So a seller just offered to sell me his group of 5 apartment buildings in Cincinnati for 2.1m, holding no note. I'm looking forward to hearing what you guys think of the deal.
Here's the scoop:
Property generally in good shape, some newer updates, no major repairs needed. (Now naturally I'd do my due diligence and make sure the seller is speaking the truth here, but for this phase let's pretend everything they said is truthful).
current gross income: 468k.
current cap: 7.7%
current occupancy: 68%
seller supplied rental comps to justify (seemingly correctly) the following proforma:
proforma gross income:732k
proforma cap: 18.7%
$ PSF: 20.50
average monthly rent: $550
comp cap rates are in the 9% range, with /unit costs between 25 and 35k, PSF averaging 35-45.
So obviously the deal isn't that hot with the current rental situation, but the comps seem to support the existence of a strong upside. Let me know what you think, and if you'd be interested in either doing a JV or straight purchasing it from me.
Your deal seems promising, particularly the PSF.
I do wonder why you would consider paying a 7.7 cap when the area shows the value at a 9 cap? Of course it does have upside with increased occupancy, but I would not pay for upside, only what it produces currently. Paying for upside takes away the upside.
You also mention 5 buildings, how many units in total and what is the layout? I am interested in looking at this more. Feel free to contact me directly.
My question when I see a deal like this is why isn't the current owner getting $732,000 in gross rents? Why is he settling for $468,000? Is he just lazy? Doesn't he understand the business? Does he like losing money? Who is currently managing the property?
Now, ask the question, what makes you believe that you can do better? Is the problem here the neighborhood or is the problem the owner? How much deferred maintenance is really needed? If the property is in good shape, why is the occupancy at 68%? On a deal like this, YOU need to be an expert in your local market. What is the demand for rentals? Are rentals overbuilt in the area? Are there a lot of newer, nicer rentals being offered for the same price as these older units? Are they located in a high crime area? In the ghetto? Over the Rhine? All these details matter and can make the difference between a good deal and a disaster.
Here's how I would evaluate the property:
Gross rents: $61,000 per month
Operating Expenses: $30,500 per month
NOI: $30,500 per month
Mortgage Payment ($2,100,000, 30 yr, 7%): $13,970 per month
Cash flow: $16,530 per month or $150 per unit per month (assuming 110 units)
If true, this would be VERY GOOD DEAL IF(and that's a big if) you could actually get the vacancy under control and fix whatever problems exist.
Obviously, the building is currently losing money.
Mike has posted many of the questions that need to be asked about the property.
Consider pursuing the occupany issue first and foremost. The overall multifamily occupany in this market is somewhere in the range of 91.5 to 93%; the current occupancy of 68% is therefore way off the mark. The key question is why? Lousy management can end up being a strong value play for you as it's reasonably easy to fix. If the problem is an old building (as is suggested by the price per door and cap rate), that's not so easy to fix, and regardless of what the owner represents, there will be deferred maintenance issues until proven otherwise.
The other key issue is this - never, never, never consider a project based on proforma numbers. Use his real, current, verifiable data to analyze the deal and consider an offer. He can't make proforma or even close to it now; it's a tremendous leap of faith (and pretty standard salesmanship) to consider proforma numbers as being close to reality.
Not surprisingly his expenses are quite high (66% of gross); that's probably due to the poor occupancy, but also suggests the potential for operating and management issues. You need to see a couple of years of expense data to make a judgement.
Finally, the owner's pitch that reasonable comps are place the cap in the 9% range really does make sense given the market and the probable age and condition of the building. Taking the owner's cap argument a step further, given the current reported NOI of 159K, the current value of this project is $1,766,666.
Getting into that range then allows you to improve occupancy and really make a strong value play - that's when it really gets interesting! You should be rewarded for taking the risk and improving the project's performance, not the current owner.
By the way, it's very reasonable to offer a letter of intent that states you'll purchase at a 9% cap (or whatever) based on verifiable current NOI......
Have fun with this one -
One other thought: if you don't have any significant previous experience with rentals, I would RUN, not walk, but RUN away from this deal. This is not a deal for a newbie and that is doubly true if you don't have any previous business experience. This building will require someone that knows what they are doing and it would break the vast majority of new investors. It's often better to want something you don't have than to have something you desperately don't want.
Mike and Co.,
I appreciate the comments. The main question is indeed if the proforma is justified, and if so, why has the current owner not already taken the steps to get to the proforma state. I have some rental experience, but nothing of this magnitude. As such, I probably would do best to partner with someone. I have enough cash on hand for a 10% downpayment, so I'd need someone else with at least that much to join me.
It can be intimidating to negotiate with an owner or owner's representative when they're clinging to their proforma. I'm sure there are lots of folks are there who might argue, but proformas are make believe - they are a very best case scenario that may or may not be attainable.
Commercial / multifamily deals have to judged upon their current numbers. Period. You should identify value plays as you analyze a project, but valuation is based on current ops. We're negotiating on a project right now that was bought on proforma and is now in foreclosure.
Your thoughts about finding a partner make good sense - have you tried presenting the project at a local REIA??? Having someone who is experienced on your team to help you evaluate a project like this can be invaluable.
Andy there are some good properties out there and some that just bleed money.
My first question is if the current owner has identified the problem with his properties-- High vacancy and low average rent why is he not willing to correct the problem and make the quarter million a year off the property.
This is screaming remodel and repair.
People are not willing to rent the property at a below market rate for some reason so tread carfully as this could be a money pit.