Analyzing a 50-unit apartment- "The 1% Rule" ?
Specialist · Annandale, MN · Member since 2016 · 14 posts · 5 votes
I have an opportunity to purchase a 50 unit apartment, along with 7 other SFR properties (14 doors total for those) from a retired old-school RE investor. He keeps telling me that he used to buy his properties using the 1% rule, and wants to sell them as such. His explanation of the rule is: If gross monthly rent on SFR is $1,000 ~ House should sell for $100k. If his 7- unit brings in $5,000, he wants to sell it for $500,000, and since the 50 unit apartment brings in $28k gross rent a month, he wants to sell for $2.8 million. I'm in the process of analyzing the apartment financials to make him an offer. But I don't know enough on how to analyze apartments to counter and negotiate. Like I said, he's very old school, has no debt on all his properties, and I know him well enough to know he's not out to swindle me. I can analyze SFR all day long, but very green in the apartment arena. It was a 5 year goal to move in that direction, but this opportunity presented itself 4 years and 3 months early. Any suggestions for analyzing?
I can tell you that an apartment unless it's brand new in Alex is not worth a 6 cap. You're likely closer to an 8 cap on the market depending on the condition, age, location, etc. Also, Alexandria is a small city, so with a little downturn, high vacancy can occur. The last thing is the expenses can be 60%+ if it is a central boiler, especially a steam boiler.
@Pete Edmonson - the 1% rule is still used for "rule of thumb" evaluation of a property. That being said, it is only a rule of thumb.
I would suggest finding out what the average Cap rate is in your market area, and base your price on that. For example, if properties in your area average a 6% cap, base your price on 6% as a negotiation. 6% would put the price at roughly $2.4mil
By using average Cap rate in the area, you have some logic behind negotiating.
@Pete Edmonson I know lots of people that use that method. If you know the local market it is a really quick way to think about things. I hope we do not have to have a huge CapEx, cost of money, deferred maintenance discussion. Before people start putting the system down let me just put it out there... I know several people that profit more than $250,000 a month from rentals that were bought using this system to analyze the deal.
If you are trying to talk him down, I would suggest looking for some major CapEx issue. Other than that good luck.
@Pete Edmonson - I agree with @Account Closed, and I usually use the 1% rule as part of my property analysis. I won't base my entire purchase plan on that, but it is definitely a quick and easy tool to use when evaluating a property.
Assuming 55% of your monthly income goes toward expenses, here are the numbers that I get using that quick tool:
So consider figuring out the Cap Rates of your area and use that as part of your negotiation. If you have ways to add value to the property (either increase income or decrease expenses), you can purchase this at 6% and then raise it to a higher Cap through value add.
@Pete Edmonson I forgot to mention something. As @Ben Wilkins mentioned the rents might be able to be raised immediately. Many people like the owner you mentioned are slow to raise rents.
@Pete Edmonson, as far as I know there are 3 main reason to improve the cash flow on buildings:
1. If the rents are below market
2. If there are any renovation needs to be done to increase the value of the property
3. Reduce the the current expenses on the property.
If you you can do any of the above, that will increase the value of the investment.
Another kmportant point is if the owner willing to finance (seller financing) any part of the purchase. Sometimes, buyers willing to accept higher price if seller finanace is in place.
Let me know if you need additional details on any of the points above.
Oleg
Thank you guys! Yes rents can be instantly raised $25. per unit to easily add $15k/ year to the bottom line, no overdue cap ex or maintenance to speak of, everything is very clean, and the owner has said he will consider carrying all or half of the down payment as a 2nd. So now it looks like I gotta find the Cap Rate for the area to negotiate a purchase price, get my contingent's set up, and move into the next step of nailing down bank and/or private funding. Thanks @BenWilkens, @MichaelBiggs, @OlegShalumov
@Pete Edmonson while I agree that you should base your purchase on cap rate for the area, as well as sales comps at a price per door level, at the end of the day it's all about the return you wan to make on you're money. If he's going to stiff arm you $2.8 million purchase or slightly lower, but in your analysis it shows you making 12% Cash on Cash every year (hypothetical situation) well it might not be the worst thing in the world to overpay a bit (and overpay is in the eyes of the beholder). You have to know what you're situation is and what return you are willing to accept and go from there. Maybe you haven't been able to find a good deal at your price point in an area you like and while maybe you'd rather pay less, you have money just sitting there so this would be a good investment at this point in time, even if it's not a great investment. There's an endless amount of situations that it could be.
