Investor · Des Moines, IA · Member since 2015 · 380 posts · 201 votes
Hey guys,
I'm looking for my first large multi-family. I come across one that is in my sweet spot as far as location. Exteriors are in good condition. Interiors are very dated, a couple of units have been completely remodeled.
$127k, $135k, $133k for each year. Maintenance being $30k-$40k, $10k "administrative", etc. This includes about $14k in management fees. These expenses seem awful high. My business will do a lot of the maintenance, but $30-40k seems quite high to begin with.
Landlord does pay heat/water, plus common area electric for a total of $25k/yr.
With this, net incomes are $30-$55k/yr which doesn't support the purchase price. I offered $822k giving me some cushion for remodeling and bringing up rents, and essentially that's too low, not even getting a counter, others interested in closer to asking price.
I'm not sure what I'm missing here, unless expenses can be cut 30-40%, it can't support the asking price.
Real Estate Broker · Canton, GA · Member since 2010 · 15k+ posts · 11k+ votes
10y
Didn't read all of it. When an asset is brand new expenses can be low such as 30% to 35% all in. Over time as things age the pendulum swings the other direction crossing over 50% of gross expected rents. Especially if landlord pays water or heat etc.
Some managers can run low expenses but they do that by not properly maintaining the asset as their bonus is generally tied to cash flow performance and reducing expenses. So when the seller sells they want a sucker buyer. One who believes what they are selling to be true with very little to no validation of the numbers. Those higher cash flows with low expenses they are showing come at a cost of deferred issues with the property. They will try to pass that off as future capex as well and not an immediate need to repair.
There are a lot of buyers right now paying stupid prices for things. Do not be one of those buyers.
Investor · Baltimore, MD · Member since 2014 · 163 posts · 51 votes
10y
Perhaps the owner is just terrible at managing the property so expenses are high. Perhaps he/she had someone come in and set a sales price for them. Perhaps he/she is an absentee owner and higher someone to sell the property for him and doesn't really understand MF valuations.
All you can do is put together an offer that you feel comfortable with. Never offer something you aren't comfortable with. If your numbers don't support it, then submit an offer with an explanation as to why you are offering 822K with your numbers for support.
Investor · Des Moines, IA · Member since 2015 · 380 posts · 201 votes
10y
Yes, there are management problems for sure. I believe they're a pretty absentee owner and leaving management with a tenant and it's not going well. Units sitting for 2-3+ months waiting to be remodeled
If I put in what I would anticipate real expenses being, then it would support that $912k price or close to. It's the fact that my anticipated expenses are so far from what they are saying the last couple of years have been, that I get concerned.
Real Estate Agent · Brooklyn, NY · Member since 2015 · 231 posts · 66 votes
10y
Chase Gochnauer
Hey. Just looking quickly at the number they don't add up to $127k a year. Figuring 40k for maintenance 10k for administrative and 14k for property managemen with utilities at 25k that comes out to around 90k. you are still missing a nice chunk that is not yet explained. Just wondering what else was missing from the list.
Investor · Lodi, CA · Member since 2015 · 29 posts · 4 votes
10y
One thing you can do is implement a RUBS program for the utilities that the owner currently pays. But as a buyer you never base your purchase offer on what the expenses could be, You base them on what the expenses currently are and what the current NOI and Market CAP rate are.
Investor · Des Moines, IA · Member since 2015 · 380 posts · 201 votes
10y
Sorry, I didn't list all expenses, just the ones that stood out as high to me.
Jim, that's what I was thinking also. I'm thinking I'd be better off looking for a A/B class of property that would have more solid numbers. It seems that a lot of these B-/C properties have a lot of "what if's" in the numbers.
Reading your opening post, I few questions come to mind:
Are you working from a pro-forma or the actual financial statements or owners tax returns?
I know you say most units are dated, have there been any significant CAPEx spend? It is not uncommon to encounter owners (or property managers) who lump the CAPEx and maintenance spend together for cash-flow tracking/projection, but someone (the owner, or accountant) should have separated them for year-end and tax filing.
