Should I do this deal? (8-unit apartment building...numbers included)

23 Replies

Hi BP,

I found an 8-unit apartment building for sale by owner on craigslist.  I've been studying real estate and reading/listening to BP for about a year and a half, but have yet to do an actual deal.  I wanted to run this deal by some people on the forums to get some advice from people wiser than I on this.

Here are the details on the property:

  • Located in western Maryland - old coal mining town; weak but seemingly steady economy; lots of blue collar workers
  • 8 units - 2 bedrooms in each unit
  • Each unit rents for $500-550 (one unit rents for $400...special deal for tenant with current owner)
    • 100% occupancy = $49,800 gross rentals/year (not including laundry below)
  • Comes with laundromat on first floor - 6 washers, 6 dryers; open to public; current income unknown to owner, but estimated by me at $250/mo
  • Taxes:  $2,800/year ($233/mo)
  • Owner-covered utilities:  $7,200/year ($600/mo)
  • Insurance:  $2,700/year ($225/mo)
  • About 1,000-1,500 sq ft of unfinished garage space on the first floor that is not being utilized.  Could potentially finish and rent out or rent out as garage/workshop space.
  • I plan on having a property management company manage the building.  Already identified a company and have spoken with them about terms.  They charge 10% of rents and a flat $100 for each tenant that they place (and will place new tenants for free if they are evicted or leave within the first year).
  • Asking price $150,000

I have already met with the seller to do some due diligence:  looked at schedule E tax returns, last year of utility bills, last two years of rent rolls, walked through building, looked at two of the units, etc.  It seems like this price generates an attractive rate of return, but I have some concerns about the long-term outlook and liquidity of the investment.

Some of my concerns:

  • Quality of tenants - this town is generally lower income, and the building is in a lower income area of the town (low of the low).  The building is in decent shape, but given the above factors, brings in some "rough around the edges" tenants.  Rent rolls showed a decent number of evictions (maybe 3 per year for the building)
  • Long term outlook of the local economy - the economy does not seem to be growing in the area, and from talking to some long term residents, it sounds like jobs are drying up.  There is an economic development plan in place by the local government, but I don't know how the execution of this plan will go.  May make finding tenants more difficult in future...as well as exiting the investment if need be.
  • Financing - banks seem to have a hard time with the 8-unit building, particularly with the low price.  I know some people to where I could get equity partners or potentially some private money to fund the entire purchase price, but this would obviously impact cash flow, and I want to feel good about the investment before pitching it to others (hence this post).

What do you think?  Would you pursue this deal if you were me?  The numbers seem good, but does that override my long term concerns?

All advice is appreciated!

Thanks, David

I should also add that there are 3 prisons in the area, contributing to a higher than average crime rate.  One website rated the national crime rate at 40/100, and this area had a rating of 72/100. 

@David Young

Even though you say the place is fully rented, I would allow a 8.3 - 10% vacancy allowance for analysis purposes.

Revenue:

Scheduled Rent:    49,800

Vacancy Allowance: 4,980

Effective Gross Revenue: 44,820

Note:  Ignore the laundry ancillary income when analysing the property ... if you are lucky it will pay for the cost of the machines and utilities they consume. 

Expenses: 

The items you present come to `15,400/yr.  To that I would add a 10% maintenance allowance and 10% for PM.

Operating Expenses = 15,400 + 4,482 + 4,482 = 24,364  (54% of effective gross revenue)

NOI = 44,820 - 24,364 = 20,456

From this you would have your debt service and a 10% CAPEx reserve.  If you are left with 10K or more after these two items, then the deal is probably worth deeper investigation.

At the asking price you end up with a CAP rate of 7.33 ... which is meaningless unless you know what CAP rate is being paid in the local area ... but could help you determine if the property is priced right for the neighbourhood.

Updated over 6 years ago

Update: Rereading my post, the CAP rate didn't sniff out well. Turns out, I must have wrong variable when I initially calculated it - the correct value should be 13.6.

@chrisseveney I haven't had a contractor look at it.  That's something I have considered doing, but didn't want to take that expense until I had done a bit more research.

I am looking to get into long term RE investments, so exit strategy isn't quite as important, since I am investing for the monthly cash flows.  That said, an exit strategy might be difficult unless I can find some other investors willing to take the building off my hands after I improve the property a bit (make a few improvements, maybe the area gets better, finish up the empty first floor space, etc).

Sounds strikingly familiar to my area. Small Blue collar town and stagnant economy. I would say if further due diligence checks out it might be worth taking a chance. There is a 15 unit apt building I've been eyeing so I'd love to see updates to this story.