A lot of people will say only buy on cap rate and while that is probably true most of the time, there's plenty of deals where you CANNOT buy based on cap rate and actually expect to win the deal. Where as if you would have overpayed you might have won the deal and still made a good return on your money. Like I said it's all dependent upon your situation.
I have an opportunity to purchase a 50 unit apartment, along with 7 other SFR properties (14 doors total for those) from a retired old-school RE investor. He keeps telling me that he used to buy his properties using the 1% rule, and wants to sell them as such. His explanation of the rule is: If gross monthly rent on SFR is $1,000 ~ House should sell for $100k. If his 7- unit brings in $5,000, he wants to sell it for $500,000, and since the 50 unit apartment brings in $28k gross rent a month, he wants to sell for $2.8 million. I'm in the process of analyzing the apartment financials to make him an offer. But I don't know enough on how to analyze apartments to counter and negotiate. Like I said, he's very old school, has no debt on all his properties, and I know him well enough to know he's not out to swindle me. I can analyze SFR all day long, but very green in the apartment arena. It was a 5 year goal to move in that direction, but this opportunity presented itself 4 years and 3 months early. Any suggestions for analyzing?
Where exactly is the apartment located? Same thing with the SFRs.
@Account Closed Alexandria, MN
@Pete Edmonson So I haven't the first clue if his price is good, bad, fair, or horrible. Even an "old school" investor has to report their returns to the government. Even an old school investor *should* be tracking collected rents, expenses, etc. What did he say when you asked him for financials? A T12? Something that can be used to come up with the actual NOI? Ideally he's using a 3rd party property manager and you can sign an NDA to get a PDF (or any record) of the actuals.
The reason I bring that up is that I've looked at properties where *collected* rents are nowhere near projected (proforma) rents. You owner says it's 50 * 560 = $28K per month, what do the rent rolls show? I've also looked at properties where expenses end up being far higher that 55% once everything is added. The latter tends to be older properties or properties in a rougher area where tenants are a little tougher on them.
if you can raise rents then you might actually be at an advantage by allowing him to use 1%.
I did the same with another property (with a similar old school landlord). he priced at 330k and was saying how he could get rents to 2700. I assured him any other investor would only blink at it if it fell within the 1% rule so I managed to buy it at 258k.
I can tell you that an apartment unless it's brand new in Alex is not worth a 6 cap. You're likely closer to an 8 cap on the market depending on the condition, age, location, etc. Also, Alexandria is a small city, so with a little downturn, high vacancy can occur. The last thing is the expenses can be 60%+ if it is a central boiler, especially a steam boiler.
I would ask him to verify all the data. Actual receipts. Show me the T12 and the deposits into an account. Show me you paid taxes on the income from the property. Expenses are tough to validate. They can be manipulated to differ or kept as off balance sheet expenses.
If he will carry paper it is worth looking hard at the project. If you can reduce cash out of pocket, that is worth a great deal. Cash preservation is always important, especially for a deal of this size. Keeping 560k or most of that sine he will finance the down is a huge value.
That is great for him if he can sell to you at the 1% rule and the comps result in market values that yield the 2% rule. Great for you if you buy at 1% rule when the market offers 0.75% on comparable properties. I'm going to take a wild guess that the situation is more like the 1st scenario.
Properties are NOT valued off of the 1% rule ... in the case of residential properties (SFRs) fair market value is determined via sold comp prices. For the 7 unit, that is commercial property, which is valued by applying the market cap rate to the property's NOI. I would encourage you to research or talk to an appraiser about how to do property valuation. If you are getting a bank loan, then appraisal will need to be ordered anyhow as a condition of financing.