If the owner is self-managing, then it is also not uncommon to use {padded} management fees as a means of drawing income from the company.
If the building has central heating and DHW in a climate like Iowa, your expenses are going to run much higher than @Jeff B.'s 30% of scheduled rent. Depending upon the age of the building and what energy efficiency retrofits have been affected, operating costs in the 50 - 60% range of gross revenue would not be surprising.
In these situations, when looking at a building in one of our "areas", we always model the property with the data provided and then run a comparative model using what we know to be reasonable numbers from other similar properties in the area. This will back-up the spidy sense that something is not quite level in the numbers provided to you.
In the end, you can only make an offer based upon the currentperformance of the business and not any future potential (if you will be the one doing the work to realise future potential, you do not want to pay the Vendor for your efforts). If the Vendor has been padding his operating numbers to float his lifestyle, to the point it makes the business appear to be underperforming, that's his problem.
One final note - we never include ancillary income (laundry, extra parking, etc) in our analysis of the property. I know many do, but it's been our experience that the money from laundry about pays for the service (machines, utilities). In {mid-sized to larger} buildings where en suite laundry is not an option, we will frequently outsource the laundry service with an appliance provider on a revenue sharing model.
Investor · Burlington, VT · Member since 2016 · 110 posts · 59 votes
10y
if you were an expert in that area , i would say you could do some of your own estimates , but that doesn't sound to be the case .
depending on the size and layout of the units , you can add direct vent rinnai space heaters , then separate heat , thats something i have always done .
Buy & Hold Owner · Redlands, CA · Member since 2015 · 5k+ posts · 2k+ votes
10y
@Roy N. "If the building has central heating and DHW in a climate like Iowa, your expenses are going to run much higher than @J Beard 's 30% of scheduled rent. Depending upon the age of the building and what energy efficiency retrofits have been affected, operating costs in the 50 - 60% range of gross revenue would not be surprising."
Yes, very likely. With private metering, heating is offloaded to the tenant, and wherever possible, I'm sure most would even make efforts to get private meters, hence several threads on BP on that subject.
And the 30% is not mine idea, no more that those %2 and 50% rules would be - - just another 'magic' number SOME use in evaluating property performance :)
Investor · Oldsmar, FL · Member since 2014 · 140 posts · 152 votes
10y
Chase,
Are there any pass through opportunities for those utilities?
I would also ask for an itemized list of supplies, maintenance, paint & decorating, Misc. Assuming they use any type of professional software, this should be as simple as selecting those accounts and running a report. If it were me, I'd want to know what the breakdown was for each of those line items to see if there is a real opportunity to cut them.
I own a property where the R&M was $110,000 when one would have expected more like $30,000-$40,000. After getting a breakdown, the culprit turned out to be 3 extra/unnecessary employees on payroll. Took over, didn't retain their positions, and the expenses magically went down to where they should have been.
At the end of the day, I'm not even sure $822k would even be bankable. I don't dabble in apartments but I imagine almost every bank would see an issue with how you plan for this property to cover the note in it's current operating state.
Reading your opening post, I few questions come to mind:
Are you working from a pro-forma or the actual financial statements or owners tax returns?
I know you say most units are dated, have there been any significant CAPEx spend? It is not uncommon to encounter owners (or property managers) who lump the CAPEx and maintenance spend together for cash-flow tracking/projection, but someone (the owner, or accountant) should have separated them for year-end and tax filing.
If the owner is self-managing, then it is also not uncommon to use {padded} management fees as a means of drawing income from the company.
If the building has central heating and DHW in a climate like Iowa, your expenses are going to run much higher than @Jeff B.'s 30% of scheduled rent. Depending upon the age of the building and what energy efficiency retrofits have been affected, operating costs in the 50 - 60% range of gross revenue would not be surprising.
In these situations, when looking at a building in one of our "areas", we always model the property with the data provided and then run a comparative model using what we know to be reasonable numbers from other similar properties in the area. This will back-up the spidy sense that something is not quite level in the numbers provided to you.
