MF - good deal or not? Help.

15 Replies

Hi everyone - I’m looking to break into MF investing and have an off market opportunity that I’m trying to evaluate. I’m mid 30’s and trying to replace my salary with income so income is important.

Here is the deal:

- Strong suburb on outskirts of Charlotte

- 12 units all 2 bed 1 bath

- B/C class area and building

- current Rents $600 per unit $86,400 per year

- Market rent: ~$750 per unit $108,000 per year

- No rehab needed except for rolling update as tenants vacate

- 100% leased, many been there for a long time

- Parking

- Residential neighborhood

- Roof and structure all in decent condition

Asking price $1M but might be able to get it for slightly under that.

What are current cap rates on fringe market multifamily deals like this?

If you were in the early stages of your investing career and wanting to grow quickly, how we you look at this deal? Any other things I should be considering/factoring in?

Thanks for any guidance.

You did not mention expenses and financing. 

Rehab cannot be zero unless it's a brand new building. You need to bugget for unit upgrades up front and have that money available when a unit becomes vacant. 

Budget at least $5K/unit for a light rehab. 

The cap rate for this deal is between 4 and 5% depending on the expenses. Is it at, above, or below market? You need to ask local apartment brokers to for market cap rates. 

It's hard to evaluate without having the financials, but if we assume 50% expense ratio, looks like a going-in 4.3% cap and a stabilized 5.4% cap. How are you planning to fund it? You own money, JV, syndicate?

A going in cap rate of 4.3% doesn't bother me, but there just doesn't seem to be a lot of upside if the stabilized cap is 5.4%. I would just get very clear on what your target returns are and then determine if this deal fits that criteria.

@DanielJenkins,

Use the CRE formula, Value(Price)= NOI/caprate.

Get the actual expenses pd from the sellers actual tax reports to calculate how much of that $600/unit rent goes to expenses... to calculate an actual Net Operating Income (NOI).

The caprate for your zip code can be retrieved from a local CRE agent....Google estimates an average of 4.8% for the Charlotte area.

That being considered, given absence of other hidden costs, this looks like a good deal on the surface. Raising your rent by $150 & NOI by 25% will increase your value by $450,000...

Originally posted by @Nick B. :

You did not mention expenses and financing. 

Rehab cannot be zero unless it's a brand new building. You need to bugget for unit upgrades up front and have that money available when a unit becomes vacant. 

Budget at least $5K/unit for a light rehab. 

The cap rate for this deal is between 4 and 5% depending on the expenses. Is it at, above, or below market? You need to ask local apartment brokers to for market cap rates. 

Very helpful indeed. Thanks, Nick. I don’t have to much insight to the exact condition of each unit as I haven’t walked each but holding a reserve is a very good idea. 

I’ll certainly check with local brokers but A cap rate of 4-5% seems quite aggressive give the fact it’s on the outskirts of a suburb of charlotte. For my first deal in MF it doesn’t feel like there’s all that much upside and might tie up a lot of capital that could perhaps generate a better return faster elsewhere? 

thanks very much @Adam Lacey . Planning on funding it 25% down and the rest loan. I think that’s a little bit of the problem here is determining a ‘good’ target return. In your experience what is a good return for these types of projects and is there something else I should be looking at that has a better return profile? 

Originally posted by @Adam Lacey:

It's hard to evaluate without having the financials, but if we assume 50% expense ratio, looks like a going-in 4.3% cap and a stabilized 5.4% cap. How are you planning to fund it? You own money, JV, syndicate?

A going in cap rate of 4.3% doesn't bother me, but there just doesn't seem to be a lot of upside if the stabilized cap is 5.4%. I would just get very clear on what your target returns are and then determine if this deal fits that criteria.

Very helpful, thanks @Joel McCloud . Will be sure to ask the seller for the exact expenses.

I’m not quite sure I’m following the $450k increased value though. If I’m buying it at a current cap rate of ($43,200 estimate NoI/$1M purchase price) does that mean I’m overpaying if the market cap rates are 4.8%? 

also not quite sure I’m following the calculations for the $450k in increased value. Sorry, takes me a minute to get up to speed :) 

Originally posted by @Joel McCloud:

@DanielJenkins,

Use the CRE formula, Value(Price)= NOI/caprate.

Get the actual expenses pd from the sellers actual tax reports to calculate how much of that $600/unit rent goes to expenses... to calculate an actual Net Operating Income (NOI).

The caprate for your zip code can be retrieved from a local CRE agent....Google estimates an average of 4.8% for the Charlotte area.

That being considered, given absence of other hidden costs, this looks like a good deal on the surface. Raising your rent by $150 & NOI by 25% will increase your value by $450,000...

Originally posted by @Daniel Jenkins :
Originally posted by @Nick B.:

You did not mention expenses and financing. 

Rehab cannot be zero unless it's a brand new building. You need to bugget for unit upgrades up front and have that money available when a unit becomes vacant. 

Budget at least $5K/unit for a light rehab. 

The cap rate for this deal is between 4 and 5% depending on the expenses. Is it at, above, or below market? You need to ask local apartment brokers to for market cap rates. 

Very helpful indeed. Thanks, Nick. I don’t have to much insight to the exact condition of each unit as I haven’t walked each but holding a reserve is a very good idea. 

I’ll certainly check with local brokers but A cap rate of 4-5% seems quite aggressive give the fact it’s on the outskirts of a suburb of charlotte. For my first deal in MF it doesn’t feel like there’s all that much upside and might tie up a lot of capital that could perhaps generate a better return faster elsewhere? 

