23 unit multifamily deal

5 Replies

Was hoping to get a little advice on this potential deal. 23 unit single building three stories with rear parking, and a small two car detached garage the is rented to two of the tenants.

12 one bedroom ($325.00) and 11 two bedroom apartments ($360.00) Gross rents of $82,300.00 2016. Expenses for 2016 (according to owners) are as follows:

Ads - $100.00

Travel - $4,018.00

Cleaning - $2,590.00

Insurance - $3,827.00

Legal - $595.00

Repairs - $6,075.00

RE Tax - $10,943.00

Utilities - $11,400.00 (Owner pays water, and electricity for hallways, and gas for hot water heater)

Total  Exp - $39,548.00

Owner is asking $30,000/unit for a total of $690,000.00

What is everyone's thoughts on this? What would be a reasonable sale price? I have already made an offer and have been countered. I would like to have your thoughts first.

I feel rents are low on this building. It is not the cream of the crop, but with a little better management could be nicer. It is known to be a low or lower income building, and owners even said "We aren't out to get everyone and like to help people so we keep the rents low". That's nice of them, but you can still help people, and have good business sense at the same time.

Thanks!

@Warren Straley  I'm not sure whether to say "run as fast as you can for the hills" or "run as fast as you can to the bank" and get a check cut.

Here's my thinking, pro and con.

Cons:  

This deal has NOI of about $40,000 and the asking price is $690,000. That's a cap rate of 6.1% on a small deal in a very small market that is either losing population or growing very, very slowly (depending on which website you look at, and I am assuming this is in your town), as well as slightly increasing poverty between 2000 and 2010 (looking at the Van Wert County data on Wikipedia). That is WAY too high a cap rate for this asset and this market. It also likely has a ton of deferred maintenance at these rents. This owner is cutting things to the bone for sure.

In addition, the seller's expense numbers are not going to be the ones you get.  The seller's insurance is probably based on a very out of date replacement cost, that is related to their low basis in the property.  Yours will be higher.  Your real estate taxes will probably also be higher - you need to ascertain when the property will be re-assessed, whether on sale or later, but in either case, when it is reassessed, the taxes will probably be higher.  I don't see any labor costs here, either, which means that the seller was doing everything himself, and you will have to as well, if you want to keep the same cost structure.  There is no expense for landscaping, snow removal, pest control, waste haulage.

So the nominal cap rate the seller is asking for of 6.1% is likely to be even lower in reality on the expense numbers you would have to pay.

Also, you only have 2016 numbers. Where are the 2017 numbers, at least through November. You need a T12 through November at the very least.

One other consideration, which affects the vacancy rate and your ability to raise rents is that buying a house is very, very cheap there.  So rents have an upper limit.  And with a shrinking population, that means buying a house will only get cheaper over time, dragging on rents.

Pros:

Here is the opportunity I see.  I don't know what rents are like in that market, so take this with a big grain of salt.  But there might be a LOT of room to move on rents.  The median household income in your town is about $40,000/year.  The general rule is that people should spend between 25 and 30 percent of their income on rent.  That means the person in that town earning the median income can comfortably afford to pay between $10,000 and $12,000 a year in rent.  Despite what I said about the poverty rate increasing there, it is still pretty low, so people can afford decent rents.

In the meantime, the tenants at this property are paying between $3900 and $4300 in rent. Even if the building is subsidized housing and has rent limits, there is still probably a lot of room to legally raise rents.  However, this will likely involve a lot of tenant turnover, so you need to brace for high vacancies for a while and to spend quite a bit of money on turns.

In addition, I don't know what the local law is there, but if you can pass utility costs to tenants through RUBS or another bill-back system, this is another huge opportunity for you.

You may have a very good candidate for a rehab/reposition on your hands.  However, you will have to determine how much it will cost per unit to rehab the property.  Also you need to get a handle on the market vacancy rate.  If it is very high, than this strategy will be more risky, and that would explain why the rents are so low.  Also, at those rent levels, I suspect that the insides of these apartments are in bad shape, and they will be very hard turns, not light turns, and those will be costly.  You may be looking at $5,000-$10,000/unit depending on how bad they are.  But, it could still be worth it.  You have to run the numbers and see.

These are my two cents.  Take them for what they are worth.

@Jonathan Twombly you are awesome to start with. Thank you for the awesome response.

If you would indulge me a bit I have a few questions for you.

1) Housing is affordable in my community. There are nice 60 to 80k houses to be found that would equal the rent on this specific building, but the rental market is EXTREMELY strong and has been for well over a decade.

We do have a stagnate population growth in a town of about 10,000 people. Still have relatively strong industry base. (One employer does have about 1,000 employees though) 

I feel the rental market will continue to be this way for years to come.

