Advice on Taking Over Mismanaged Multi-Family (8-Flat)

10 Replies

I am closing on an 8-flat next week in Lincolnshire, IL (NW Suburb of Chicago). There are 6 - 2beds/1bath units and 2 - 1bed/1bath units.

Currently, it is rented far below fair mark rent. The lady who we are buying it from is 92. Her husband built the building in ’74 and passed away a few years back. It was never managed well. Some people have lived there for 20 years without rent increases.

Current rent-roll is as follows:

  • 1 bed – Current: $735 -Verbal agreement with the tenant at $850
  • 1 bed - Current: $ 800 -Verbal agreement with the tenant at $950
  • 2 bed – vacant ->Projected: $1,300
  • 2 bed - vacant ->Projected: $1,350
  • 2 bed – vacant ->Projected: $1,400
  • 2 bed - Current: $865 -Verbal agreement with the tenant at $1200
  • 2 bed - Current: $635 -Verbal agreement with the tenant at $1000
  • 2 bed Current: $1000 -Verbal agreement with the tenant at $1300

All of the current tenants are month to month. The 3 vacant units will rent for $1400- 1350/month. There are small differences in the floor plan and one is a garden level, that is why I projected a slight price difference in the rental estimates.

I am a lawyer so I am familiar with sending written notice to all the tenants because they are month to month. I intend to make all the current tenants go through the application process. I have talked to several of them and many of them cannot afford fair market rents. Some are willing to stay and sort of meet in the middle of fair market and current rent.

The struggle I am havening is the balancing act of raising rent, repairing the building, and the cost of re-leasing. The cost of turn-over is high and there are no guarantees with how fast we will find tenants. Thus, it doesn’t seem worth raising rent from $1,200 to $1,400 if it is going to cost me $3,000 to remodel a bit, and account for vacancy. Some of the currently occupied units need a decent amount of work. 


The building is in a great school district and new homes on the same street are in the 7-figure price range. We are looking to re-fi and cash out ASAP. We will be doing a lot of work to the building once we take over management.

Aside from getting the vacant units occupied, does anyone have any tips, advice, or stories from experience on taking over management control of a building that is seriously rented below fair market value? Any tips or experience anyone has on taking over management control of a mismanaged multifamily would be greatly appreciated.

Thanks,

Shawn

My main thought is that you're going to have to turn/update/repair those units eventually. Might as well accept that now. How do you want to work the timing? If the current tenants qualify under your requirements, can you put them on leases and over the next few years, rotate them out while repairing their units?

What's your timeline for your ownership on the building? Are you planning on holding for the long term?

Chances are good that once you get in there you'll find a lot more wrong with the place than you thought. If you find large CapEx items after you buy, can you afford for the currently occupied units to be vacant? Can you afford the same situation after you refi and your debt service goes up?

The building currently has 3 vacant units. I would suggest that you renovate one unit to bring it up to par with market equivalents and discover the true market rent. Once you know what the true market rent is you can plan accordingly. I don’t know if there are common interior hallways or other common areas. If so, I would upgrade them to give the building better curb appeal. Once the vacant units are renovated and rented I would then start rotating the under market tenants out. When the renovations begin, the under market tenants will see the writing on the wall and will likely move out on their own. 

I had a similar situation with a 10 unit building in Florida. When I took possession, 3 units were vacant. I refinished the exterior, renovated the pool and updated the landscaping. I renovated the 3 vacant units, and before they were even finished I started getting notices from the remaining tenants. Of the original tenants, all of them except one moved out within 90 days. The one that remained agreed to pay the higher rent. He was thrilled with what I had done with the property. 

@Shawn Good Sounds like an outstanding opportunity from your description. I would renovate the three units and common areas, maybe a little landscaping and paint outside? Unless you are in a marginal or bad area you should have no problem finding tenants. Looks like 2 tenants might even be candidates for the newly renovated units freeing up their units to get renovated as well. 

If you think spending 3000 to get 200 dollars a month more rent is a bad deal then you need to redo the math or maybe this is not for you. Personally, if I can get 200 dollars a month more by spending 3k I will do that all day long. Also work out what 5% vacancy looks like in an 8 unit-number of months-allowing for some down time to renovate you should have quite a bit of difficulty hitting that number (that's almost 5 months of vacancies) I can't get close to 5% in my 12 unit building; more like 3% max and that includes some reno at turnover.

