Rental Property Investor · Houston, TX · Member since 2018 · 106 posts · 56 votes
Hi all,
I am in due diligence state for this deal (seller financing). The seller is an old guy who manages the property himself and does not use any software. He even mixed with personal bank account with all rent deposits.
In the process of verifying rents, we requested last 1 year cash flow (bank statements). He said he doesn't want to go through trouble of inking all the personal transactions but to provide last 4 months. He said he will provide lease audit & P&L statement YTD. The property has 40% tenants (mtm), 20% very long term (more than 20 years).
Do you think it is norm and enough to do financial due diligence for this property? If it were bank financing deal, what would bank request?
Yes, you should always do due diligence commensurate with the risk you are taking on the property.
The bank probably wouldn't lend on a deal like this and the Seller knows it. Ask your attorney to review leases, vendor agreements, age of major appliances, budget for capex, cap rate, do you have individual meters?
Yes, you should always do due diligence commensurate with the risk you are taking on the property.
The bank probably wouldn't lend on a deal like this and the Seller knows it. Ask your attorney to review leases, vendor agreements, age of major appliances, budget for capex, cap rate, do you have individual meters?
@Ronald Rohde Seller is really pushing back on providing more than 4 months. He has provided all the leases, deposits, vendor agreements and capex on every items. Just not rent deposits on cash flow source for more than 1 year.
Individual meters on electricity, water is paid by landlords and seller provided all the bills statements.
Risk vs. Reward. Does the potential reward justify the risk?
Since it's owner financing, you don't need to worry about satisfying the lender with 2 years' worth of financials, but you need to have a good feeling you can still make money.
I'd say that if your VERY conservative estimates still net a healthy return, then proceed. Basically, you need to do a lot of legwork, and inspect EVERY unit with a fine-tooth comb, including current leases and tenants. Normal due-diligence stuff, but bring along contractors, property managers, etc, just like if you were starting from scratch. His lack of record keeping doesn't kill the deal, it just leaves more work on your end to find out if the deal is worth it. That comes at a premium, and should be reflected in the price of the deal, with a heavy discount to you for doing all the legwork that he neglected.
4 months of financials leads me to believe he juiced up the rent, I would not rely on any of the month to month tenants. underwrite long terms income only.
Also check the rents with comps to see if they are correct..or too high or low. You can use Rentometer.com to check comps for free. I suggest you do this and if you find a problem with them being too high for the area and condition of the property then I would walk...There are many red flags here.
20 units for $3MM in Houston? I assume that's inside the loop? a bit pricey for Houston market. what's the cap rate? I hope you have value add opportunities in it
it's a tricky situation. On one side, there's possibility that seller may have manipulate the rent/leases for recent months to support higher sale price and insisting only have 4 months to supply (not unlikely but much more difficult to manipulate a full 2 years of record than just 4 months). On the other side, seller may be telling the truth that he's just simply not a sophisticated owner and he simply don't have longer period of record to provide. I'd suggest try to validate those info in a different way by conducting marketing research of comparable rent, asking the tenant directly how much they're paying, etc. In the end, you'll have to make decision based on whether you feel like the seller is lying and hiding something or if he may be telling the truth (subjectively so no guarantee if you made the right decision or not). If the rent comparable supports it, I wouldn't worry too much about those month to month. Worst case you can replace them with 1 year lease new tenant with current market rent, just make sure you factor those turnover cost in your budget.
@Brandon Yuan It's in the middle of Montrose and rent comps are lower than the market given that there are so many long term tenants. Current cap is 6.5% with value add potentials.
Thawda don't forget an important step I see most investors make, not doing a cost segregation on the property to maximize the tax benefits and deductions. I can do a preliminary evaluation for you for free once you purchase so you can see how the deductions are accelerated. If you are going to go in and update, I can show you how to classify the improvements to get the most deductions. Montrose is a good area.
@Account Closed We usually use the 80/20 (80% building 20% land) rule but here it is flipped, yes I believe I would make sense but the preliminary evaluation will tell us that. Second question: We use your depreciation schedule on your tax returns but if you just purchased within the year and you do not have one then your CPA will give you a cost basis for us to go by. It takes roughly 48 hours to get the preliminary evaluation and it is usually 10-30% under what a full study would see in savings.
@Account Closed A bit more clarification on cost segregation for this property.
1. Cost segregation is based on the actual cost basis. If the assessed land value is $1.5mm and the building value is $350K your building value ratio is approximately 18.9% of total value ($350K /$1.85mm) A $3mm purchase price raises your building cost basis up from $350K assessed to $567,567 actual. Even though the land value is extremely high, there should be enough assets in $567K to make the cost segregation more than worth your while.
2. As shown above you use a ratio between the assessed values and the purchase price to figure the actual cost basis. Your CPA will generally put together a depreciation schedule showing this prior to filing taxes for the year of acquisition. Cost segregation results in a very detailed depreciation schedule with every asset in the building identified and properly classified.
Another thing to consider is that the additional cash flow from cost segregation will increase your DSCR (after tax of course) which will make it easier to secure funding.
Since the assessed values are so out of line with the norm It may make sense to challenge the assessed values. Errors from the assessors office are more common than you'd think and are often revised favorably when challenged.
If you have any other questions on the topic please feel free to PM me!