First Apartment Analysis - What Am I Missing?

Multi-Family and Apartment Investing
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First Apartment Analysis - What Am I Missing?

Ryan York
Investor · Harrison Township, MI · Member since 2015 · 131 posts · 45 votes

Hey all!

Happy Monday.

My partner and I have been looking into apartments for a little while now, and we think we've finally come across a deal that works for us.

The complex is 8 units. Currently only one unit is rented out. Three units aren't in bad shape and can be rented out basically immediately with some very basic cosmetic work. We plan to rehab the remaining 5 units over the next 5 months.

Our plan is to rehab the units, get them rented out, and refinance out as much cash as possible as soon as possible. I'm planning for 3 years.

I've attached some PDFs below including our repair costs and analysis on returns. We feel like it's a good opportunity. Which leads me to the all important question, what am I missing? I'll bullet point some numbers below.

Purchase Price: 230k (cash only per the seller)

Rehab: 98k

Gross Rent After Rehab: 5600

Estimated Cash Flow After All Expenses: 12,278 annually

Estimated NOI After Rehab: 33,560 (including vacancy, all expenses)

Estimated ARV based on 10% cap rate in 3 years: 335,600

Post Rehab:

We'd refi and pull out roughly 268k (80% of our estimated 335k valuation), leaving us with about 60k in the property and a payment of $1,773 at 5% interest and 20 year term.

We realize the ARV isn't stellar in relation to what we'd have in it. I have a few reasons to believe it's still a good deal for us. First, most sold apartments in the area are closer to 9-9.5% cap rates. I'm just being conservative there. Second, we really like the area. It's currently probably a C area now, but it has all the makings for turning into the next popular little "main street" hang out spot. Lastly, the cash flow on this would be very good. I'm seeing over 20% cash on cash returns with all expenses included.

If we're even a little bit right about the area, and it went to say, an 8% cap rate, we'd be sitting pretty. If the market tanked, rent would have to drop 30-40% for us to start cash flowing negative. Assuming that didn't happen, we could easily hold the property until it rebounds.

Are we being blinded by the cash flow returns? Is the ARV too tight with the repair costs? What else?

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Anthony Dooley
Investor · Columbus, GA · Member since 2014 · 2k+ posts · 1k+ votes
8y

It doesn't matter what they are asking. There is only one unit producing income. You cannot value the property based on projections. You should value the property based on how much income it has produced in the past 12-24 months. You said you would buy it for 230K and put another 100K in rehab costs. That is 330K. Then your projection in 3 years is that it will be worth $335K? So it only increases $5,000 in 3 years after spending $100K? C area, 10 Cap? You are speculating Sir, not investing.

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  • Russ Draper
    Investor · Boston, MA · Member since 2015 · 398 posts · 147 votes
    9y

    Ok so obvious questions, why aren't those vacant units rented now if they are pretty much ready to go?  Have you checked out other units for rent to compare?  Are you being realistic on your rental numbers?  Are there any obvious red flags with maintenance on the building that could be costly to fix (structural, asbestos, etc)?

    1Reply
  • Taylor Chiu
    Real Estate Agent · Salt Lake City, UT · Member since 2014 · 473 posts · 230 votes
    9y

    Cool post @Ryan York. The deal looks pretty solid to me, as long as you can keep the rehab within your specified budget. Question though, why will it take 3 years to pull your money back out? Seems like you'd be able to do it quicker, like in a year?

