Deal Gone Bad? Your thoughts???

Question

I'm a newbie in the investing game, and I have been working on an owner finance deal for an 8-plex (1BR/1BA units).  Zoning is good, tenant history is good, condition of property is good, and numbers are really good (34% cap rate / 100% occupancy).  Perhaps the numbers are in fact too good?

In doing my homework, I found that two of the tenants are on the sexual offender list (they have lived in the complex for 9/10 years).  I'm very concerned about future resale issues, general liabilities, tenant complaints, etc.

Anyone care to share their experience in renting with similar circumstances?

Michael Seeker · Answer

If he/she is looking to take capital immediately, then owner financing sounds a bit out there.  Usually people that offer owner financing are experienced investors or somebody looking to sell to somebody who may not be able to get financing or something that may not be financeable.

24% cap rate is still very high.  Anything with that kind of return is likely to come with A LOT of problems both with regard to the building itself and also neighboring properties as well as the tenants.

Are you positive you're calculating cap rate correctly?  24% ROI would make sense on a leveraged property, but like somebody else mentioned, selling a property with owner financing, even at a ridiculous interest rate would net the seller significantly less money each month in exchange for a presumably small up front capital influx.  Roughly how much would you be putting down on the deal?

Ben Startz · Answer

Thank you @Bill_Jacobsen, @J_Martin, and @Joe_Fairless.

I incorrectly stated that.. .make it 24% actually.  I really appreciate the guidance.  In doing more research, I was alarmed at the number of offenders, not in one particular area... but everywhere.  I guess it calmed my initial fears.

Bill:  To your note about why.  Inherited property with health issues in fam, and looking to take capital immediately, versus stringing it out.

Thanks again, you guys rock!

Bill Jacobsen · Answer

It is surprising that an owner who is making 34% on a property would sell to you with owner financing.  For instance if he offers you 8% financing he is willing to take less than 1/4 his previous income.

I would look very carefully as to why he is willing to do so.

Bill

J. Martin · Answer

A 34% cap rate is OUT OF THIS WORLD! Look over your calculations again, do a thorough inspection of the building/foundation, or something! Talk to local CRE brokers or get a local multi-family report from CBRE or "market research". Or loopnet.com if you can find something. Look at market GRM and cap rates for multifamily. Have an experienced broker/investor/someone go over your numbers. I've seen estimates from 35-45% of gross rents in expenses for MF as a rough estimate, depending on circumstances. On the high side in low-rent areas. May differ in your area.

If you can find buildings that truly return all of the purchase price in 3 years of profit (non-compounded!), you will be a millionaire in  no time from the inflow of capital to your doorstep!

I think it's a good idea to switch the management company either way, regardless of whether or not they knew. What are the odds that you would have selected the current company if you were to perform a diligent search and find a great manager? Regarding offenders, in SF Bay Area, there are strong tenant protections. Make sure you understand the local tenant laws thoroughly before you take any action. And maybe bring it up to the broker/seller when you're negotiating the final details and try to get some concession.. good luck if you end up going through all due diligence and end up getting it! But understand what the risks and numbers are before you jump in...

Joe Fairless · Answer

@Ben Startz did you mean to say the cap rate is 34%?

Re: the sexual offenders, I think that might be indicative of a larger property management issue. Generally speaking, if a landlord knowingly allows that type of tenant then they will probably be slacking on many other aspects of the property upkeep and are riding it to the ground.

The other option is that they don't know there are offenders living there in which case that oversight is a red flag.

In either case, I wouldn't rule the property out because you can always kick out the offenders but I would but a big ole magnifying glass on the property and do a very detailed analysis during due diligence.

I recommend next steps being speaking to a prop mgmt company about the property, the area and the ease of getting the offenders out. I'd also determine if what the bad tenants are paying is market rent (perhaps they are paying more which is why they are still there).

Net-net - Lots to do but there's a solution. There always is.