I'm looking for advice on how to evaluate a 100% vacant multifamily property. There are currently no tenants but looking to fill 10 units. The building has recently been completely gutted and renovated, and why it is currently 100% unoccupied.
Our previous deals/ offers have been on active properties with prior year actuals to analyze to help formulate an offer based on NOI so this approach is unfamiliar for us.
Some additional background:
- Current owners have had the units listed on the usual third party sites for a few weeks. There has been interest but no applications, as it appears to be overpriced by around $100 (I suspect with the strategy of starting asking rents high, and then coming down as required). It's in a developing area, so $100 is a big deal.
- It's in a stable MSA and our belief is at the right asking price the units will fill, but it's hard to forecast how long it will take to fill with tenants that meet our (reasonable) criteria and the correct asking rent.
- We've spoken to some local PMs who share the belief it will fill within 2-3 months, but it's a matter of time, and landing on the right price.
- The building is 10 small studios/1 bedrooms (~450 sf)
Any guidance on how to evaluate something like this? The risk is in the unknown timing to get to 100% occupancy and potential variance between expected rent and actuals once filled.
Is the right approach to create our own pro forma using conservative unit rents, expected expenses, and then a best guess at how long it will take to fill 100% and apply that average vacancy to the units to land on a forecast NOI? Can we then use an elevated cap rate to price in some of the risk of the project? Typical cap rates for this area/asset class are around 8%.
Thanks in advance for any insight or help!
@James McCloskey I would analyze the deal like any other. The only difference I would do is build in a higher vacancy into my modeling for the first 2 years. Maybe the MSA Average is around 4% - 5%, but I might put it at 50% for year one, 85% for year two, then up to 95% for year three. I would also make sure that I add in extra cash to the deal so I have a healthy starting reserve as the property wouldn't have cash flow for the first few months.
@James McCloskey - I would also really dig into the property during due diligence to make sure there isn't any underlying problems with the deal. Are there gang shootings two blocks away. When you drive to the building, is there a rough crowd that always stands on the corner. Do the units look nice on paper/photos, but when you get there you see sub standard work. Basically double check everything to make sure the issue to them not being rented really is that they are priced too high.
I would work with your broker to determine the submarket. The MSA data is all well and good, but may not provide the data you'll need for a true special case. Once you have a submarket, call all the vacant properties in the area matching your profile for their rental rates, and have your broker see if they can connect you with owners of those properties. See if you can get from the owners their actual vacancy and rental rates. Then build your profile off the best guess from that data. From there I like @Andrew Kerr 's suggestions on building the numbers for initial uptake and a strong reserve.
I should have noted, the reason for the zero vacancy is the building was just completely gutted and rehabbed and COs only just obtained.
I definitely plan on using a higher average vacancy in year one given starting from zero or very few leases in place. But I'm finding with that conservative approach my offer price is so far from asking. A more realistic number that has a shot at getting to an accepted number assumes more risk in case leasing up takes longer than expected.
Thanks Shawn, definitely connecting with other local owners/brokers and third party sites to justify my assumptions... Hopefully there is a price that works given the reasonable unknowns and risk premium of low vacancy.
Appreciate the feedback!