    0Reply
  • Ryan York
    OP
    Investor · Harrison Township, MI · Member since 2015 · 131 posts · 45 votes
    9y
    Russ Draper thanks for picking! The current owner inherited the property. They aren’t really interested in operating it. The seven vacant units need to pass city inspection. We have a copy of the report and it’s all tic tac stuff like smoke detectors and weeds. We plan to get a new inspection done before closing. I’m assuming this is the main reason they haven’t bothered. We’re really eyeing a longer term play so we’re definitely doing more rehab than necessary for the current market but we’d like to establish the place as one of the nicer complexes. Many of the nearby buildings are ugly and super beat up inside. We walked through with our contractor and we all agreed that no huge problems seem to need fixing. They disclosed that the furnaces are old and need replacing. We hope to be able to pay for that with capex reserves and cash flow as we start to accumulate some cash. Obviously if they break sooner we will have to come out of pocket. As far as rent goes, I used rentometer and called a few nearby complexes. Like I said before, we’re doing more than we probably should at this stage of the market but we’ll also be able to attract a better tenant. We’re still cheaper than 2/1 single family houses and many 1/1 sfh. We will definitely be one of the nicest complexes in the area after the rehab. Taylor Chiu Thanks for commenting! Three years is really more of a conservative thing than anything. It’s our first apartment so I’m just assuming things won’t go completely as planned. I know many banks require a seasoning period with proof of steady income. I figure if it takes 8 months to get fully up and running, another year for proof, and a few more months for something unforeseen, we would be into year 3.
    1Reply
  • Roberto Gutierrez
    Nashville, TN · Member since 2017 · 95 posts · 91 votes
    8y

    The issue I see with this one is that your not buying it based on current cash flows. I understand it is 8 units for 230k, but the going in cap rate must be very low. You mentioned if the furnaces go out you will hopefully replace them with reserves or cash flow. I would make sure you have that money allocated from the start because you're down a unit if that goes and you can't fix it. I wouldn't be surprised if expenses are higher than 50% of gross rent on a property this small, so you might need to increase that number. 

    I also think you should recalculate your cash on cash with the first couple of years in mind. If you are buying this in cash you probably won't see much of a return the first year, and if you cash flow 13k in year 2 your at a 4% cash on cash with the 330k all in costs. Again this is assuming you are buying with cash which i may be misinterpreting. 

    It just seems like a lot of risk for a small reward. For an asset that isn't occupied I think you should be able to refi and pull out all of the cash. If you have that much cash to invest you could even invest passively in a syndication or partner with a syndicator. You could fund the pursuit costs for 6 sizeable (100 unit) multifamily properties with 300k and end up with all of your money back and hundreds of units in three years.

    3Reply
  • Anthony Dooley
    Investor · Columbus, GA · Member since 2014 · 2k+ posts · 1k+ votes
    8y

    It doesn't matter what they are asking. There is only one unit producing income. You cannot value the property based on projections. You should value the property based on how much income it has produced in the past 12-24 months. You said you would buy it for 230K and put another 100K in rehab costs. That is 330K. Then your projection in 3 years is that it will be worth $335K? So it only increases $5,000 in 3 years after spending $100K? C area, 10 Cap? You are speculating Sir, not investing.