@David Young

 I follow @Roy N.'s logic but not his conclusion. I make the cap rate $20,456 / $150,000 = 13.6%. Clearly that is priced as a Class D property and from your description of the area that sounds about right.

You mentioned that you're investing for the monthly cash flows. Well, this type of property is all about the cash flow since the tenant population will never get wealthy enough to boost the rent and NOI. If you're willing to put in the work, put up with the grief from shady tenants and take a risk on the local economy I think this could be a solid investment. You're certainly being compensated for the work and risks.

I also like the potential upsides. The garage and laundromat might not be worth a huge amount but I'd take a property with them over an equivalent property without. 

You mentioned that you're having trouble with financing. Probably the deal is too small for most commercial lenders to be interested. I suggest calling around to find lenders who specialize in small deals. For example I know US Bank has a special program for small commercial mortgages in which they can perform an in-house appraisal based primarily on income. I believe the maximum loan amount is around $100k or $150k. This would be perfect for you.

Good responses to the math in this thread so will refrain from an opine except to say whether the deal looks good, and that all depends on... An exit. When investing for the long term none of us ever really want to sell a building. However, life throws us curves, situations change, divorces come unexpectedly, in other words s_hit happens. When it does happen and you need to access capital that capital is sometimes tied up in real estate assets. So when there is a limited or timely period to exit a property it can present unforeseen problems. Now, I personally like ugly properties. They've been among my best earners, but I bought them well aware that I might have a hard time selling them and planned my life/portfolio accordingly. Since you've already registered a concern about exiting this property if I were in your shoes I'd perhaps reverse engineer from that concern to see if that is in fact the type of first property you want to buy and own. Now, buying us good, and having an exit problem is much better than not owning and not having any ownership problems so just make sure you want to own THIS one, but even if you don't, don't let it dissuade you from buying a deal this year.
Originally posted by @Juan Cristales :

@Roy N.

Can there be two different cap rates? As in a "nicer" part of town vs. "not-so-nice" part of town? 

 Juan:

CAP rates are local and are simply a barometer indicating what people are willing to pay for a given amount of cash-flow in that area. It is quite probable that areas in different parts of the City may see properties selling at different CAP rates based upon desirability and risk.

You also must remember that CAP is a course indicator of valuation - you would still need to examine the particular deal and make adjustments for age of the property, state of repair and current performance.

@Nick L.

Good catch ... I had an HP user error and recalled the wrong variable giving me the CAP rate for another property I was analysing.

Hello David, I am still new and learning Multi-Family.   I have been analyzing a lot of properties others, like you, have been posting as well as my own.

@Roy N. Covered most of the usual numbers, so I will not rehash that.  I do have a few questions:

Physical property:

 What year was it built?

What is the square footage?

When were major Capex last replaced (roof, heat/HVAC, boiler?)?

You state you walked the property ... Did you see any obvious repairs or rehab needed?  Or is this a turn-key?   Even a basic cosmetic rehab would be a minimum of $20 per sf.  Like @Chris Sereney said ... have it inspected.

Financing:

What and when was latest Assessment Value?

Do you have cash to put into the purchase (skin in the game)?

Here is an example of a commercial loan for this type of property that I have seen in Texas. 4.5% APR 30 yrs 75% ARV excellent credit. Using @Roy N. Numbers for NOI ( $20,456);

Purchase Price........... $150,000

25% Down payment ..$  37,500

Financed ..,.................$112,500

Mortgage Payment ... $570 month ($6,840 yr).

Cash Flow = NOI - Debt Service

$13,616 =  $20,456 - $6840

That averages $141.75 per unit per month

With good terms and excellent credit!

This is a FSBO right? Will he do Seller Finance?

Hope this helps.

John

David, I have some experience in smaller multi-family properties  (6-40 units). What I've found, especially in class C or D areas, is that strategic and focused management is the life blood of the property. Without sound  management in place, the property will never maximize  full potential. I know you're not investing in your home area, so if the different financial  metrics work, a thorough  vetting of the management company should be your next step. 

Originally posted by @John Leavelle :

Here is an example of a commercial loan for this type of property that I have seen in Texas. 4.5% APR 30 yrs 75% ARV excellent credit. Using @Roy N. Numbers for NOI ( $20,456);

Purchase Price........... $150,000

25% Down payment ..$  37,500

Financed ..,.................$112,500

Mortgage Payment ... $570 month ($6,840 yr).

Cash Flow = NOI - Debt Service

$13,616 =  $20,456 - $6840

That averages $141.75 per unit per month

 John:

That still wouldn't be free cash flow.  Depending upon the age and condition of the asset, one should budget up to a 10% CAPEx reserve ($4,482) to be taken from the 13,616, leaving $9,134.   