Cap rates going in are almost meaningless. What makes a difference is an exit cap rate. If similar properties continue to sell at 4.5% cap rate in 5 years and your NOI grows to $100K, you may reasonably plan your exit at 5% cap rate and get $2M upon exit.

If market cap rates increase to 7% you're sill in good shape at $100K NOI but not so much if your NOI is below $70K.

Can you grow NOI to $100K? That depends on how much you can increase rents and how you control expenses.

Nice unit mix. should rent well. You will need to budget for the rehab. If your 100% leased then for sure the rents are too low. 

I wouldn't worry about cap rate. If it cash flows and hits your returns, thats all that matters. 

If I were in early stage of my career and wanting to grow fast, I would do fix and flip houses until I had about $500k in cash, then passively invest most of it while I continue to fix and flip houses on the side to create more cash to invest

@DanielJenkins, Remember Value = NOI/ Cap rate and Cap rate= NOI/Value

Your original post indicated no update is needed. Assuming your expenses are 50% of that $600/month... your NOI is $300×12 apartments x 12 months= $43,200 yearly. If you paid $900,000, your caprate is NOI/VALUE Or $43200/$900,000= 0.048 or 4.8%. If you increase your rents to $750/month, keeping your expenses constant, your New NOI =$300+$150=$450 ×12 Apartments x12 months= $64,800.

As Value =NOI/Caprate, your New Value =$64,800/4.8%= $1,350,000 an increase in your $900,000 investment of $450,000. Not a bad ROI at all in my opinion.

Very helpful, Nick. I guess the thing I'm struggling with a bit is determining the purchase cap rate. I will speak to a lot of local brokers to get their input but is their feedack is that typical cap rates for this type of asset in this fringe location are 5% does that then mean that my purchase price of ~$1M is too high. Am I overpaying for the in place cash flow?

Cheers

Originally posted by @Nick B. :
Originally posted by @Daniel Jenkins:
Originally posted by @Nick B.:

You did not mention expenses and financing. 

Rehab cannot be zero unless it's a brand new building. You need to bugget for unit upgrades up front and have that money available when a unit becomes vacant. 

Budget at least $5K/unit for a light rehab. 

The cap rate for this deal is between 4 and 5% depending on the expenses. Is it at, above, or below market? You need to ask local apartment brokers to for market cap rates. 

Very helpful indeed. Thanks, Nick. I don’t have to much insight to the exact condition of each unit as I haven’t walked each but holding a reserve is a very good idea. 

I’ll certainly check with local brokers but A cap rate of 4-5% seems quite aggressive give the fact it’s on the outskirts of a suburb of charlotte. For my first deal in MF it doesn’t feel like there’s all that much upside and might tie up a lot of capital that could perhaps generate a better return faster elsewhere? 

Cap rates going in are almost meaningless. What makes a difference is an exit cap rate. If similar properties continue to sell at 4.5% cap rate in 5 years and your NOI grows to $100K, you may reasonably plan your exit at 5% cap rate and get $2M upon exit.

If market cap rates increase to 7% you're sill in good shape at $100K NOI but not so much if your NOI is below $70K.

Can you grow NOI to $100K? That depends on how much you can increase rents and how you control expenses.

Great points. Thanks Joseph. Would love to do more fix and flips but it feels like the margins are tight. Lots of competition on the aquisitions and tough to find quality crews to execute the rehabs. That's just what I'm finding though, probably doing it wrong :)

Originally posted by @Joseph Bramante :

Nice unit mix. should rent well. You will need to budget for the rehab. If your 100% leased then for sure the rents are too low. 

I wouldn't worry about cap rate. If it cash flows and hits your returns, thats all that matters. 

If I were in early stage of my career and wanting to grow fast, I would do fix and flip houses until I had about $500k in cash, then passively invest most of it while I continue to fix and flip houses on the side to create more cash to invest

Very helpful indeed. Really appreciate the detailed work through. This makes a lot of sense. I guess my one concern is that the purchase cap rate of ~4.5% feels aggressive for a fringe location C building like this. I'm second guessing if a buyer once stabilized will pay 5% or close to that on the exit. 

Also, what would you underwrite for financing 75% LTV? 5.5-6%

Originally posted by @Joel McCloud :

@DanielJenkins, Remember Value = NOI/ Cap rate and Cap rate= NOI/Value

Your original post indicated no update is needed. Assuming your expenses are 50% of that $600/month... your NOI is $300×12 apartments x 12 months= $43,200 yearly. If you paid $900,000, your caprate is NOI/VALUE Or $43200/$900,000= 0.048 or 4.8%. If you increase your rents to $750/month, keeping your expenses constant, your New NOI =$300+$150=$450 ×12 Apartments x12 months= $64,800.

As Value =NOI/Caprate, your New Value =$64,800/4.8%= $1,350,000 an increase in your $900,000 investment of $450,000. Not a bad ROI at all in my opinion.

Originally posted by @Daniel Jenkins :
Very helpful, Nick. I guess the thing I'm struggling with a bit is determining the purchase cap rate. I will speak to a lot of local brokers to get their input but is their feedack is that typical cap rates for this type of asset in this fringe location are 5% does that then mean that my purchase price of ~$1M is too high. Am I overpaying for the in place cash flow?

Like I said before, purchase cap rate is not that important. You need to start from your exit value and work your way back to the purchase price:

  • Take current market rents and adjust them for 5 years hold (e.g. apply 3% annual growth). That's your future gross income
  • Take current expenses, adjust them for your situation (e.g., property taxes may go up), and then project their growth in 5 years.
  • Subtract future expenses from future gross rents and get future NOI.
  • Divide future NOI by future cap rate and get future value.
  • Subtract selling expenses, buying expenses, rehab money, and expected capital gains from the future value. The result is your offer price.