    5Reply
  • Adam Adams
    Podcaster & Multi-Family Apartment Investor · Denver, CO · Member since 2016 · 273 posts · 138 votes
    8y
    The one thing you're definitely missing is some expenses. You'll probably be operating at a 50%-60% expense ratio. (So your cap rate is showing much higher than it will be) Also I'm worried about the all cash contingency from the seller. (It is common for sellers to request this when they know a lender will not lend on the property.) I would make your first deal a conservative one. Wishing you success! -AAA
    1Reply
  • Ryan York
    OP
    Investor · Harrison Township, MI · Member since 2015 · 131 posts · 45 votes
    8y
    David Rawls
    0Reply
  • Ryan York
    OP
    Investor · Harrison Township, MI · Member since 2015 · 131 posts · 45 votes
    8y
    Roberto Gutierrez thanks for commenting man! Realistically I’d say it doesn’t even have a cap rate of it’s own per se currently. It has one out of eight units occupied. Yes the cap rate now and over the last year would be horrifically low but it’s also not performing anywhere near it’s conservative potential. I looked at it more like what do I think this thing could realistically do with tenants in place, and what value and cash flow would it have at that time. It’s always tough to speculate at what I think it will be worth 3 or 5 years later because no one really Knows. We can make an educated guess at it but maybe the market ranks in six months. I saw the cash flow and thought it seemed like a safe play even if the market tanks. If it goes up, then I’ll have even more equity. Related to the cash flow, I didn't really know how to handle that. I did prepare something that tracks the income during the first year with the rehab, but I didn't really consider the returns during that time. The CoC will be pretty bad, but that's be to expected considering most of the property will be vacant for several months. I attached a new spreadsheet to show you what I mean. When you're looking at a project in full, how would you factor the pre-rehab stages into things? Thoughts?
    0Reply
  • Ryan York
    OP
    Investor · Harrison Township, MI · Member since 2015 · 131 posts · 45 votes
    8y
    Anthony Dooley thanks for making me think! So how would you value a value add property like this then? If it hasn’t had hardly any tenants in the last year (reasons for that aside), meaning very little income, what do you offer? You could take a stab at the total expenses and obviously you’ll end up with some sort of terrible negative cash flow and negative revenue. I agree that’s a concern but it’s also the idea of a value add with bad management. I would argue that I’m not speculating at all. Whereas most value add plays are buying with the hope that their property appraises for significantly more than they pay in 2-5 years, I’m buying mostly for the cash flow. I’m seeing pretty solid returns with basically no appreciation at all. If we’re even a little bit right about the area, this turns into a killer deal. If we’re wrong and it stays the same or even gets a little worse, we still cash flow positive until it turns around. Sure I’m assuming some rent values and that we can get tenanted, but that’s all current market values. I’m not banking on anything getting better in the future. It’d be nice though 😊 thoughts?
    1Reply
  • Ryan York
    OP
    Investor · Harrison Township, MI · Member since 2015 · 131 posts · 45 votes
    8y

    @Roberto Gutierrez

    0Reply
  • Ryan York
    OP
    Investor · Harrison Township, MI · Member since 2015 · 131 posts · 45 votes
    8y

    @Adam Adams Thanks adam! I agree I'd like our first deal to be a no doubter, but we work with what we have I suppose. You mentioned the expenses. Currently, the spreadsheet has them at about 45%. Normally, I would agree that they're going to hover around 50%, but I figured that considering all of the units have just been rehabbed, it might be a bit lower. I'm still accounting for $550/mo in capex and $250/mo in general repairs. That's 15% of the monthly income. Furnaces here are about $1600 a piece, so unless all of them break in the same month, or the first month, between our cash flow, capex and repair money, they shouldn't be too bad. If they do all break, we'll have the money to fix them so we won't be sitting with a bunch of units we can't rent because of the furnace. The utilities are bit a lower because we plan to use RUBS. 

    What else would you include that I haven't in the spreadsheet?

    0Reply
  • Anthony Dooley
    Investor · Columbus, GA · Member since 2014 · 2k+ posts · 1k+ votes
    8y

    I am going to guess that this has been on the market for a while. I value a property the same way a bank does. Net Operating Income divided by the prevailing cap rate. If you over pay a little, it won't kill you. I would offer to lease all 8 units for $200 per month for 1 year with an option to purchase it for full price at the end. Then I would use my cash to renovate one unit and get it rented. Then a second, etc. At the end of the year, if all of your predictions come true, you buy it. BTW, the seller gets "all cash" at the sale. That doesn't mean it has to be your cash.

    2Reply
  • Frederick Kirk Wendel
    Custodian · Lander, WY · Member since 2017 · 59 posts · 29 votes
    8y
    Originally posted by @Anthony Dooley:

    I am going to guess that this has been on the market for a while. I value a property the same way a bank does. Net Operating Income divided by the prevailing cap rate. If you over pay a little, it won't kill you. I would offer to lease all 8 units for $200 per month for 1 year with an option to purchase it for full price at the end. Then I would use my cash to renovate one unit and get it rented. Then a second, etc. At the end of the year, if all of your predictions come true, you buy it. BTW, the seller gets "all cash" at the sale. That doesn't mean it has to be your cash.

     Love this idea. I am just now running numbers on a 16 unit prop with 4 vacant. I really have no business looking at something this big just yet. just getting my first (get to know the market) 100 properties numbers under my belt.

    but if the seller sat on this for a year, you can approach it as a good move on his part to let you try and make it work, Even if after a year you back out. The owner will have better numbers to seek a new deal.

