Is it a stabilized property or not?

Question

I am making an offer on a 6 unit 1 bed/1 bath property. The owner has upgraded all the apartments in 2019 and brought in new tenants on a month-to-month lease this year with market rents. He put the property up for sale after the last tenant signed on in June 2020. Should I be concerned? The first tenant was brought in Feb 2020 and all of them have been there since they signed the lease between Feb and June. Any suggestions/thoughts are greatly appreciated. Thanks.

Gerry Logan · Answer

Hi Arun,

I have closed on one 10-unit building and have another 12-unit closing this month. The properties are C and D grade neighborhoods in Milwaukee. In both of the buildings we have our tenants on month-to-month leases. In your lower grade areas you typically will have higher turnover. The month-to-month leases allow you to more easily remove tenants that stop paying rents. Additionally, you can also raise rents quicker as mentioned above.

One of the buildings is currently being remodeled and rents will be raised. The plan is to complete the rehab then rent the units out at the higer price. Once the entire property is stabilized with the new rents then we will do a cash out re-fi to pull out the equity for another deal. Our bank wants to see the new rents being paid for around 1 year.

It sounds to me like your building is almost stabilized with the new higher rents.

Evan Polaski · Answer

@Arun Jain, I agree that month to month tenants have some big advantages over long term leases, operationally.  That being said, it is generally outside of the norm, so an appraiser and the bank may not view it favorably, especially since your longest lease is now only at 9 months, and shortest at 5.

As noted, I would do a full lease audit on each tenant, as well as tenant interviews.  I would also make sure there was a financing contingency (likely will be anyways).

Greg Dickerson · Answer

Some properties in some areas do much better as month to month or short term rentals vs annual lease. The main thing is to make sure to audit the leases, vet the finances thoroughly and vet the tenants and approve them yourself according to your standards. Make sure the owner did a proper credit check, employment verification and approval process in accordance with local and sate laws.

Bjorn Ahlblad · Answer

@Arun Jain during this time (and all the time in my opinion having done MTM and 1 year leases too) you are way better off with MTM leases than 1 year leases. Why? You can raise rents and give 30 day notices to potentially get people out if needed. Although the impact of moratoriums is still there. Generally longer term leases protect tenants not LL's. All our tenants are MTM and we collect 1st and last months rent, plus security deposit prior to move in.

Eric Johnson · Answer

A better question to ask is what state are you buying in? If you have any difficulty with these tenants, you should know the timeline on the process of replacing them.

You can stipulate one year leases, but then one of those six tenants probably won't agree, so you have a problem there. You need to make sure you can actually get them out if the need arises, even if the lease is month to month.

Jonathan Barr · Answer

Its a little weird that he didn't have them sign a one year lease.  That's basically the norm.   I would make stipulation in your contract that requires the seller to sign one year leases with these tenants.   That way at least you have more of guarantee for the next year. I would closely look at collections make sure these people don't owe anything or are late.   Due to Covid you don't know if these may have lost jobs.   So it would also be a good idea to see the background information for these tenants.  If they are in service industry their might be some concern there.   That's my two cents hope that helps.