Apartment Building Question
Real Estate Consultant · Memphis, TN · Member since 2008 · 23 posts · 4 votes
Hey Everyone,
I just found an apartment building for sale at what I think is a great price, but I would like a second opinion. Here is the information:
List Price: $345,000
Units: 16, All 2BR 1BA
Rent Price: $600 per unit (low estimate)
Taxes: $6,890 per year
Insurance: Approximately $12,000 per year (estimated $800 per unit... is this even close?)
I am very familiar with single family residential homes and have been a wholesaler for a while (over 12 homes last month), but I have never invested in a multi unit building. What other costs am I over looking and would this be a good deal?
Looks like a deal to me:
Rent: $9600/month
Expenses: $4800/month (50% rule, I'm pretty confident a building like this won't manage lower expenses than this)
NOI: $4800/month
P&I: $2779 ($345K at 7.5% for 20 years)
Cash flow: $2021
Cash flow: $126/unit/month
I'd want to be sure the expenses aren't going to run more than the projected 50%. I'd be concerned in particular about management costs, maintenance, especially any deferred maintenance, and vacancies.
But this seem worth a closer look.
Jon,
You could write a real estate investing book. Everything you need to know, all on one page!
I have seen you do this break down for so many people. Do all of your properties fit this model (if you don't mind me asking)?
Its Mike's model more than mine. I only have a grand total of one rental, so far. In addition to a piece of a mini-storage (which actually fits this model, too, though I could only dream of $100/unit cash flow.) The hard money loans actually produce a pretty nice return, but I'm on the prowl for more rentals now.
As I've said in other posts, I generally assume 40% for expenses. Mostly because I'm willing to absorb the property management, for the moment. Further, there's a speculative aspect to my strategy. My farm area has strong job growth prospects, and is seeing a lot of redevelopment. And, even then, I don't manage $100/month in cash flow. With the "cash flow = rent - PITI" mythical formula, though, I'm well over $100. And I have reserves to handle a hit.
That said, if I was looking at an apt building like this in my farm area, I would evaluate it exactly as I say. Costs are going to be higher with an apt building, if for no other reason than the city has higher requirements for apartments, that is, a different building code for 3+ unit buildings. There's more competition, too, for apartment tenants. And, managing 12-16 units is a lot more work than a few SFRs. I'd be all over this deal, though. In my area, an above average deal would be $35-40K for 1/1 units that rent for $500-550.
Hard to sell a one page book :-)
All properties do NOT fit this model.
Commercial apartment buildings (5 units+) are an entirely different investment vehicle than residential rentals.
That said, using 50% for commercial multifamily may be ok, and it may not be. I have seen many of these units with much higher OE.
Best way to calculate this type of deal is to use the current financial statements (apartment units usually have much better record keeping than residential units).
Take the current rent roll and add up the current gross income.
Your operating expense ration can vary greatly depending on the CURRENT occupancy levels. A high occupancy level 92%+ will usually have the 50% OE. A lower occupancy level such as 80% will most likely have a higher OE ratio.
Your estimate of the insurance is very high, insurance usually runs lower than property taxes, not higher. For a 16 unit, your insurance should be more like $7500, although it depends on the age, condition, and location of your units.
Another key indicator to look at here is the cost per unit of $21,562 for a $600 monthly rental unit is very good.
What is the total rentable square footage? This is another indicator to look at.
If you are really interested in analizing this investment, send me a PM or email and I will help you with it.
This looks like a smoking deal to me. I'd investigate further to see what it looks like. I'm mostly interested in defered maintainence. I'd want to figure out what repairs you have to make immediately.
On a cash flow deal, that is what you are looking for.
Boy O Boy... Mr. Holdman and Mr. Barnard are all over this one. Either way you go, GREAT advice from both.
This Deal is Sweet too... If you can manage to keep the Occupancy rate up for the next year, pocket your cashflow and increase the rents @ inflation rates (staying competitive with the rental market) you can always sell next year showing a GREAT cap rate at a price far far above what you paid. And if it doesn't sell... well, holding this one is just as good.
Good Luck,
Dustin
Thanks for the help guys! I guess I'm so used to wholesaling single family residential homes that cashflow, typically, between $150 and $200+ a month that the profit margin per unit which I came up with of somewhere around $160ish per month just didnt seem like it was a "steal". I mean my personal houses typically cashflow around $250+ per month and it seemed like I would be putting all my eggs in one basket. But on the other hand, wouldnt this be a commercial loan that would not effect the personal residence +3 rentals that many banks are going off of these days?
My guess from those statements would be you're underestimating expenses on your SFRs. On the one I mention, rent - PITI is will over $300, but I'd make no claims that's the cash flow.
Will makes a good point. Expenses may be much higher on multis. I've seen seller provided APODs where expense + vacancy was 70+%. And, since I always assume sellers slant things in the most optimal direction, I'd be inclined to suspect they're higher still.
This would definitely not be a "conforming" Fannie Mae loan. That's where the four property limit comes from.
Mike, you sure do know how to pick out one word from an entire sentance or post and then attempt to destroy it in a comment.