In the end, you can only make an offer based upon the currentperformance of the business and not any future potential (if you will be the one doing the work to realise future potential, you do not want to pay the Vendor for your efforts). If the Vendor has been padding his operating numbers to float his lifestyle, to the point it makes the business appear to be underperforming, that's his problem.
Thanks for the response Roy. This is the downside to being new to larger multi-family, is it's harder to know the numbers on similar performing properties. I am very familiar with SFHs, which as a percentage, has much lower expenses than what I'm seeing here.
It did say that capex is included in some of the expenses, and I asked for clarification there but didn't get a good answer. I would imagine depreciation of capex would be removed from the operating expenses for the purpose of selling. I have the "projected pro forma" as well as income statements from the last few years.
The heating system is a boiler, there are two separate twin 12 unit buildings. The units do have newer vinyl windows, but original early 70's cabinets, counters, etc. Bathrooms are a bit rough as well. Exterior has <10 year old roof and decks, and is a brick exterior. Parking lot is in decent shape. But inside, I would want to redo the common areas to update the look and could possibly bring in higher rents because of it, maybe an add'l 12% return on my $100k upgrades to update it in increased rents.
@Roy N. "If the building has central heating and DHW in a climate like Iowa, your expenses are going to run much higher than Jeff Beard 's 30% of scheduled rent. Depending upon the age of the building and what energy efficiency retrofits have been affected, operating costs in the 50 - 60% range of gross revenue would not be surprising."
Yes, very likely. With private metering, heating is offloaded to the tenant, and wherever possible, I'm sure most would even make efforts to get private meters, hence several threads on BP on that subject.
And the 30% is not mine idea, no more that those %2 and 50% rules would be - - just another 'magic' number SOME use in evaluating property performance :)
J
We've done this very analysis several times.
Central heating in a building of that size typically means boiler. If there is a single manifold (not a given) and you have the space in the mechanical room (also not a given), I suppose you could install 24 small boilers and metre each to the unit it supplies .... or you could rip-out the hydronic system and install electric baseboards (and DHW heaters) and off-load the heating costs to your tenants.
However, the costs of such an undertaking are not insubstantial and, would {most} often be better spent improving the performance of the building envelope and, if needed and possible, upgrading the central boiler to a {smaller output} high-efficency, direct-vented, gas-fired boiler.
In our personal case, we have a business ethos which basically says it the building performs so poorly that the heating/cooling and DHW costs are too much for us, then they are too much to reasonably expect our tenant to shoulder. Which translates into improving the envelop before off-loading to your tenants.
Investor · Des Moines, IA · Member since 2015 · 380 posts · 201 votes
10y
Originally posted by @Account Closed:
Chase,
Are there any pass through opportunities for those utilities?
I would also ask for an itemized list of supplies, maintenance, paint & decorating, Misc. Assuming they use any type of professional software, this should be as simple as selecting those accounts and running a report. If it were me, I'd want to know what the breakdown was for each of those line items to see if there is a real opportunity to cut them.
I own a property where the R&M was $110,000 when one would have expected more like $30,000-$40,000. After getting a breakdown, the culprit turned out to be 3 extra/unnecessary employees on payroll. Took over, didn't retain their positions, and the expenses magically went down to where they should have been.
At the end of the day, I'm not even sure $822k would even be bankable. I don't dabble in apartments but I imagine almost every bank would see an issue with how you plan for this property to cover the note in it's current operating state.
I don't see any great way to meter off the utilities. It's one boiler for each of the 12 units. Boilers appear to be in good condition, but unsure how feasible it'd be to split them off.
I have asked for breakdowns but haven't gotten much detail. I am meeting the agent on another property tonight and will press for more info.
I sent what I had over to two banks, fully pre-approved on one(they already have all of my info) and a tentative approval on another.
They had an on-site manager for like 15 years and he passed away, and they have another one now for 1.5 years or so and they haven't been doing so well.
