than you think to do. Why not start with a quad instead and rehab it and rent out and create equity?? Gain experience on a small scale with limited risk.
I'm at the point now where I'm basically cash poor. In the past 6 months I've made 4 acquisitions. My biggest being a 6 family building. So for me, the goal was continued growth but with no money, I would have to start turning to an equity partner or wholesaling. Master lease options seemed like a sound strategy.
Appreciate all the comments everyone. Definitely good to get some different perspectives on a deal this big.
- Real Estate Broker · Canton, GA · Member since 2010 · 15k+ posts · 11k+ votes12y
The key to this Samson is how much time will it take away from your other properties and obligations? I just do not look at a return but how hard I have to work for a return.
Example when I first started as an agent years ago I worked on smaller vacant apartment buildings. They were gut jobs with being brick but needing say 12k a door to rehab. After negotiating short sale, water liens, and bank to waive recourse against the seller and meet with government officials etc. the purchase price was 3k a door. So for 4 months of work at 30 doors that is a 90k purchase price and 5,400 in commission. I quickly learned that wasn't worth my time. Conversely spending 3 to 5 months closing out a very large apartment building for a client where the check is 6 figures or higher is.
You do not want to give this seller a personal guarantee, cross -collateralizing your other properties, and want non-recourse. You need to just give it back or walk away if it doesn't turn out as expected. If the seller wants an over-inflated price and security just walk away.
Growing units is good as long as works overall. I had clients years ago that owned 224 units total over 11 buildings. Some they bought well and some they overpaid for at the height of the market. The largest was a 60 unit and some 20's and 30's with smaller ones mixed in. They were spread out in a suburban town about 2 miles in a circle.
The good properties ended up supporting the bad ones that were bleeding cash. We call this portfolio averaging your returns and expenses. You do not want a bad purchase making the portfolio overall go to a cash neutral or losing position or consuming all of your time. One bad property can undo all the good choices that have been made over the years in a heartbeat. They ended up shorting the 60 unit that was draining them dry. They have less units today but are still doing okay.
Bigger is only better when you can buy right and have the resources and structure in place to handle it effectively.
- Rental Property Investor · Brookline, MA · Member since 2013 · 1k+ posts · 777 votes12y
What am I missing about this deal. Cap rates aside:
I see $9033/month in projected income via rent.
I see $7970/month in expenses.
That leaves $1063/month for P&I and profit. I don't see any money in this deal. Certainly not 4-5k/month in your pocket. I take it the NOI is projected to be much higher than 108k/year, correct?
Are you going to work to drive down expenses by quite a bit? If so, how.
- Lender · Tyngsboro, MA · Member since 2009 · 3k+ posts · 2k+ votes12y
Samson, I see a few discrepancies that I'd like clarification on.
First, I don't know of any area of Manchester where market rent is 750 for a 1BR and 800-900 for a 2 BR, and they are selling for a 12-14 cap. A friend with a 12 unit is getting 500 for a 1BR and 650 for a 2BR, probably not in your area, but my point is, her neighborhood is marginal and she is getting low rents. If you are getting (or can get) higher rents, the neighborhood should be a good one, and you won't be getting a 12-14 cap in Manchester in this lifetime in a good neighborhood.
If you're using proforma numbers to calculate cap, then don't. That's pie in the sky.
Third, it seems like you might have some numbers missing from your expenses if you are seeing a 12-14 cap. Lots of people advertise NOI and cap rates that seem very attractive, but leave out things like maintenance costs, water bills, etc.
Fourth, rentometer pulls data from advertisements, it doesn't mean those are always actual rents.
Fifth, you are saying it has a negative NOI, which I assume means you are taking the NOI of 55,000 and deducting the expenses of 95,645. NOI by definition is gross rents minus vacancy minus operating expenses, so I'm wondering if your NOI figure of $55,000 is actually gross actual rents. Is that the case?
Maybe I'm misinterpreting your information.
- Investor · Chicago, IL · Member since 2013 · 227 posts · 31 votes12y
My Comments to your post below.
Originally posted by @Ann Bellamy:
Samson, I see a few discrepancies that I'd like clarification on."First, I don't know of any area of Manchester where market rent is 750 for a 1BR and 800-900 for a 2 BR, and they are selling for a 12-14 cap. A friend with a 12 unit is getting 500 for a 1BR and 650 for a 2BR, probably not in your area, but my point is, her neighborhood is marginal and she is getting low rents. If you are getting (or can get) higher rents, the neighborhood should be a good one, and you won't be getting a 12-14 cap in Manchester in this lifetime in a good neighborhood.
If you're using proforma numbers to calculate cap, then don't. That's pie in the sky."
***I asked an appraiser familiar with the area who specializes in Multiplexes for hes thoughts on area market caps. He told me 12-14%. Based on the available info I was able to dig up on 6+ unit multi pricing and reported NOI seem to confirm this number. I don't know if these numbers hold true or not when you start clearing 10+ units. But I know many of the Multiplexes in the 30+ range are getting much lower caps based on there asking price and their reported NOI. Again all numbers I'd confirm at the due diligence phase.
Third, it seems like you might have some numbers missing from your expenses if you are seeing a 12-14 cap. Lots of people advertise NOI and cap rates that seem very attractive, but leave out things like maintenance costs, water bills, etc.
***I have a detailed operating expense report from the seller over the past 2 years which includes all cost related to maintenance, property management, and cleaning, reserves, etc. which averages around 95k year over year. I guess I should have clarified my initial post. 12-14% is what was reported to me as what the cap rate for the area is. Its NOT what they are currently getting. Realistically I wouldn't expect anything more than 10% for a personal cap rate.
Based on the my Project NOI of 117000 and 10% cap, The estimated value is going to be in 1.17 Million.
Fourth, rentometer pulls data from advertisements, it doesn't mean those are always actual rents.
***This may be true for this area, but I've had pretty good success renting based on the rentometer price in Lowell. I also used this service called www.reisreports.com to further verify rents in the area compared to other buildings which also seemed to confirm my assumptions. It was my first time using the service, so I'm not sure how good or accurate it is. It will take some experience but I'm fairly confident that the existing rents are out of sync with the local market even if I am off by +/-$100.
Fifth, you are saying it has a negative NOI, which I assume means you are taking the NOI of 55,000 and deducting the expenses of 95,645. NOI by definition is gross rents minus vacancy minus operating expenses, so I'm wondering if your NOI figure of $55,000 is actually gross actual rents. Is that the case?
***I guess negative NOI is inaccurate. What I mean to say is that the existing NOI barely makes enough to cover his debt service which is around 4500 per month. Factoring in the vacancies hes had for the past 2 years he has been negatively cashflowing. Gross rents at there current rent price is 150K.
If rentometer is accurate, and I hope it is, Gross rents can potentially be increased to 225-235K fully rented. I assume as we scale up the quality of the place the existing expense will go up.
Maybe I'm misinterpreting your information.
***Yeah I didn't expect some many people to scrutinize my numbers. I originally wrote this post because I was excited to even be at the table. This is great though since it served as a sanity check. But I'll take care to more carefully detail my posts in the future.
@Ann Bellamy undefined
- Investor · Raleigh, NC · Member since 2013 · 40 posts · 2 votes12y
@Samson Kay - just reading through this post and wondered if you went through with this deal and if so how things are going?....
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