The bank cares not for the return you are trying to make, if the property doesn't appraise, you are not getting a mortgage. The market also doesn't care about the return you are trying to make, if you try to buy or sell the properties based on your return criteria, and the market disagrees, there will probably not be a transaction unless of course your return expectation results in you over paying ... the market will let you do that, but the bank still might take issue with it :)
@Pete Edmonson NOI and cap rates. Figure out your gross rents, vacancy and expenses(excluding finance charges) for the NOI. Then determine what the fair market cap rates are in your area and you will get your valuation of the property. Then its deciding whether your willing to pay that cap rate and whether you and the seller want to deviate from it to make it more favorable for either party.
Good luck and reach out if you want to chat through the deal!
All this info is truly dynamic, so thank you! I've received non-audited financials, walked through (but not fully inspected with my team) the property, and am massaging the purchase price in my spreadsheets down to the point to get me a cap rate of 10. With annual NOI of $226k, [$346k income-$120 expenses= ] and a Cap Rate of 10, that puts my PA at approx $2.2m. A couple of positives- a.) there is definitely room to raise rents modestly while reducing some expenses, b.) all 50 units are fully furnished! (I told you he was old school). So his 1% rule included all furniture, personal property, chattel, etc. Some negatives to consider a.) HUGE monthly DS of at least $11k-15K, b.) Property taxes will probably triple once the new value gets recorded. c.) He's in his 80's and still runs the property so finely-tuned it's like Wonka's Chocolate Factory- which I would have a hard time duplicating, which means my expenses for "unknowns" has to go up. Is it possible to feel 'in over your head' and 'confident you can slay the dragon' at the same time :)
@Rusty Pollard, the answer is luck (or preparation meets opportunity).
No-joke, 20+ years ago my Investment Realtor used to live in this same 50-unit place, and got to know the owner and his wife really well, (realtor was getting back on his feet, raising his kid, renting from them, and this couple takes a liking to him) and fast forward to now, and the owner wants to sell all his properties. So- my realtor told me about it. And yes, most of the properties he is liquidating is 'off market' right now.
Luck more often comes to those working hard to make things happen! Networking is absolutely key. Congrats on the find!
I have a duplex in the St. Paul area and some of my partners are very active in that area. Feel free to reach out if you'd like to chat or if you need someone to bounce ideas off of.
@Account Closed Alexandria, MN
If market data is correct, it appears a 1 bedroom apartment in the area goes for anywhere from $490 to $518. So I would use $504 for rent. Is rent declining or something? It also seems the vacancy rate in the area is above national average at 11.7% so occupancy rate of about 88.3%.
Using these numbers, gross revenue then is about $267,019 and estimating 50% expenses, NOI = $133,510; the cap rate for the area does seem to be somewhere in the 6% range so estimated value = $2,225,160.
This would also mean a price per door of $44,503 and a price to sales/income of 8.33.
The range of the price to sales does seem to mirror industry. So you can multiply gross sales by 7.5 to 8 to get rough estimate of value.
I have an opportunity to purchase a 50 unit apartment, along with 7 other SFR properties (14 doors total for those) from a retired old-school RE investor. He keeps telling me that he used to buy his properties using the 1% rule, and wants to sell them as such. His explanation of the rule is: If gross monthly rent on SFR is $1,000 ~ House should sell for $100k. If his 7- unit brings in $5,000, he wants to sell it for $500,000, and since the 50 unit apartment brings in $28k gross rent a month, he wants to sell for $2.8 million. I'm in the process of analyzing the apartment financials to make him an offer. But I don't know enough on how to analyze apartments to counter and negotiate. Like I said, he's very old school, has no debt on all his properties, and I know him well enough to know he's not out to swindle me. I can analyze SFR all day long, but very green in the apartment arena. It was a 5 year goal to move in that direction, but this opportunity presented itself 4 years and 3 months early. Any suggestions for analyzing?
I would not pay $2.8M for a $28K rent roll. I recently paid $1.19M for an 80 unit with a $30K rent roll. Feel free to PM me and I'll send you the spreadsheet I use to value larger multis.
