University Turnkey Portfolio: Rents of $7550/month

[Jack Tucker]

Here's the deal: I'm looking to raise some cash for another project and want to sell some or all of my University of Georgia (Athens) rental properties. As the current owner and manager, I'm so sure that these properties will perform that I'm putting my money where my mouth is. After all, RISK is the biggest question we all face when sizing up any investment. What if I contractually guaranteed current market rent on these properties for 12 months? What if I provided FREE property management on these properties for 12 months? I achieve my capital-raising goals and you get a hassle-free, low-risk investment and an honest partner for one year. It's a win-win. Check out the attached hot sheet of my modest portfolio for sale. I'm not an agent nor am I looking for new representation, but agents are protected.

[Jon Holdman]

To calculate cap rates I'm simply applying the 50% rule. That rule of thumb says that 50% of gross scheduled rents will go to vacancy, capital and expenses. From the remaining 50% you have to cover debt service. This rule of thumb is discussed at length in the rental property and landlording forum.

So, cap rate is simply:

cap rate = (annual rent/2) / price

Yes, there are a bunch of categories. Trouble with trying to slice this onion into many slices is that you're tempted to trim each slice just a little more. You end up underestimating the true expenses.

And many expenses are irregular. You will say, probably with good justification, the properties are in good condition. Yet tenants will still break faucets and stain carpets. The IRS says flooring lasts five years. Judges around here think three is a more reasonable number for carpets. Roofs might last 20 years. So, I have to account for all those expenses, even if the roof is brand new, the faucets work now and the carpet was just replace last year.

Vacancy is a real number.

Evictions may not happen every year, but if someone owns 50 units, then, yeah, they probably have at least one at some point in the process all the time.

These sound like student rentals. I've looked at some of these in the past. I have been consistently appalled at the condition of the units. Men or women, it doesn't matter. Its the rare student that keeps their unit neat. The norm is messy and some are flat out pigs. And you can count on a turnover every year, with make ready costs every time. The area where I looked (Greeley, CO - University of Northern CO) was mostly school year rentals. You could count on 10 months rent. You might get summer months at a discount. So that figures into the vacancy equation.

I'm always going to independently verify the seller's numbers for rent and value. For rent, I'll look at craigslist and any other local resources (e.g., the student housing office.) If possible, I'll drive the area and start calling. Value is the usual process via comps.

Now, I fully admit I'm painting turnkeys with a broad brush. I've looked at too many of these that had some or all of these characteristics:

• Junker property that was given a shoddy, cosmetic rehab. The buyer will have ongoing maintenance expenses.
• Overstated rent, often with a guarantee. The buyer's good for a year then discovers true rents are significantly less.
• Overstated demand. The tenants just aren't there, which translates into lower than expected rent.
• Overstated value. The buyer eventually gets tired of losing money and tries to sell only to discover the property is worth less than they paid

As a buyer, there is always a cost to buying a turnkey. The buyer is giving up some potential profit in exchange for having someone else do the bulk of the work. But this is also an industry rife with bad actors who are pawning bad deals off onto unsuspecting, often distant buyers. They're hoping the buyer is not going to do any significant due diligence or investigation on their own. They're hoping they use their "Bay Area, CA" eyes to look at the property and say "that's really cheap" when in reality its overpriced for the area where the property is located.

Now, as a seller, I'm not really telling you to use the 50% rule or a more detailed calculation in marketing your properties. No seller does. Look at the MLS. Its full of investment properties that say "this cash flows" when the listing agent really just means "if you put 20% down the rent will be a bit more than your PITI payment". I call that "phony cash flow". You'll put yourself at a disadvantage if you use a more realistic assessment. But realize that savvy buyers are going to be more pessimistic in their evaluation of your properties.