Multi Family Analysis

9 Replies

Hi BP,

I wanted to get some insight on analyzing a multi family deal. If I were to purchase an 8 unit property with a few current vacancies, but all are rent ready, is there a rule of thumb on how much the value of the property I should consider?

For example:

Scenario 1: An 8 unit property has a total rent roll at market rent fully occupied of $100,000. There are currently 4 vacancies making the actual rent roll $50,000. Obviously the seller wouldn't sell for half price just because the units are vacant. What gross income would you evaluate the property at assuming no upgrades need to be made to the units? Would there be some middle ground?

Scenario 2: This leads into my next question. If the same property has a current rent roll below market rent and is fully occupied. The rent roll is now $70,000. Assuming no upgrades to the units need to be made, and let's say the current rent roll for all leases ends in 6 months and than I can bump it up to $100,000 at zero cost (obviously hypothetical). Is there a general middle ground of gross income I should be evaluating a property at? In this scenario, I would have a total gross income for the year at $85,000. Would I than evaluate it at exactly $85,000? Or is there some middle ground that I would evaluate due to future gains and future value, so I can potentially evaluate the property at $90K or $95K which will account for my work of getting the rents up to market?

Scenario 3: Than my last question would be adding that next variable in, cost to upgrade to get to market rent. How would one factor in a projected cost to upgrade to market rent? Would you subtract the project cost straight from your purchase price? Or again, is there a middle ground that you would typically evaluate the property at for future value?

I know this is a lot, but any insight would be appreciated!

Thank you

@Jason Rosenbaum wouldn't it be great if sellers would sell for half price when a property is 50% occupied? This is where analysis becomes a bit more of an art than a science. 

Here's something that may help a bit. In the commercial world, say for a vacant office space, I will often see them projecting 6-12 months of vacancy to fill it and maybe $10/square foot in tenant upgrades. So that vacant office space is not worthless, there is just cost and time involved to lease it. And in my experience that is generally true.

Now for residential like an 8 unit properties it's somewhat different because these days, in most areas they are in very high demand. So if there is like a 98% occupancy in the area of the property vacant units are worth pretty close to the same as occupied units. Units that are down and will take 4 weeks of rehab at $5k are worth less.

Luckily there is a fairly easy way to evaluate all of these things, discounted cash flow over time using internal rate of return.

Do a spreadsheet showing income in and costs out over time. If the units can be rented immediately with little cost they will value about the same as an occupied unit.

Figure in a vacancy percentage in the proforma a little higher than normal. Maybe 10%-15% vacancy since the are 4 units vacant that you have to fill. 

Construction costs can be deducted from your top purchase price. I do it the opposite direction. I add construction costs to my purchase price in order to come up with the cap rate I am looking for. Probably depends on the tool you use which way that goes. 

Good Luck - Matt

Base the value on the actual rent that the property currently produces. If it could produce $100K, then why isn't it? I would not pay for value that is not actually there in hopes that it would appear later. If you are going to make improvements to try and add value, you would do that with one of the vacant units and try an increase in that unit. If it stays vacant, you only spent money on one unit. If it rents out quickly for more rent, then do that to all of your vacant units.

@Jason Rosenbaum . The scenario you are describing is the typical value add. If the place's vacancy is higher than average, then the place is most likely under-managed. If you feel you can do better ...

Let me ask you these few questions: How confident are you to fill up the place (100% occupancy rate) at the current rent price? Once the place has been stabilized, what's your strategy? You keeping the place ? For how long? You refinancing or you are selling?

The price I would be  willing to pay will really depend on my overall strategy. Using Michael Blank Deal Analyzer can actually help you run all these scenarios. (I'm not associate with Michael, but I have used his tool on my deals).

On this type of property I would not make an offer based on what the asset COULD produce. If it could do better and the seller wants a higher valuation then they should be putting the work in to command the higher valuation. If you put the hard work into getting the units rented and raising rents then you get to reap the upside on the deal and not the seller. This is a typical value add play here.

Thank you all for the responses. @Jeff Kehl this makes perfect sense since the units still are worth something even if they are vacant. I understand I am doing the work to add value, which is why I was asking how much I should discount based on the work that I myself put in. The thing is, I am very new, so the projections of construction costs and how long it would take to get to market rent would be very difficult for me, and may be wayy off. This is where I lack the most - I am a strong numbers guy but have no clue how much to project when it comes to construction. I guess this would only come from more experience? If you have any suggestions on how someone who is new to make a relatively accurate projection on construction that would be much appreciated. But that being said, any offer I put on a property will be just a guess at that point because I cannot accurately project the construction value. Then when I do my due diligence, I will get estimates and back out or move forward accordingly. This is where I fear the most. I will need to make another spreadsheet for this. Thanks for the input!

@Henri Meli I am looking to buy and hold and add as much value as possible over a period, then refi in 4-5 years. I am confident that I would be able to get rents up to market than apply a projected vacancy rate. When I do my analysis, I would typically look at the potential gross income than apply a vacancy rate to that. Over the course of 10, 20, 30 years there will never be 100% occupancy, but I subtract that projected rate from the overall rent roll. I will take a look at link you sent over. Thanks a lot! 

@Jason Rosenbaum you're right to be concerned about the construction costs. When you take on a value-add project there are two main risks, the construction and the property management. Are you planning to do the the PM yourself? If not I would spend my energy finding the couple best PMs in the area and let them recommend contractors. 

If you're going to pm yourself you just need to spend a lot of time finding as many quality contractors as you can and getting bids from them.

@Jason Rosenbaum there are bunch of different variables in play here, but I'll just throw somethings out there that might help you:)

1. This is 8 units and will be considered a commercial property and need a commercial loan (5+ units is commercial). The bank will probably want 25-30% down and will look to see how much the properties financials are. If the property is only at 50% occupancy the bank will see that. You'll need to present the rent roll if you are wanting to get approved for a loan.

2. If you don't know what the market rents go to or go to and look at rents in the surrounding area which are comparable to the property you plan to buy. 

3. Banks like to lend on properties usually with a Debt Service Ratio 1.25 or higher. This means that for every dollar of debt the property has in generates $1.25. DSCR= Net Operating Income/ Annual Debt Service.

4. Also you will need to have a better estimate of what the property is really worth and how much value you would want to add. I would hire an appraiser to get a better idea of what the value is worth. Once you know, you'll be able to use the information for the bank as well. But, I would not pay on a ProForma valuation of a property. I would buy it based on the actual numbers that it's currently at (the bank will as well).

5. Figure out how much you would want to put into each unit. Maybe add another 5-10k per unit. Contact 2 or 3 contractors  and start getting quotes. See what they offer. It can't hurt. but, I'm not sure of what the actual property needs. However, I would try and figure out the bottom line of the property (break even point). If the property is at 50% occupancy are you still cash flow positive? What if the occupancy drops to 30%, are you still at a profit? These are questions that you should know and be able to answer. You don't want to take on a value add property and run out of funding.

6. Look into an exit strategy. I know that you stated you want to buy and hold which is good, but everyone has a number. Maybe you will hold for 15 years and then sell or cash out refi after 5 years. Whatever you decide, you should keep an end goal really in mind.

Hopefully this helps. 

Best of luck:)

Everyone else has covered most of the bases, but the first question I would ask and want answered is "Why are half the units vacant?"  I've see too many properties touted as "value-add" where the seller is really saying "add the value to ME by paying my inflated price!