2) Rental rates on this building in my opinion are VERY low. $325 for a one bedroom (twelve total) and $360 for a two bedroom (eleven total) WITH water/trash included. I feel that those rents could be raised to at least $350 to $375 for a one bedroom and $425 to $450 for a two bedroom AND change water so that tenants pays.

3) Still learning on the CAP rates (which I should know by now), but what in your opinion is a good CAP rate to shoot for? I am assuming that a higher CAP rate is better, but I still am not sure.

4) I never trust a sellers numbers (especially when they all end in zeros!) And the seller did do a lot of the work himself. That was probably why the travel bill was so high as he lives an hour away. I would not have that bill, but would probably be tacked onto the repairs because I would try to hire more out.

5) You were right on taxes, and I forgot to include that part. It is currently assessed at $394,400 so basically taxes would double upon sale/reassessment. I still need to get a straight answer from the court house if it will be reassessed upon sale , or in 2020 because it is on a 3 year cycle and they just reassessed in 2017.

6) I have already given my insurance agent the info on the building, and am still waiting for a quote so I know what I would be in for.

7) The units are not in bad shape (or at least the three that he originally showed me) I would like to see all of them before making final decision, but it appeared that all they needed was new carpet, paint, kitchen/bath update. Has newer vinyl windows in the entire building, and just had a new roof only a few years ago. Exterior is all brick which I like very much.

8) I would like to re-plumb the building and have separate meters for all of the tenants. I know that would be an expensive endeavor, but would be worth it in the end to drop $10,000 in expenses from the balance sheet.

I see this as a good opportunity at a relatively low buy-in. I already have 20 units, and looking to expand. I started on SFH and will not go back. I just like the idea of doubling my portfolio with one purchase.


Based on the above what do you think of this deal? Thank you again for the advice!

Hi Warren:  I'm glad this was helpful.  See my answers below.

Originally posted by @Warren Straley :

@Jonathan Twombly you are awesome to start with. Thank you for the awesome response.

If you would indulge me a bit I have a few questions for you.

1) Housing is affordable in my community. There are nice 60 to 80k houses to be found that would equal the rent on this specific building, but the rental market is EXTREMELY strong and has been for well over a decade.

I would get some specificity on this:  what does "extremely strong" mean?  What is the local vacancy rate for rental housing?  Is there new construction in the pipeline that will change the vacancy rate?

We do have a stagnate population growth in a town of about 10,000 people. Still have relatively strong industry base. (One employer does have about 1,000 employees though) 

So much dependency on one employer is a little troubling, unless its something that's not going anywhere, like a power utility or a military supplier.

I feel the rental market will continue to be this way for years to come.

This may well be true, but until you put some evidence behind this statement, it's just speculation. It's always tempting to paint a favorable picture in your mind when you want to do something like this, but you need to think about this like a business and get some actual facts to support your theory.

2) Rental rates on this building in my opinion are VERY low. $325 for a one bedroom (twelve total) and $360 for a two bedroom (eleven total) WITH water/trash included. I feel that those rents could be raised to at least $350 to $375 for a one bedroom and $425 to $450 for a two bedroom AND change water so that tenants pays.

What are the actual market rents in the area?  You need to do this research.  They could be higher, which would be a good thing for you and make this deal worth doing.  Assuming rents of $375 and $450, that brings you to about $108,900 for yearly rents - once you have re-tenanted the property, which will take at least one year. However, we also know that your taxes and insurance are going to rise, let's assume by about $15,000 for both.  So that still leaves you with NOI of only about $45,000, assuming that all the other costs stay the same, which I doubt they will.  $45,000 of NOI on a $690,000 deal only gives you a cap rate of 6.5% - too low in my opinion, even in this market, for a deal like this.

I would do some more research on local rents and see what the market rents are for a newly renovated C-class asset, given its location.  If there are any local properties that compete with this one, call them up and pretend to be a renter, and ask them their rents.  Be sure to try to get an idea of the size of the apartments and the amenities.  You might even want to sign up and visit a vacant unit, pretending to be a renter so you can get a good idea.  This is called "shopping" the competition, and it is a very good way to compare the rents in the market.  Make sure you do this with all the competing properties.  If you can establish that the local rents are really more in the $500-700 range, then you may have something here.

I'd say that you want this deal to be an 8% cap rate at the very least.  At this sale price, that means $55,000 of NOI.  Or, at the current NOI, that means a sale price of $500,000.

3) Still learning on the CAP rates (which I should know by now), but what in your opinion is a good CAP rate to shoot for? I am assuming that a higher CAP rate is better, but I still am not sure.

Yes, higher is better.  The calculation is NOI/sales price = cap rate, so the higher the cap rate, the higher a percentage of the sale price the NOI represents.