Do your homework on the price, get an inspection and don't look back!

Thanks @Taylor L. for your reply.

How do you want to work the timing?
We plan to fill vacant units and bump up rents on existing tenants or have them vacate. Timelines for the leasing is a bit up in the air. This is a high-end area. There is not a lot of multi-family building below 50-100 units. I think since the location is in a great residential neighborhood and next to a commuter train, we should have the vacant units fixed and leased in 4 months. Once the vacant are leased we will attack raising rents and repairing and updating the currently rented units.

What's your timeline for your ownership on the building? Are you planning on holding for the long term?
We Should close on 8/16. We are holding this long-term. This is probably a property I will never sell unless I start getting into 50+ units. It is a great location, well maintained, and should be easy to lease.

Can you afford for the currently occupied units to be vacant? Not all of them. We structured the loan to be interest only for the first 16 months. Payments should be pretty low. I think having 4 of the units occupied at fair market should cover debt service and most month to month costs for the property.

Can you afford the same situation after you refi and your debt service goes up? We budgeted 45k in repairs off the bat. It needs a new roof, new washers, new dryers, several new kitchen appliances, a lot of paint, many light fixtures, among other things. We should be doing very well after re-fi, we got quite a good deal. Also we got a piece of vacant land we may develop into a high end single family home or just sell. The vacant land in this area sells for (189-150k). There are several home recently built that sold for +900k a few doors down.

or L. for your reply.

How do you want to work the timing?
We plan to fill vacant units and bump up rents on existing tenants or have them vacate. Timelines for the leasing is a bit up in the air. This is a high-end area. There is not a lot of multi-family building below 50-100 units. I think since the location is in a great residential neighborhood and next to a commuter train, we should have the vacant units fixed and leased in 4 months. Once the vacant are leased we will attack raising rents and repairing and updating the currently rented units.

What's your timeline for your ownership on the building? Are you planning on holding for the long term?
We Should close on 8/16. We are holding this long-term. This is probably a property I will never sell unless I start getting into 50+ units. It is a great location, well maintained, and should be easy to lease.

Can you afford for the currently occupied units to be vacant? Not all of them. We structured the loan to be interest only for the first 16 months. Payments should be pretty low. I think having 4 of the units occupied at fair market should cover debt service and most month to month costs for the property.

Can you afford the same situation after you refi and your debt service goes up? We budgeted 45k in repairs off the bat. It needs a new roof, new washers, new dryers, several new kitchen appliances, a lot of paint, many light fixtures, among other things. We should be doing very well after re-fi, we got quite a good deal. Also we got a piece of vacant land we may develop into a high end single family home or just sell. The vacant land in this area sells for (189-150k). There are several home recently built that sold for +900k a few doors down.

I appreciate your reply @Bjorn Ahlblad!

The only outdoor thing needed at this time is the roof. It could be repaired, but we are going to replace it. The building is half brick and half vinyl. We are definitely going to need to do some tree trimming, but the landscape is decent. There is a ton of land for this area.

I agree spending 3000 to get 200 dollars a month more rent is a bad deal, but it is hard to calculate how long it will take to re-lease the units. Physical labor and materials are not the concern, it is the re-leaseing. One extra month adds 1300+ to the costs. I think we should have a better idea of how long it will take to get units occupied once we have the vacant units leased.

Hey @Dennis Cosgrave thanks for your input.

So 2 of the 3 vacant units are very updated. The owner’s daughter lived in 2 of them and opened up the wall so she had a 4 bed 2 bath essentially. We need to upgrade the appliances, close the wall, and do some minor cosmetic work. The building common areas look like the 70’s. We need new lights, a lot of paint, and some vinyl flooring.


When the original tenants moved out of your building did they put up any struggle? One of the tenants told me point blank “this is low-income housing.” 2 of the 3 problem tenants are on fixed incomes. They will never find anything priced or located like this within many miles. The building is currently losing money because the tenant are paying next to nothing for this area of the suburbs. There are a few tenants who have expressed excitement for new ownership and the positive things we plan to do to the building.

