So I’ve been looking at a lot of apartment buildings for sale lately. What I’ve noticed is that owners, each and every time are asking way too much for their properties. Without fail they are skimping on expenses, or not even reporting the true cost of repairs, maintenance and capital improvements in their proforma. Obviously this is very frustrating.
Here is an example
This is what an owner sent me earlier this week. I was a bit surprised to say the least. This guy states he has owned the property for 14 years and this is the quality of his report. Few issues I see right off the bat, there is not one line for repairs & Maintenance. Nothing for capital repairs, even though he states that he recently replaced the siding on the building.
It also appears that they were able to collect every single month of rent from each of the 10 units last year. Doubt It!
Couple other things that stick out to me as I research this deal is the following. City records show that the owner bought this building 11 years ago, not 14. He seems completely unwilling to provide a copy of his Schedule E and does not have a report for the first 3 quarters of 2015.
I will make an offer next week at the right price and Ill take Brandon's advice & include a letter of intent / Resume.
Welcome to investment real estate.
It's not uncommon for owner/managers to keep crappy books. As an investor working directly with a seller you should set yourself up to anticipate more of the same, more often than not.
If you're working with a real estate professional, I would recommend you use them to ferret out this information. Be insistent with that you need the information to enable you to make an informed decision. They too may find the sellers records to be challenging, but they should have a better chance at extracting this information from the sellers as opposed to the seller opening up their proverbial skirt to a potential buyer.
Inquiring minds want to know:
Is there a fine line (or any line, really) between crappy books and pure fantasy?
@ben talks a lot about the finer points of due diligence.
I will add one point of my own: If the spreadsheet looks like it was produced in five minutes or less... oh, I forget the rest.
See if the seller would show you their Schedule E. Then compare it to a P&L statement and ask a rhetorical question: "Are you lying to me or to the IRS?"
My partner and i call these sellers Mom and Pop Apartments. They have no systems, minimal web presence, inadequate bookkeeping, deferred maintenance, and the list goes on and on.
You need to get his last 2 years of tax returns, so you can make an offer based on his ACTUAL numbers. He is going to balk, just tell him the bank is going to want to see these figures for you to get financing. Sometimes the seller is hiding something, sometimes they are so disorganized that it may take them time to get everything together.
You always have to keep in mind you make your money when you buy. If you purchase this property at your criteria ( i look for 10% cash on cash 8 cap and 1.3 Debt service), then when you reposition this underperforming asset, you will be forcing the appreciation and you will be able to refinance the property down the road. (in the near future,, depending how long it takes to get the job done)
I mentioned in another post about proformas and how they tend to be rosy predictions of the future. Just tell the seller you will buy his property at his price if he hits these proforma numbers, which he won't.
Stick to your guns and don't overpay, and have patience with these types of sellers. Most people give up and don't walk that extra mile to get the job done. Remember, there is no traffic after that extra mile
@Thomas Blaine I once looked at and tried to analyze a 70+ unit multifamily property with records worse than the one's you posted. It's amazing the lack of professionalism you see with some owners/operators.
I agree with the other members that you should insist on the schedule E. It's unlikely that the owner is going to under report expenses to the IRS. Income is another issue but hopefully you can reconcile the owners bank account with a lease audit to confirm they are actually collecting the stated rents.
If you do obtain the schedule E and the overall expenses are low, it's likely they are skimping on maintenance, repairs, advertising, etc. I would throw them out all together and build a budget that illustrates what expenses should be if it was properly managed and base my offer on this.
Thanks for the replys. I have had no response from the sellers since Thurday now. Its seems like everytime I start asking a seller for real information, Schedule E, Insurance info, Lease information, they start to get spooked. Its like they think buyers are not going to ask for this information.
I imagine they already start thinking "This isnt the buyer for me, He's asking to many questions".
I really like the idea of including a letter from the bank and title Company. I know I can show my self as a credible buyer. The hard part is convincing the seller to sell at the "Right" price!
I sympathize with your plight. As a veteran buyer in the eight to twelve unit space(I'm in fact obsessed with that property size- it's generally too large for the mom and pop buyers, and always too small for institutional money, so the cap rates tend to be rather sweet,) I've experienced what you're dealing with several times, and I wrote something in my recent book on this point.
Sellers are incentivized to inflate numbers to you for the best selling price, but it's your job to be a savvy buyer. A seller will not tell you about any substantive defects related to the property, and it's your job to find them- bring your property manager along for the building inspection. Ignore the pro forma, it's meaningless. Base part of your analysis on the leases(I'm assuming those have been provided to you,) verify that the leases are essentially market rent- if they are under, you're actually in luck as you'll have future upside, and you can factor the below market rent into your purchase offer- and if they're over, that may signal that some desperate tenants signed leases that they'll break at the first opportunity. I'd rather be in the former situation than in the latter. The rest of your analysis should focus on the usual issues- local occupancy rates, mechanicals, utility expenses, taxes, building condition, etc.(remember- what you spend on the building may be very different than what the last guy spent. Maybe the roof has neared the end of its useful life at the time of your purchase? What if he replaced everything 10 years ago- his capex could be very low, but the building may need a big refresh upon its sale. Don't count on the seller to do your figuring, that'll make you very poor, very quickly.)
The suggestions to insist upon the schedule E or the tax returns are interesting- most investors can figure out what a building needs(in terms of capex and operating expenses) and what the rents and vacancy rate should be(as those are functions of area, the economy, curb appeal, management skill, and so on,) so if I were selling a 10 unit and a buyer insisted upon my seeing any part of my tax return, I'd consider that buyer to be an irritant and I'd find one who was capable of doing their own proper due diligence. Further, if someone buying a 10 unit can't figure out what a building needs, they have no business buying a 10 unit.
Good luck with it!
Take the listed price and divide by the GSI -- this is the Gross Rent Multiplier. If it's over 10, then question the price.
Without expenses you can't get to the NOI, so take GSI * 30% as a default expense (it's a guess, but if reality is bigger, then the property is in poor condition).
NOI divided by the (mortgage *12) is the DSCR and you'll need 1.2, 1.3 or bigger for the loan. If these don't pencil in - - walk away.
Today I will make an offer based on what the "building needs(in terms of capex and operating expenses) and what the rents and vacancy rate should be(as those are functions of area, the economy, curb appeal, management skill, and so on,)"
Becasuse you're right @Michael If I can't figure that stuff out I shouldnt even be making an offer!
Ill let you know how it goes.
That's very good to hear- go crush it!
I offered 100k below asking. It was a fair offer based on expenses, repairs & maintenance fro this building. The offer was flatly denied with no counter. I have had this happen now 3 times. I have tried to engage these owners to try to learn something from them. Maybe get their ideas on the value but they do not seem to want to talk at all.
Just real quick: The capital reserve account that you are talking about is not an expense therefore it will not show up as one. Also there are a lot of associated costs such as legal, office expenses that will be rolled into General and Admin, often times those are missing as well.
So far as the Schedule E's they are lying to one of 3 people: the IRS, you, or their wife.
Finally your offer. I know that you may have a CAP rate in mind that you want to see for the purchase price but just go ahead and throw that out the window. You are buying the property for what you will make it not necessarily for what it is today. It is a tough idea to handle but once I did I have been able to make competitive offers and still do really well.
@Seth, I agree. I guess I need to throw it all out the window and start a new strategy. I was a trying for a 9 Cap and at least 12% COC.
On to the next one!
I'm running into the same issue in the Royal Oak area.
Any luck since the last post here?