100% Owner Financing Deal - Chicago Heights

9 Replies

I just sent in a LOI (Letter of intent) on the purchase of a twelve unit apartment building using Owner financing. Basically I will be able to take possession of the property for his cost of commisions and any closing costs related to creation of the mortgage.

I wanted to see what everyone thinks about my strategy. Here are the numbers

Purchase Price: 290,000

interest rate is 8.5% with 5 year bubble payment, 30 year amort.

NOI is 27,868

for a cap of approx. 9.6%.

Cap Ex in the near term I estimate to be around 25000, for basically a new rubber roof and water heaters.

Current owner is retiring and is looking to sell his property for some passive income. But at these numbers I'm getting into the property for basically a thin cash on cash return of 1109.85 for the year. Terrible numbers.

BUT.

Rents are below market by about 100 bucks each unit. All the tenants are at will. So my intention is to immediately raise rents for a quick return of 1200 a month after Debt service. Then I plan on spending approximately 10000, to submeter both gas and water and pass this expense on to the tenant. This will reduce my annual Operating expenses by approximately 11000 per year.

Changing my NOI to approximately 48400.

At the same cap rate as what I bought it the value of the property will increase to $504167, a net increase of approximately 504167 - (290000+25000capex+10000submeter) = 179167 in less than one years time.


In addition to this, Since my loan to value is 290,000/504167 = 57%, I plan to cash out refinance to recoup my cap ex and submetering investment and reduce my monthly payment in 6-12 months to the market rate of approximate 5.5% for additional cashflow.

I think this looks like a great deal since I have low front end cost and barrier to entry.

What do you guys think?

Samson,

How old is the building? How is the house heated? If it's through water boiler - submetering it might cost more than what you think or it might not even be possible to submeter it. Make your contract contingent to you being able to submeter the utilities at a cost of $10K or less.

Also, when you submeter the property - I assume you will pass the cost of heat (or the other utilities) to the tenant. You can raise the rent $100 per month but if on top of that you pass the cost of the utilities too, you are not being reasonable. Passing the utilities to the tenants is basically a rent increase. If the units have a lot of section 8, section 8 may not necessarily approve a higher rent. Or, you might end up with a lot of vacancies when you raise the rent $100 AND pass the utlities to the tenants also.

Lastly, in Chicago Heights - there are good parts of it and then there are not so good parts. I walked away from 2 deals from Chicago Heights recently. One is a house I can buy for $760 and another, a 4-plex I can buy for $36K. I walked away from these because they are in bad parts of Chicago Heights.

Looks good on paper, but after you raise the rents by $100/mo, on what appears to be $400/mo units, And add the water/gas to the tenants, expect some vacancy issues. The rubber roof sounds like a bit of a band aid, or is that standard there? Do you have any reason to believe the owner would sell with such a small down pmt?

What is your basis for believing that you can increase the tenants' costs by 45% without incurring significant vacancies? Because that is what you are talking about, when you talk about increasing the rent by $100 and passing them $77 a month in utilities.

There is a theory in Political Science called "Relative Deprivation." It was developed by an historian of the French Revolution, who noted that the poor of France were much better off than the poor of the Germanies, or Eastern Europe, who did not rebel. This guy noted that the what happened was that things were much worse for those poor French than they HAD BEEN, within recent memory, and this change is their relative position was more important psychologically that the fact that the were objectively not all that badly off.

A similar thing can happen with tenants. Even if $577 a month is in fact a fair market rent, if they have been paying $400, they will rebel. There probably won't by guillotines, but there will be vacancies. They would actually rather pay that same $577 to another landlord, who they do not perceive as having tried to screw them, even if it means the inconvenience and expense of a move.

How long will it take you to fill 12 empty units?

100% owner financing was actually my brokers idea. Apparently there's another owner finance offer. I think the best play is to pass down the expenses to the tenant to reduce the expenses which are ridiculous.

That being said you are probably right about raising rents simultaneously as being excessive. Next year it might be ok to raise rents further incrementally

Rents are actually 535. You think an incremental raise to 575 along with passing expenses is more reasonable? Perhaps I'll apply the change with half the units and the other half 6 months later to avoid a mass exodus

This is all sounds great in theory. I have been there before. When you start making big jump demands in rental increases be prepared for the tenants to give a list of demands they want fixed or new items before they will pay an increase. They are paying what they pay probably because the units need some major TLC.

You need to look at the LOYALTY factor on the rent roll. If out of 12 units rents have been kept long and say 8 tenants have been there 5 years etc. then those units will be run down. If they leave you have to count vacancy loss and the money put into the unit. If you are asking closer to top market a new tenant will look at things very differently than a tenant that has been there 5 years. Flaky paint, dirty carpet, old countertops an existing tenant might not care but to a new one looks un kept and filthy.

On utility find out if it is common for the landlords to pay in the area. If it is you are wasting your money. I would rather offload utility than increase rent to boost the bottom line. Most of the tenants stay and you have a huge savings. On average tenants use 30% more of something when they do not pay for it. They also tend to not report plumbing or mechanical issues with a property as they are not paying for it.

No way on the 8.5% interest rate. You need the cash flow in the beginning to turn this ship around and make it shine again. You don't want a seller to offload a dog on you and cripple you just when you are trying to walk and then run. At the very least make it say 5.5% with a stepped up interest rate after 6 months goes to 6% and 12 6.5% etc. This way the seller gets a benefit the longer it hangs out but doesn't crush you in the beginning.

Since you are wanting to increase revenue while you turn around in addition to 30 year amort. make the loan interest only. That can increase your cash flow. Since you are forcing equity and turning around to refi later then short term pay down is not important but monthly payment is. Try to get no personal guarantee or recourse. If recourse only limit it to your LLC.

Hope it helps.

Hey @Samson Kay , I agree with what @Joel Owens is saying - don't forget when you're turning a building around you'll have a significant dip in income in the first year and it's incredibly important to have a significant amount of money in reserve up front (don't depend on what cash flow looks like on paper) to get over that hump. You don't want to do the former owner's heavy lifting to get it fixed up but then give it back to him in a foreclosure before the income stabilizes.

@Joel Owens

Great advice and feedback Joel. Looking to break into the commercial real estate arena soon.

@Jay O. ,

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