Conflicted during due dilligence inspection

9 Replies

This post is long, you've been warned.

Here is the orginal deal:

Purchase - $75,000

Down - $18,750

Mortgage - $56,250 ($285/month @ 4.5%)

Here's where things get a little more difficult. The current owner hasn't increased rents in several years, currently is renting the two 1bd/1ba units at $250/mo, average in the area is right around $500. The 2bd/1ba is renting at $490 and average is $650.

So of course I plan on increasing rents in line with the fair market value and actually expect at least one of the tenants in the 1bd/1ba to leave (they've been there 8 and 10 years).

So current Rent - $990; Adjusted Rent -$1,320 ($1,500 * .88 Occupancy)

Expenses - $541/month

NOI - $449 ; Adjusted Rents - $779

Cash Flow - $164 ; Adjusted Rents - $494

Now during our inspection, we have found that the roof needs to be replaced, actually only $4,000 surprisingly. But also the electrical all needs to come out at $14,000. I previously looked at a reno loan and a $20,000 was about $311/month. So it seems like the choices aren't great.

During this inspection, I also received a call from our agent informing us they have a client looking to sell an 8-plex, triplex, and duplex as a block which I can definitely buy if I don't go through with this current triplex, may be able to buy both depending on what additional repairs I pay for up front or if I pull in another partner for the additional 13 units which I'd rather not do. These 13 units are all currently occupied save one of the units in the 8-plex.

Of course this is all happening 2 days before my due diligence period is over, thank you for whatever insight you might provide.

I'll be gone for probably the next 12-13 hours, but I'll be glad to answer any questions there may be when I return.

If the owner is not in a position to cover the extra $18,000, I think you have to walk. Who wants to have nearly $40,000 tied up at a half percent return?

@Paul Danieli Sorry if I was unclear, but the $164 current cash flow and $494 cash flow after adjusting rents was monthly. So yearly cash flow should be $5928. However, the full inspection has been completed and delivered, and there are some additional critical items to replace bringing the total investment to about $58,561.....ugh

So then it'd be $5928/$58,561 = 10.1% cash on cash, which while better than 1% or 0.5%, is still worse than I get on my stocks which require no time effort whatsoever.

I realize that all of these items do not necessarily need to be addressed immediately, but I don't feel like that should change how I do my calculations right? I will have to perform these repairs in the somewhat near future, and about $20,000 absolutely must be done ASAP.

Which as you stated will tie up about $40,000 immediately, plus another $18,561 slightly deferred. Not looking so great

So for anyone keeping score at home, or if you'd like to share your input here are where the figures currently stand:

Purchase Price: $74,250

Financed: $55,687.50

Down Pay : $18,562.50

Close & Inspection: $2,625

Repairs: $37,373.60 ($22,781 has to happen now; $14,592.60 can wait, a little)

Total Invested: $43,968.50 - $58,561.10 depending upon repairs calculation

NOI (Monthly/Yearly): $778.58 / $9,342.96

Debt Service/Month: $282.16

Cash Flow (M/Y): $496.42 / $5,957.08

With so much cash needed for repairs, I'm just not seeing how this can work...guess I should thank my inspector. Thoughts on any way to salvage this property or is it just straight up move on and not even try?

Does landlord pay water??

If so I would take current rent at 990 X 12 = 11,880

11,880 X .40 ( 60% costs) = 4,752 NOI

47,520 sales price at a 10 cap with no deferred maintenance.

47,520 - 20,000 ( estimate repairs but probably worse) = 27,520 purchase

This one is a loser of epic proportions. Seller leased low and didn't fix anything for years and sucked out the cash flow and now wants a sucker to buy it. The tenants have likely just stayed there because it's so cheap and have dealt with the issues. As soon as you come in saying raising rents they will all be gone. I think you under estimate how hard it is to raise rents on tenants and how hard they will fight you on it. Even if you make it brand new the current tenants might not have the financial standing to pay more if they wanted to. You would have to review the lease file for that and validate on your own.

I NEVER pay for potential. If I am going to work for that increased return then it's at my purchase price. Has to be a great deal going in for current status and an excellent deal if I can turn it to what I think it can be. If it's a good deal if I turn it but a loser at current income levels versus what the seller wants then it's a NO GO.

The only time I would consider this is if the property sits on a nice piece of land slated for redevelopment where I know with my land development back ground I can get a great return selling off and having it torn down. I would make sure tenants in that case are month to month so I can sell and have flexibility for the buyer. I would keep the property the same and put no money into it while waiting for the buy out and tear down.

Thanks so much for the input, when running the original numbers it had great potential, and was even marginally +EV under current rents. But once all these needed repairs were discovered, things looked pretty bleak.

Glad to hear others agreeing that this is no good, I'm out

As a learning point, total necessary repairs are $37,373.60.

I broke down the NOI in an excel sheet to $424.08/month ($5,088.96/year). You were really close with 40% estimate versus 42.83% when itemizing expenses, that's really neat to me.

So with a 10% Cap rate, 5,088.96/.10 = $50,889.60 with 0 deferred maintenance.

From this $50,889.60 would you subtract the entire 37,373.60? Leaving an offer of $13,516? It just blows my mind that the offer really does need to be this low.

And is 10% a good general rule of thumb for cap rate? I'm clearly quite new at all this and I'm not really sure how to get a good estimate of what a cap rate should be for a given territory.

Thank you so much, you've been so much help already in my short time on this forum, I don't know why I didn't come sooner!

Honestly even at $13,500 those repairs just seen too much to overcome. That's a lot of tied up

Originally posted by @Mason Keith :

And is 10% a good general rule of thumb for cap rate? I'm clearly quite new at all this and I'm not really sure how to get a good estimate of what a cap rate should be for a given territory.

Thank you so much, you've been so much help already in my short time on this forum, I don't know why I didn't come sooner!

There is no rule of thumb for cap rates. Cap rates are set by the local market. That is, they reflect how much cash buyers are willing to exchange for one year of projected NOI. It does not reflect profitability.

You are very unlikely to be able to find reliable cap rate comps for a 3 unit building so you should completely ignore cap rates. To determine what the current market is paying you could just look at sales comps for similar properties. You could also look at GRM's. Gross rent multipliers. You need to know approximate rents and sales prices. If most sales of similar properties are selling for 8-10 times the annual gross rents you would have to justify why you would want to pay more that that for a property. Again, like a cap rate this does not predict profitability. It, like a cap rate only tells you what the market is paying at the current time.

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