Lease Option for an Apartment Building?

Question

I was hoping to get some input, I have a "potential" deal in which a landlord has his 4 unit apartment building on the market. I spoke with him and because it's a 2 hour drive for him for maint. grass cutting, etc. he wants to sell. I asked if he had any interest in some "creative financing" such as a lease option or sub 2, and guess what  HE DID! He wants me to come to him with some ideas as to how to structure it. Easier said than done. He has four apartments, 2-2 bedrooms and 2 -1 bedrooms that are all rented out. There is a lot of posts on how to do a lease puchase or sub 2 to "flip" or live in yourself, but I have not come across any for a property that someone would want to keep as a rental. Any input would be really helpful...

N/A N/A · Answer

Wow, thanks for all of the great advice, I have been in contact with the owner of the property and am going to meet with him tonight. He is looking to get out what he put into and is interested in a possible sub to deal. I only need to work out who pays the taxes, ins. I am really excited that he will meet with me hopefully I can try to work out a deal.

Scott Miller · Answer

Just a point of clarification---4 units are considered residential properties and not commercial...

Regards,

Scott Miller

Account Closed · Answer

Picking up on TC's comment...

Run the standard NOI calculation. Best to use real numbers but you can use estimates when starting.

That will show you how much cash is left to pay you and pay the mortgage.

I negotiate with sellers by working from the NOI. The building can only support the debt service that the income can cover after all expenses and reserves. If they want a high price they need to show how the income can cover the price.

A flip way to think about this.

Lets assume something is worth $100K. The seller really wants $110K.

I will pay the $110K if they agree to $100 a month, no interest until the debt is paid back. The property most likely will cash flow for me. They get their price. They need to wait 91.67 years.

Yes I would be over paying. But am I really doing so if I have an asset that produces good cash flow and I can pay it off over a very long time with inflation adjusted income. Or did I effectively get a discount on the price given the terms? Note that if a seller goes for such a deal you can be pretty sure that at some point in the future they will seek an early exit so you can buy the debt back at a discount.

John Corey

Tom C · Answer

Justin,

Run your numbers again. If you throw in a 5% vacancy rate, you are already in the hole. This is using my tax rate of .5% and insurance rate set at .2%. Going owner finiancing is usually more expensive, since they normally charge a higher interes rate. No matter how you slice it, you are going to have over or near $2500.00 PITI.

Account Closed · Answer

Justin,

There may not be a deal here. Focus on the numbers. Deciding to use a lease option solution vs. something else can be decided after reviewing the numbers.

Forget what was paid at auction. The prior price might matter to the seller but it really does not change you deal.

Using MikeOH's 50% rule the total rent is $2,180 so the available cash to pay a mortgage would be $1,090. The other 50% being used for maintenance and other running costs (except debt service).

When you say the rents should go up how do you know? You mentioned having issues find comps. Are you sure of your rent figures?

What have you estimated for improvements?

I do not see anything that indicates it is over priced. You made a reference to the market and the agent's commission but offered nothing that shows the place is overpriced. Just because there is an agent's fee does not mean it is over priced. Can you explain your thinking? You might be right but I can not tell with given what you wrote.

John Corey

N/A N/A · Answer

Thanks John for the info, here is where I am at:

4 unit bldg listed for $369,000
(was purchased at auction in 9/06 for $305,000)

Rent total monthly roll of $2,180.00

Rents are due to go up and some improvements should be done (paint, etc.)

With the market the was it is, I am sure it's overpriced (due to realtor fees), its hard to comap as its in a small town and there is not another to compare to. I have not seen any improvements done so with the new landlord not even owning for 1 year I think it need to be priced near $320-330,000. After all it was bought at auction.

I wanted to structure something along the lines of some small cash down and a possible 2 year agreement with me able to forgoe a few initial payments to use for improvements. Then I thought I could pay him monthly with the rent rolls. That is where I get stuck. Assuming his mortgage payment is 1,500 a month I obviously don't want to give him everything and not be able to have some type of income or buffer. Also, I am not sure how to structure the 2 year deal to buy him completley out. terms, etc.

Thanks Justin

Account Closed · Answer

The concept is not really any different if you are dealing with a rental. Even a rental that has 4 units.

You can do a master lease with the seller and then sublease the units.

You can even do a lease option with the seller and then decide if you want to do a lease option with an owner occupant who deals with the 3 other units.

Most anything you have heard of will still work.

All the normal issues about buying on a lease. You are only a tenant and if the present owner has problems it can mess up your ability to take title later.

A land contract (contract for deed) can be better when you are buying but not something you generally want to offer when selling. When selling focus on a lease option as the ball stays more in your court.

If you want to drill into details then put up some info as to the deal and what you are thinking.

John Corey