Rental Property Investor · Fredericton, New Brunswick · Member since 2013 · 7k+ posts · 4k+ votes
10y
Chase:
More questions:
Is there a separate boiler per building or a common heating plant for both buildings? What is the fuel type? What is the age of the boilers? Are the boilers the sole source of DHW or are there separate gas/oil fired hot water heaters? {this is significant as it will determine whether the boiler need fire year round}.
Are the roofs flat or pitched? If flat, then is it membrane or tar & gravel? If membrane, what type and was any significant amount of insulation installed before the new roof was torched down?
If it is a pitched roof, is the pitched roof original, or were the buildings over-roofed? If original, has any insulation been added (don't hold your breath}? If over-roofed, did they remove the old flat roof (membrane or tar & gravel) and/or lay down insulation (at least R40) when the over-roof was installed?
12-units are fairly small to get economies of scale - sharing a heating plant would help - but large enough you are dealing with commercial facilities.
Based upon your description of the units and common areas, I would assume a full overhaul/upgrade of each was going to be required over the next 3-5 years (at 10-15K/unit, you will be budgeting 240K - 360K ... this will include your common areas ... and hoping you can do it cheaper).
At this point, I would be more concerned on the condition and performance of the infrastructure: fabric/envelope (insulation and air sealing, windows & doors, roofs); HVAC; DHW; electrical, etc. as those will be the most disruptive and expensive items to address.
Your area will also play a part in determining if the price is acceptable. Assuming the infrastructure is - at least in part - as dated as the decor, is 40-41K/unit reasonable/acceptable in your area? How do current rents compare to market? Will an improvement to market rent justify/pay-back the cost of bringing the building up-to-date?
{I cannot answer this ... here, it would be considered cheap ... an updated building would fetch $800 - $900/month per 2-bdrm and $675 - $750 for a1-bdrm unit and would transact at $70 - $80K/unit
However, it does not sound cheap from what you have provided about the building and your area.}
Remember - patience is your best tool and sometimes the best deal is the one you let go.
I see we are leap-frogging one another with our posts.
One boiler for both buildings may have been a good thing ... but separate heating plants leaves the opportunity of splitting-up the buildings in the future.
@Jeff B. - boilers are not always an issue, it is possible to have a very efficient hydronic heating system ... even a common plant for multiple buildings ... but the HVAC plant has to be but one part of a cohesive system. The bigger problem has been our {North American} practice of erecting mediocre buildings and oversizing the HVAC system to compromise.
Buy & Hold Owner · Redlands, CA · Member since 2015 · 5k+ posts · 2k+ votes
10y
We easily fall prey to assuming "my area, conditions" are typical - - kind of silly when you think about it. Not only is the weather vastly different from the N. East to the S. West, but homes are built differently and methods of heating/cooling also vary vastly. (as a native California it's easy to loose touch with other regions).
Googling will show that the dominant utility expense for American homes is heating.
I tried feeding the above, along with the ask price and revenue numbers into our modelling software. Once again the BIG CAVEAT that I do not know your area.
When you lump maintenance and Paint & Decorating together the total is about 10% of scheduled rent, which is not unreasonable for maintenance.
The Admin management fee is ~6% of scheduled rent, which again is not unreasonable if a PM were managing a building of that size.
The Water/Sewer numbers seem a little high, but your utility costs could well be greater than ours ... and/or you have really old 3 & 5 gallon toilets and 2.5 - 5 usg shower heads.
The gas bill makes me wonder:
- just how much insulation there is in the building envelope;
- whether the zone controls are effective (or are folks too hot and opening windows);
- whether the boiler fires to make all DHW
I'm not sure why there is an on-site management fee of $12K unless this is inclusive of "rent in-kind" to the Superintendent.
I will assume the Services number includes yard work, snow removal, janitorial, pest control.
The Supplies amount of 14K is high when you consider maintenance and Paint & Decorating are already accounted.
Are the professional fees legal costs for evictions/judgements?
I would flag the Misc as a potential - owner's pocket - category.