I suggest going through all of the financial numbers very carefully and then showing those numbers to him along with what real expenses are for the property. Be sure you add back in the cost for the property taxes when you're showing this to him, as well as hiring management and maintenance if he does those items himself. The other thing a lot of people miss would be accounting fees and bookkeeping fees Also if there are any comps that you can show him with in the last few years that would be helpful as well. You can show him the areas of vacancy rate the current market rent and all of that to ensure him that you are not giving have a lowball offer
I have an opportunity to purchase a 50 unit apartment, along with 7 other SFR properties (14 doors total for those) from a retired old-school RE investor. He keeps telling me that he used to buy his properties using the 1% rule, and wants to sell them as such. His explanation of the rule is: If gross monthly rent on SFR is $1,000 ~ House should sell for $100k. If his 7- unit brings in $5,000, he wants to sell it for $500,000, and since the 50 unit apartment brings in $28k gross rent a month, he wants to sell for $2.8 million. I'm in the process of analyzing the apartment financials to make him an offer. But I don't know enough on how to analyze apartments to counter and negotiate. Like I said, he's very old school, has no debt on all his properties, and I know him well enough to know he's not out to swindle me. I can analyze SFR all day long, but very green in the apartment arena. It was a 5 year goal to move in that direction, but this opportunity presented itself 4 years and 3 months early. Any suggestions for analyzing?
I would not pay $2.8M for a $28K rent roll. I recently paid $1.19M for an 80 unit with a $30K rent roll. Feel free to PM me and I'll send you the spreadsheet I use to value larger multis.
Are you saying you recently bought an 80 unit apartment in Alexandria MN at that price? This would be a property in a similar condition not requiring rehab? The price per door will often vary per market.
I have an opportunity to purchase a 50 unit apartment, along with 7 other SFR properties (14 doors total for those) from a retired old-school RE investor. He keeps telling me that he used to buy his properties using the 1% rule, and wants to sell them as such. His explanation of the rule is: If gross monthly rent on SFR is $1,000 ~ House should sell for $100k. If his 7- unit brings in $5,000, he wants to sell it for $500,000, and since the 50 unit apartment brings in $28k gross rent a month, he wants to sell for $2.8 million. I'm in the process of analyzing the apartment financials to make him an offer. But I don't know enough on how to analyze apartments to counter and negotiate. Like I said, he's very old school, has no debt on all his properties, and I know him well enough to know he's not out to swindle me. I can analyze SFR all day long, but very green in the apartment arena. It was a 5 year goal to move in that direction, but this opportunity presented itself 4 years and 3 months early. Any suggestions for analyzing?
I would not pay $2.8M for a $28K rent roll. I recently paid $1.19M for an 80 unit with a $30K rent roll. Feel free to PM me and I'll send you the spreadsheet I use to value larger multis.
Are you saying you recently bought an 80 unit apartment in Alexandria MN at that price? This would be a property in a similar condition not requiring rehab? The price per door will often vary per market.
The property required no rehab and was constructed in the 90's. The only issue that came up during inspection was two broken rafters, a couple disengaged shingles, a few holes in the vinyl siding, and cracks in the sidewalks. Total estimate to fix everything was about $5k. Property was 100% occupied at takeover and located near Charlotte, NC.
Are you saying you recently bought an 80 unit apartment in Alexandria MN at that price? This would be a property in a similar condition not requiring rehab? The price per door will often vary per market.
The property required no rehab and was constructed in the 90's. The only issue that came up during inspection was two broken rafters, a couple disengaged shingles, a few holes in the vinyl siding, and cracks in the sidewalks. Total estimate to fix everything was about $5k. Property was 100% occupied at takeover and located near Charlotte, NC.
Interesting... for all we know, you may have overpaid for your property based on what the market rate is in Charlotte NC. Some areas in MN price per door is between $70,000 to $75,000. That is within the state of MN. I included a map here just so someone else can help count how many states exist between NC and MN :)
Again, different markets have different prices and cap rates. In New York City for instance, $400,000 to $500,000 per door or more is normal rate.