@Shawn Good I recently went through this dilemma on a 19 unit in Berwyn. My partner pushed hard to vacate the whole building and do a full rehab. I am very glad that we did. If this building is one you intend to hold forever (which makes sense due to the area), then I would figure out how to finance the construction. Vacate the whole building and hustle on the re-leasing. You will be very grateful in 6 months when you have a full rent roll and great tenants in place.  I leased units all winter last year in Berwyn, and I was filling them almost as fast as I could turn them. Don't let people get you worried about lease ups in the winter. If you are aggressive and have a great product you will find tenants. 

Originally posted by @John Warren :

@Shawn Good I recently went through this dilemma on a 19 unit in Berwyn. My partner pushed hard to vacate the whole building and do a full rehab. I am very glad that we did. If this building is one you intend to hold forever (which makes sense due to the area), then I would figure out how to finance the construction. Vacate the whole building and hustle on the re-leasing. You will be very grateful in 6 months when you have a full rent roll and great tenants in place.  I leased units all winter last year in Berwyn, and I was filling them almost as fast as I could turn them. Don't let people get you worried about lease ups in the winter. If you are aggressive and have a great product you will find tenants. 

Hey John, thanks for the reply. We are not going to vacate all of the units, although I wish to some degree that we could. The building is in pretty good shape and many of the units have updated kitchens and baths. We will be doing some mostly cosmetic stuff ( A LOT of paint) and the roof. Good to hear from someone locally that pulled off re-leasing in the winter months in the Chicago area.

 

Originally posted by @Shawn Good :

The struggle I am havening is the balancing act of raising rent, repairing the building, and the cost of re-leasing. The cost of turn-over is high and there are no guarantees with how fast we will find tenants. Thus, it doesn’t seem worth raising rent from $1,200 to $1,400 if it is going to cost me $3,000 to remodel a bit, and account for vacancy. Some of the currently occupied units need a decent amount of work. 


The building is in a great school district and new homes on the same street are in the 7-figure price range. We are looking to re-fi and cash out ASAP. We will be doing a lot of work to the building once we take over management.

Aside from getting the vacant units occupied, does anyone have any tips, advice, or stories from experience on taking over management control of a building that is seriously rented below fair market value? Any tips or experience anyone has on taking over management control of a mismanaged multifamily would be greatly appreciated.

When our objective is to refinance & pull our cash out we use the following process:

1. We instruct the management company to send out the standard new owner letter.  The letter indicates that we will be renovating the property, what the new rents will be for those are on month to month rents.  Our letter also indicates that we will help, to the best of our ability, tenants find new locations if they cannot afford the new rent.  That's one benefit of being an investor with other properties plus having a real estate license with access to properties for rent beyond ours.  If you don't have a license then you may consider partnering with a realtor to help the tenants find a new location.

2. Once the first unit is complete we'll usually schedule a showing for the existing tenants;  i.e give them the 1st crack to move in.  Maybe even give them a discount to move out of their unit into the new unit if their unit needs updating & that update is critical to support the new appraisal & refinance.  

Our first priority is to get the renovations complete, a new appraisal & refinance. In the circumstance you described of not spending $3K to remodel for only a $200/month increase in rent for a unit, conflicts with the strategy of investing that $3K, getting a new appraisal that will show an increase in Net Income for the property, then getting $3K back from the refinace.   

If it's a financial decision, then it is easy. You raise rent to full market value and do the renovation. If you keep existing tenants in at $1200/month vs $1400/month, then you're losing $2400/year. It would cost $3000 to renovate. So by renovating you are making an 80% return on investment add in for renovation and marketing and you will be fully recovering your investment in 24 months or so. It looks like you will lose out on about $1100/month in rent total, between the tenants, which is $13,200/year. Thats a value of $220,000 at a 6% cap rate. 

This sounds more like a personal/emotional decision. If you asked the tenants what they can afford, of course they will tell you they can't pay full rent and will negotiate it down. Question that I have: Did you run their background checks? Check their credit and verify their income levels. If they don't qualify to your standards, then don't keep them. If they do, then you need to decide if it's a financial decision or an emotional one. Either raise their rent to market, because they can afford it, ask them to move or just raise it enough so they still qualify to your standards. 

Also, you're raising rents to different levels. These tenants will talk and you're going to have some unhappy tenants that are paying more for the same.