Discounting for Immediate Renovations and Repairs

6 Replies

When looking at an investment with value-add rehab, obviously we need to take market cap rate and discount for the actual costs of repairs. But there is no reason to take on the risk, time, lost rent, and work for the same return as a turnkey.

My question then is how much do you discount and how do you phrase that discount? That is, do you discount x dollars, or require a better cap rate, etc., and how much? It obviously depends on the work required, but some typical scenarios would help!

I watched an 1890's farmhouse come duplex listed for $89,900 for 18 months. With an 800 ft deep double lot & a huge barn in disrepair, it had two 3 bed/2 bath units but in pre '70's disrepair.

I watched it drop to $69,900 & sell subject to financing which I knew it wouldn't pass. The seller had finally put in new low end furnaces & small HW tanks leaving the old stuff in the basement.

When it dropped to $55,000 & his tenants finally left we walked in & offered $40,000 cash, close in 30 & we were told to leave ... 10 days later we were asked to raise it to $45,000 & we had a deal. Flipped it to a fellow investor & hold the note @ 12%. The investor rehabbed it for $25,000 & it's now definitely worth $89k.

In fact he just got a $10k insurance payout for the Barn that was seriously damaged by the last winter & ice.

@Pat L. :

Reading between the lines, you are saying there is not really a set percentage, but once you get to the point of value-add, to make it work the seller needs to be distressed and willing to look beyond cap rates and NOI.

I am really interested in 20+ unit properties. Would you say that holds true in this space, or is there a way to keep the discussion on the level of cap rate discounts and/or rehab costs with a multiplier (1.5x or 2x?) to close the deal? 

Thanks, Seth

Would the 70% Rule (ARV * 70% - Repair costs) not apply even on larger properties?

Originally posted by @Michael Roy :

Would the 70% Rule (ARV * 70% - Repair costs) not apply even on larger properties?

Not so much. Residential is largely based on comps so this works. I could have a larger MF that has an NOI that is 70% of what I think it can make after rehab. Thus ARV stabilized value * 70% leaves me with that same value. There is no discount taken for the 12-24 months I worked to get there, the opportunity cost of my investment, or the risk I took doing so. In most scenarios I would be better off buying a smaller turnkey for the same cap rate.

@Seth C.

I'm not sure if you are referring to single family/small multifamily turnkey properties in your first post or are referring to large mulitfamily properties that are already stabilized.  I'm going to assume the first.

Value add opportunities in large multi family properties is very difficult to find.  What is even more difficult about this space is who your competition is.  You are competing against people with deep pockets that don't need double digit returns for this to be attractive to them.    Since real estate is open to every type of investor, the guys on the bottom can't imagine why someone would buy a class A multi at a 5 cap.  Things change the more money you have to put to work.  Also your resources that you have change to find the deals and rehab the deals.  Take that deal you originally talked about.  People buy those deals because they have money to put to work and/or they can do the rehabs cheaper than you can.  

It is difficult for novice/part time investors to ever compete against professionals.  Typically the only way they can is on price.  If for you the returns for a large multi is less than the returns you can get from a turnkey provider than maybe you should explore that further.  

It all depends on what your ultimate goal is and your resources to get there.  If all you are looking for is yield, then just be a private lender and lend money.  You should be able to find someone that will pay high single digits up to low teens with out a problem.  All you have to do is deal with that person and you have the property as collateral.  You can find lots of upstanding people that are looking for private funds.  

On top of all this there is a problem with the "50% Rule" for expenses, since the BP calculator and others use this rule discounting from GSI, while others still, who are well-known and respected on the forums and elsewhere, discount from EGI (ie after economic vacancy is already deducted). So which one is it, #askBP ?

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