My comment about commercial multifamily was to ONLY say that is is a more complex and more economy of scale investment vehicle, both for positive and negative. I never said that people do not LIVE in apartments. Of course they do. My other point is that from a loan standpoint, 5+ units is considered a commercail unit, not residential.
After having to explain that in more detail, I agree with the goose to golden egg. Very true, although, if the strategy was not to keep cash flow for years to come, then selling could give you the lump sum profit.
As far as sellers providing their financials, while it is true that they can hide or fudge some figures, there are some key figures they can not. Those are the ones we look for to narrow down the OE. Then the balance we estimate as you pointed out.
"What's the point of having a forum if you're going to analyze posts outside the forum?"
We are analizing posts in the forum Mike. Have you not read above.
I did offer assistance in more detail which can not possible be done in this forum.
I guess im near sighted... I do understand this one could yield so much better in the long run, but as a young investor trying to move up earlier in life we need a few lump sum gains... Down-payment moneys to spread around, and we have to eat too :D . Just my perspective.
Dustin
I agree Dustin, hence my "lump sum profit comment.
David,
Taxes, insurance, utilities, vacancies, management fees to name a few. Each and every one of these can be verified from actual invoices or county records as the case may be.
Administration, advertising, repairs, etc. can all be manilulated so making educated estimates is necessary for some OE.
Great discussion! I hope this doesn't stray too far from the topic, but I have a question about Jon Holdman's answer on 11/24. You calculated debt service based upon 100% LTV and I was curious about the reasoning there. Is that just a way of doing a quick evaluation to see if the deal makes sense? I have heard that for commercial properties 70% is, (I'm not completely sure how to ask this) more regular?
I crunched the numbers based on the 7.5% Jon mentioned, then figured 70% LTV, but used the 50% rule to calculate VCC, insurance, and other expenses. What I didn't do is calculate the cost of the financing and/or closing costs because I have no idea what those might be. Here is what I came up with:
345,000 price
103,500 dwnpmt
241,500 mortgage
20 year period @ 7.5%
57,600 annual NOI (based on 600/unit average)
23,346 annual debt service
34,254 BTCF
So without any closing/finance costs and the 50% rule this baby has a 16.7% cap rate and a (before tax) cash on cash return of 33%! This doesn't seem possible. Can anyone tell me if I'm doing the math right on this? Would this be your approach to the analysis? Are my assumptions wrong?
This is all pretty new to me, so any advice/correction anyone would care to offer would be greatly appreciated.
Thanks!
Yes, using 100% financing is just a way to evaluate the deal. It amounts to paying yourself the same rate and terms on your down payment as the actual loan. Its the opposite of a cap rate calculation, which assumes 0% financing.
Your cash on cash calculation looks correct.
Yes, I'd consider this a nice deal. I'll take one, too, please.
Note again, that this is just the numbers. This could be in a horrible neighborhood and can never be rented. It might be priced double what the identical building next door is priced at. It might be condemed by the city. It might need $200K in work. Without a closer look, who knows. But it certainly appears to be worth that look.
Aaron, Your math is right with the numbers you used to plug in but you have to realize several things:
1. The reason Jon calculated the loan at 100% LTV is based on the premis that there is an opportunity cost to your down payment. In other words, if you didn't place 25% down ($86,250 + closing costs) you could have invested that $ in some other vehicle producing a positive return. I have a different opinion on that matter where I calculate the COC (cash on cash) return and if my COC blows away any other investment option, I have a green light for that particular analysis.
2. I do not use the 50% rule as Mike and others due, particularly with commercial multifamily units. I would get the current rent roll and verify, to find the current occupancy. Then I take that out of the gross rents. Then from the AGI (adjusted gross income), I deduct the expense ratio, which at that point will be a minimum of 50% in almost every case, and depending on the occupancy rate, could be much higher. For instance, if you were looking at this 16 unit and it had 4 vacant units or 75% occupancy, the OE ratio, will be higher than 50%. If it is 100% occupied, I know that can not be forever, so I plug in the areas average vacancy rate (I use 10%). At this occupancy level, OE ratios will be lower than if only 75% occupancy.
3. Identify if the owner pays any or all of the utilities. This can dramatically effect the OE ratio, which ultimatley is why I do not like using ratio %'s.
Here is how I see this deal:
Rent: $9600/month (100% occupancy)
Less vacancy of 15% (Guessing)
AGI = 8,160
Expenses: $4080 (based on 50% OE ratio, could be higher)
NOI: $4080 monthly
14.19 Cap rate at ask price (very good)
P&I: $1829 $258,750 @ 7% 25 year ammortization
Cash flow: $2251
Cash flow: $140 per unit per month
COC = 28.1% (very good)
DSCR = 2.23 (Stellar and bank approved)
Now lets borrow the 25% down at 8%, 25 year amm.
Additional debt service = $666 monthly
New cash flow = $1585 monthly or $99 per unit (Just made the cut)
New DSCR = 1.635 (still passes bank approval)
New COC = 190% (Only cash down was 10k closing costs) Here is where COC does not mean as much as it can be infinate with no money invested.