Ironically, I recently analysied a 42-unit building whose operating costs are within 8K of the numbers above (it has distributed heating and hot water) and a 25-unit building (central heat / hot water) whose operating costs were 15K lower.
We easily fall prey to assuming "my area, conditions" are typical - - kind of silly when you think about it. Not only is the weather vastly different from the N. East to the S. West, but homes are built differently and methods of heating/cooling also vary vastly. (as a native California it's easy to loose touch with other regions).
Googling will show that the dominant utility expense for American homes is heating.
Precisely ... I did a little online look and Iowa's winters are a little warmer, but not terribly different than our own (this year being an exception).
Real Estate Broker · Canton, GA · Member since 2010 · 15k+ posts · 11k+ votes
10y
Didn't read all of it. When an asset is brand new expenses can be low such as 30% to 35% all in. Over time as things age the pendulum swings the other direction crossing over 50% of gross expected rents. Especially if landlord pays water or heat etc.
Some managers can run low expenses but they do that by not properly maintaining the asset as their bonus is generally tied to cash flow performance and reducing expenses. So when the seller sells they want a sucker buyer. One who believes what they are selling to be true with very little to no validation of the numbers. Those higher cash flows with low expenses they are showing come at a cost of deferred issues with the property. They will try to pass that off as future capex as well and not an immediate need to repair.
There are a lot of buyers right now paying stupid prices for things. Do not be one of those buyers.
Investor · San Jose, CA · Member since 2012 · 2k+ posts · 3k+ votes
10y
Chase,
I've analyzed enough of these low-end deals to know that the reported expenses are not out of line. In fact, it might be a little low with 3% property taxes and no capex factored in. 1.8% rent/value ratio sounds cool and looks good on paper, but it's a 6 cap at list price. Where do you think the 2% rule comes from? Some people short-change themselves by either inexperience or not being realistic with their analysis.
Just want to put things in perspective so the fellow Bay Area investors don't get lured into these low end products and get whacked. It's easy to buy, but it's not easy to get out without taking a loss. Buying right is a must.
Real Estate Broker · Canton, GA · Member since 2010 · 15k+ posts · 11k+ votes
10y
This is a conversation I have weekly with various investors across the country. What yield you get is tied to what I call the "hassle factor".
This means to me how much of a headache and time is involved on my part for the expected return? 4 years ago you could buy an apartment building and even with a headache the rent growth looked good recovering from the bottom of the market and equity growth potential was high. The cap rate you could buy at was great.
Today people are selling multifamily at 6 caps. Underwritten with real numbers likely 5 caps. Property taxes are increasing at these properties because city and county assessors are going out on the hunt for more money. That eats into multifamily returns.
If all I am getting is a 6 cap then I tell clients we can get a brand new NNN lease building with 15 years guaranteed by a national tenant for that where you get 2% increases a year and DO NOTHING for NNN.
Work or no work for the same yield it's a no brainer.
I have looked at businesses before as well. Those can't just throw off 15%. They have to throw off way more than that to justify the investment versus real estate. Everything is relative to the work involved.
This is just the way I personally look at investments.
Investor · Des Moines, IA · Member since 2015 · 380 posts · 201 votes
10y
Hey guys, sorry I was out looking at another building tonight. Thanks for everyone's info, I had come to a lot of the same conclusions as you guys, which leads me to believe that I'm not crazy in thinking this is not worth $912k. Maybe they'll come to reality eventually and we can deal but sounds like I need to pass for now.
Another property I looked at tonight is a 20 unit for $700k. Running numbers on it, it's realistically around the 7-8% cap rate but it is an older building and likely will have higher CapEx than I've calculated.
Tricky to find a good deal. I'm thinking my best bet will be to move up my price range and look for more solid, newer, properties even if the cap rate is a little lower.
Rental Property Investor · Grand Jct, IA · Member since 2011 · 17 posts · 5 votes
10y
expenses avg 131k gross income is 186k value of the property is 547,810 and not a penny more. Why are you trying to justify the 912k over priced the income tells you what the price or real value of the property is, 822k is to much $547,810 is whats its worth.