Of course, you must also pay taxes out of this "cash flow".

Looks like a potentially great find! Others have run through the numbers adeptly, so I will leave that alone. Let me answer a few other questions for you:

You don't need to hire a contractor (yet) to get an idea of the capX expenses waiting for you. Ask for the year of the roof, windows, boiler, and electrical wiring. Those are your big 4 (plus doors - but those can be seen yourself).

You mentioned "the area may get better" I would suggest that the prison is not moving, and thus the area will not get better. Not that this is a bad thing or a deal killer - but don't assume that an area by a prison will turn into a hot neighborhood.

And most importantly @Billy Guyette is ABSOLUTELY right that in C/D properties - management company is everything. So call around to some other agencies and ask them if they manage anything else in that area. You can also drop by some larger complexes in the area and look for the management company's sign (they always put them up on the bigger properties). Give them a call.

Good luck

Originally posted by @Steve B. :
how are the prisons affecting the crime rate? are they running an outpatient program?

 In some cases once the inmates are released, they decide life was better in prison and will commit another crime just to be put back in. Hence the increase in crime rate. There is a town in Texas where I've heard of this happening. 

Honestly, judging by the price and market rent, this class of rentals will look a lot better on paper than in actuality. Have you seen the units and the tenants? I honestly don't think there are much profit after the repeatedly broken front gate every couple of days and the back rent. I believe you get what you pay for.

@Chris Seveney @Roy N. @Nathan Duncan @Nick L. @Christopher Telles @John Leavelle @Billy Guyette @Travis Lloyd @Nazz Wang @James Syed

Thank you all for your comments and help on this thread.  I thought I would provide and update, as some time has passed.

I sat on this deal for a while and some other stuff came up in my life (had a kid, moved, etc), so I was a little distracted.  I checked back in with the owner a few days ago and he said he had it under contract with someone.  No big deal. Wasn't incredibly disappointed, as I had some concerns that I've expressed above.  He called me back a few days later to tell me that the deal had fallen through while he was on the way to the settlement office.  So its back on the table.

To answer some of the questions/concerns above...

@Roy N. - the $13,616 cash flow number that @John Leavelle came up with uses your NOI number of $24,456 that you listed earlier in the thread (thanks for calculating all of that, by the way). In that number I believe you included taxes (from my original list of expenses), as well as a 10% reserve for maintenance and a 10% reserve for CAPEX. So his cash flow numbers actually might be close if the assumptions hold up.

@James Syed - thanks for the tip.  I had dinner with the owner and got copies of all of his utility bills for the last two years.  His estimates check out to be accurate.  Where he was being "optimistic" was the gross rent estimates.  Building had been usually 20%-40% occupied over the past two years.  He chalks it up to him having medical issues during those times and not being able to look for tenants (plausible).  He currently does have 7/8 of the building occupied (at last check), so that is better.  Although like I said before, the building seems to have high turnover which will hurt income.

@John Leavelle - The original building is quite old (want to say early 1900s).  It was completely gutted and refinished by the current owner 10 years ago.  The 2015 tax assessment was $129,300.  I want to say each of the 8 units is around 800 sq ft.  There were no obvious cosmetic repairs needed in the two units I looked at.  Although if there are unruly tenants in there now, I can imagine that a few things would need to be fixed when the tenant turns over.  I don't have a ton of cash to put into this (a few thousand), and would likely go in with another equity partner to provide most of the down payment money.  Thanks for running the numbers.  Yup, this one is for sale by owner.  And I asked - he doesn't want to do seller financing, although he does own it outright.

@Billy Guyette @Travis Lloyd - thanks for your advice on the property management.  I will do some extended due diligence there.  All I've done so far are phone interviews.

If anyone else has any additional comments, thoughts, or advice, feel free to chime in!

Best, David

Forget about the numbers for a second.  Is a class D property the way you want to go?  that is the first decision you need to make right out of the gate.

Do you have management lined up?  Make sure you can even get a good management company willing to manage is the "lowest of low" rental areas as you put it.  Managing this type of property yourself when you are a new investor is a recipe for disaster in my opinion.

I personally do not have any experience investing yet, however I know from what I've read the market is more important than the property. You can deal with some issues with the repairs, but if the property is in a crummy neighborhood with not a lot of employment, you could have a tough time renting it out, especially if the coal industry takes a turn for the worse there. Again, that's just based on what I've read, no actual experience myself.

my advice is to stay away. Why start your real estate investing career with a risky deal. My two cents is real estate investing is all about minimizing risk and maximizing opportunity. Nothing worse than having to chase your money with the low-end tenants, you will never ever get paid. There are a lot of good deals that are performing out there, find one of those and go after it aggressively.