IMHO this deal is sweet, almost TOO sweet which sends up a red flag to look deep. Apt buildings although residences are a different beast. Each State has a different set of rules to abide by in addition to federal guidelines on residential housing. I am not big on the number crunching area. Since its almost too good to pass up I would enter into a contract with a LOT of subject to's, mainly inspections so you can perform your due diligence. I'd immediately call a commercial broker that specializes in that area in apt bldg sales and see what's up for sale or recently sold, get their I & E info on those buildings to compare. With 16 units you can inspect each apartment as to condition, check the roof, major components etc. to determine what you need to put into it. I'd look at each lease-how quickly are they turning over? evictions? late payments? Verify the expenses by invoice? Check the insurance policy-cost is very high. This is not like a SFR - a roof on a house costs x dollars. A flat tar roof is far more expensive as an example. Was the bldg built before 1978? If so you may have a lead paint issue?
Financials are all well and good but owners do lie (hard to believe) eh? With apts its much easier. If I own Building ABC and I want to sell it because its a pain in the neck, its very easy to deposit some rents from Building DEF into my ABC account to account for some vacancies from May through Sept. I'm still declaring my income but Building ABC looks really great doesn't it? If I had to fix something major in Building ABC and I pay it out of Building DEF, Building ABC looks like it has low expenses, doesn't it? Don't trust tax returns; don't trust owner financials - trace out the last year yourself. Check with the municipality if there have been or are any outstanding Code Violations. Check with the police dept how many times they've been at the address and for what kind of calls. I've even gone as far as sending my girlfriend over looking for an apartment, sending a Super over looking for a job. Tenants love to talk about their building, their landlord, the neighborhood - it's like a mini soap opera but packed with info you would not otherwise have access to.
If the #'s are verified and there are no unknowns or major problems I would JUMP on this one.
This is why I use the 50% rule, because it is based on data from hundreds of thousands of rental units in the United States and not guesswork.
In the quote above, two numbers (10% AND 15%) was used for vacancy allowance in just two paragraphs. It's simply a guess, whereas the 50% rule is based on actual data.
Furthermore, you'll see that the 50% rule was used incorrectly by Will when it was applied. The 50% includes vacancy, it isn't added on. In the above example, Will subtracts the vacancy and then subtracts 50% for operating expenses, which is incorrect and not based on anything other than a wild guess. I'm not arguing that Will shouldn't perform his due diligence that way or by using a Weegie Board for that matter, I'm just saying that it isn't based on actual data.
As I've said many times before, I think that a person should do all possible due diligence. Nail down all the expenses that are knowable (like taxes, insurance, management, etc). See if there are any extraordinary circumstances that would make the expenses higher than 50% of the gross rents and determine if that is a temporary or permanent condition.
If there is some permanent extraordinary circumstance that would make the operating expense greater than 50%, use the higher number. If not, use 50%.
Key points here are that operating expenses in multis are NOT higher than 50% and there is no data to suggest they are. Operating expenses in distressed and mismanaged properties (SFHs or multis) will often (usually) be above 50%. Obviously, after you buy the property; do necessary rehab; and manage it properly, those expenses should return to the norm of 45% to 50%. Also obvious is that you need enough money to be able to support the property during the rehab and return to competent management.
Mike
Mike, I understand what you are saying and for your business model, I do not disagree with your financial analysis approach. What you are misunderstanding here is that I am not guessing. The reason for the "guess" of 15% in this situation is that the original poster did not give us information on the current occupancy. I used a "guess" for the purpose of my financial analysis approach in this thread. I also stated that "IF" a property I am looking at has a current occupnacy of 100%, I know that can not stay the same ALL the time and I alos know that the average vacancy rate will range from 6%-12% so I use 10% so my numbers are safe, as far as occupancy goes.
I use no weegie boards and do much less guesswork than your choice to use a simple rule of 50% as if it would fit every unit. I do not think it does.
At any rate, nothing wrong with your apporach on the analysis and nothing wrong with mine, so PLEASE do not argue or poke holes in mine. I am not doing that to yours. I am simply giving the original poster and all the readers of this thread an alternative viewpoint and financial approach on these types of investment vehicles.
I have personally analized hundreds of apartment complexes and I have found that my approach has worked and been most accurate for me.
All that said, each person now has the option to use MikeOh's financial analysis approach on this type of unit and also has my approach. Nothing wrong with that right MIke? :lol:
Mike please don't skewer me for this but I believe I have seen the "50% rule" in other books although it might not have that exact wording. I was reading "The Complete Guide to Buying and Selling Apartment Buildings" by Steve Berges last night and he used that as his way of initially screening buildings.
Now that I have said that, my experience has been that expense ratios typically fall around 65% (plus or minus 5) excluding vacancy rates. I've been using 50% as a conservative estimate in my calculations though and if a building is break-even based on those numbers then I explore further.
Chris
If you do see something else using that formula, please send me a quote and the date it was published.
Why would you use 50% as a conservative estimate if your experience shows that they are 65%. That doesn't sound very conservative to me.
Thanks,
Mike