    1Reply
  • Michael Badin
    Rental Property Investor · Apex, NC · Member since 2015 · 197 posts · 102 votes
    8y

    One thing you are likely underestimating is your repair costs.  I realize you walked the property with your contractor and agreed that it looks like not much needs to be done, but looks can be deceiving.  How old is the property?  What are the local codes, if you end up having to open up one wall the local codes could end up having you to bring the entire property up to code.  That of course is a drastic example but as an insurance adjuster for 14 years, I have seen it happen.  

    0Reply
  • Richard White
    Carolina Beach, NC · Member since 2017 · 51 posts · 15 votes
    8y
    If the current owner inherited but isn't interested in operating it, what were the financials and occupancy before he/she got it? That should be able to tell you something about the area. What is occupancy like at buildings around you? Check rent.com, CL and ApartmentFinder to see how many units are available in the area and what's the going rate. Waiting on gentrification is great, but you are going to need to lock in leases now to pay for your rehabs and cap ex.
    0Reply
  • Ryan York
    OP
    Investor · Harrison Township, MI · Member since 2015 · 131 posts · 45 votes
    8y

    @Anthony Dooley Thanks again Anthony. I do like idea. It sounds like a master lease. Would you say that most sellers are going to be willing to do something like this, especially if they're talking to more than one buyer? 

    @Michael Badin Thanks man. I agree. I think there's always that risk though. Outside of a property inspection, what else would you recommend? The place was built in 1970, so it certainly isn't new, but we see properties much older all of the time in our parts. I mentioned that they failed city inspection earlier in the year. I think that's almost an advantage because it didn't show anything huge like electrical, plumbing etc. 

    @Richard White Thanks Rich. That's a good idea. We did ask for current numbers and they didn't have any. We will try seeing if they can dig up anything previous. Occupancy is up and down, but to me, it looks totally dependent on the management of the property. There's a couple nicer buildings that are full and a couple dumps with terrible reviews that aren't so full. As far as the actual rent, I'll check those out as well. The more references the better.

    0Reply
  • Anthony Dooley
    Investor · Columbus, GA · Member since 2014 · 2k+ posts · 1k+ votes
    8y

    @ryan york 100% of sellers will never accept if you don't offer. Once you rehab it, you can get traditional financing. If it never gets done, you are not broke and stuck with a bad deal.

    0Reply
  • Michael Badin
    Rental Property Investor · Apex, NC · Member since 2015 · 197 posts · 102 votes
    8y

    @Ryan York- Ok 1970 is not bad. If it was 1870 then yea much bigger concern. Biggest concern I would have with 1970 would be asbestos. Did the failed inspection mention it? being built in 1970 there is a very good change it has some. If it does it could be no big deal at first but if/ when the time comes that you have to do repairs (or since it sounds like you plan on doing renovations) and have to cut into it you will most likely be required to remove it ALL. (At least in the room/ unit affected) Asbestos abetment can get costly quickly. EPA / local authorities have specific regulation with how it is to be addressed.  This is not something that would necessarily stop me from buying a property but it is something I would want to make sure I accounted for when evaluating the property. Also although all the plumbing passed, it is over 40 years old and it is possible that they still used cast iron for the drain lines. If they did you will start to have some repair needs there, just something to budget for.  

    0Reply
  • Jeff Kehl
    Rental Property Investor · Charlottesville, VA · Member since 2012 · 1k+ posts · 726 votes
    8y

    @Ryan York Sounds like a good deal to me. Has several attributes I look for. Disinterested seller, improving area, dated property but not that old. Your rehab budget at $12k/unit seems more than generous. For a property like that I would probably budget more like $5-7k/unit in rehab.

    I can't see your numbers when I click on them but make sure you are aware of all utility costs and how they are paid.

    Also make sure you're not counting on the refinance because often the appraisers will be very conservative on raising the value.

    If the owners are looking for a cash offer maybe start out low and see what you can get them down to.

    In any case, don't be afraid of it, lock it up with a due diligence and then analyze it in excruciating detail.

    0Reply
  • Ryan York
    OP
    Investor · Harrison Township, MI · Member since 2015 · 131 posts · 45 votes
    8y
    Jeff Kehl thanks Jeff. Utilities were somewhat of a question mark because of the lack of information the seller has. Our plan is to utilize RUBS which would eliminate a lot of the utility expenses. With that said, not many apartments are Doing that in the area so we’re not totally sure how it will go. Most of The other apartments are also poorly managed or not very nice though. I think there’s an opportunity to be one of the nicer apartments in the area for a relatively low rehab cost. I think there’s a need for nicer housing in order for the city to really take off. I realize it’s only eight units but I’m confident there are at least eight people who would be willing to pay a little bit more for a quality space close to the main drag.
    0Reply
  • Russ Draper
    Investor · Boston, MA · Member since 2015 · 398 posts · 147 votes
    8y

    If the owner doesn't owe a mortgage/note on this property, then its your job to find out how much they will really accept to get this sold.  That 1 unit probably doesn't pay the taxes let alone anything else!  I am sure they really want to sell, your offer should be much lower IMO as your return figures above are quite low!

    0Reply
  • Rick M.
    Rental Property Investor · Fort Lauderdale, FL · Member since 2017 · 151 posts · 94 votes
    8y
    Originally posted by @Adam Adams:

    Also I'm worried about the all cash contingency from the seller. (It is common for sellers to request this when they know a lender will not lend on the property.)

    I was going to say the problem with "Cash only" looks like he's looking to dump the property on you that no bank would touch. With that much cash I'd go elsewhere. Besides at the end of the sale the seller gets cash anyway, whether its your cash or the banks is to be determined by you.

    0Reply
  • James Canoy
    Kingston, NY · Member since 2017 · 252 posts · 138 votes
    8y

    I'm going to add my newbie 2 cents. Why are the units vacant? I would talk to the only renter and see why. What is it like living there? Is it a crack house? Was someone killed there? Maybe you could spend the night in one of the units and see what it is like at night. What are the crime stats? Is there anything going on like mold, lead, asbestos, or the fact that it used to be a gas station in the 20's and still has concealed tanks?

    Beyond that not all speculation is bad. It can't be. Everything we do comes with certain assumptions. You are the expert on the area and only you will know what type or area it is. I wouldn't bet good money on gentrification rolling through but you still might have found a needle.

    0Reply
  • Xavier Randall
    Insurance Agent · Lakewood, CA · Member since 2013 · 171 posts · 98 votes
    8y

    @ryan

    @Ryan York I've bought a couple of vacant 4 units over the past couple of years. But they were in what I call "Adjacent Spill Over Areas". That's an area next to a HOT area. You get access to the same benefits but for a little less rent but quality living. The problem with sellers who inherited properties is that they can either unrealistic about the value or they have to split the pot with other family members and can't go too low on the price. @Anthony Dooley is giving you some INCREDIBLY good advice. LISTEN TO HIM!! You need to structure the deal so it works in your favor, especially being that your speculating. Find a top property manager in the area an get him to give you an analysis on the market. I use the 1.5% - 2% rule. Meaning your total monthly rent should be 1.5%-2% of the purchase price. Do you have your rehab numbers from an actual contractor? Do you have a proper insurance quote? Most insurance companies will have a different policy while it's vacant then convert when it's an actual rental property ready for occupancy. Are the taxes and all other municipal costs current? Have you pulled title? Will the units be individually metered? How's the plumbing, electrical, roof? I use to asset manage properties in Michigan and everyone of them had a sump pump.

    You want this to be successful so don't skimp on the due diligence. You do this one right and it will set the pace for future purchases. I'd love to help anyway I can.

    0Reply
  • Ryan York
    OP
    Investor · Harrison Township, MI · Member since 2015 · 131 posts · 45 votes
    8y

    @Russ Draper Thanks Russ. What kind of returns are you getting that you think 20% Coc and 30% total return is low? I need one of your properties lol.

    FYI, thanks to all for your insight. Always helpful! They accepted a higher offer unfortunately.

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