Another very important calculation is the debt service coverage ratio (DSCR).  It will be hard to get a loan for a commercial property if the DSCR is lower than 1.25x.  The calculation here is usually something like NOI minus required reserves (usually $250-350/unit/year)/debt service = DSCR.  So, assuming again the NOI is $40,000 and you have $300/unit/year of required reserves ($6,900), that leaves about $34,000 to work with.  However, at this sales price, on this NOI, and assuming a 75% LTV loan at 5.00% interest your annual debt service is going to be $43,116.  You will have a DSCR of about 0.80, rather than the 1.25X you need to qualify.  And, in my experience, you really need a DSCR of at least 1.5x to make any money, because you will have capital needs to pay after you pay debt service.

4) I never trust a sellers numbers (especially when they all end in zeros!) And the seller did do a lot of the work himself. That was probably why the travel bill was so high as he lives an hour away. I would not have that bill, but would probably be tacked onto the repairs because I would try to hire more out.

5) You were right on taxes, and I forgot to include that part. It is currently assessed at $394,400 so basically taxes would double upon sale/reassessment. I still need to get a straight answer from the court house if it will be reassessed upon sale , or in 2020 because it is on a 3 year cycle and they just reassessed in 2017.

Yes, be sure to check this, it's critical.

6) I have already given my insurance agent the info on the building, and am still waiting for a quote so I know what I would be in for.

7) The units are not in bad shape (or at least the three that he originally showed me) I would like to see all of them before making final decision, but it appeared that all they needed was new carpet, paint, kitchen/bath update. Has newer vinyl windows in the entire building, and just had a new roof only a few years ago. Exterior is all brick which I like very much.

Make sure you see ALL the units before you close.  And see as many more as you can before you go into contract.  You probably saw the best ones.  Based on what you're saying, if you need to replace carpets, countertops, vanities, paint, etc., you could be looking at upwards of $5K a unit, including labor.  But I am not an expert on estimating rehab costs.  Go back to the property with a contractor and get him to give you the worst case scenario.  You can then use this to bargain the seller down.

8) I would like to re-plumb the building and have separate meters for all of the tenants. I know that would be an expensive endeavor, but would be worth it in the end to drop $10,000 in expenses from the balance sheet.

Do you need to re-plumb the building, or just submeter it?  It's a good rule of thumb when considering capital improvements to ask whether your investment will return 20% or more. If you will save $10,000 a year on this, then spending $50,000 is worthwhile.  You will get an extra $10K in your pocket every year AND when you cap $10K at an 8% cap rate, it adds $125,000 in value to the property.

I see this as a good opportunity at a relatively low buy-in. I already have 20 units, and looking to expand. I started on SFH and will not go back. I just like the idea of doubling my portfolio with one purchase.


Based on the above what do you think of this deal? Thank you again for the advice!

Overall, I think there is some potential opportunity here, but a lot of risk too.  I would dig into the numbers very critically, both at the property itself and in terms of the market vacancies and rents.  It could be good, but I won't say it's a slam-dunk.

Hope this helps.

Originally posted by @Jonathan Twombly :
Hi Warren:  I'm glad this was helpful.  See my answers below.

Originally posted by @Warren Straley:

@Jonathan Twombly you are awesome to start with. Thank you for the awesome response.

If you would indulge me a bit I have a few questions for you.

1) Housing is affordable in my community. There are nice 60 to 80k houses to be found that would equal the rent on this specific building, but the rental market is EXTREMELY strong and has been for well over a decade.

I would get some specificity on this:  what does "extremely strong" mean?  What is the local vacancy rate for rental housing?  Is there new construction in the pipeline that will change the vacancy rate?

Extremely strong means there is a shortage of rentals in my area. We have on average 4 people calling our office daily for rentals. That might not seem like a lot, but it is to us. I stopped advertising my vacancies (rarely have them anyway), and just let word of mouth spread between my tenants. Usually takes a week or less to fill a unit. I also just build two brand new duplexes. As soon as I finished a unit there is someone wanting to rent it immediately. I would say vacancy rate in my town is pretty low. Maybe like 5% or less. Not sure how to calculate that, but I hardly see for rent signs anywhere, and my personal vacancy rate is about <1%. There is some new construction coming though. They are starting a new 132 house subdivision, but I don't see how that will affect the rental market here too much. That will free up some existing homes to become more rentals, but don't feel it will make that large of an impact. Rental rates for decent two bedroom home are around $550 and for a three bedroom $650. I have a very nice one bedroom home that I get $525 out of.


We do have a stagnate population growth in a town of about 10,000 people. Still have relatively strong industry base. (One employer does have about 1,000 employees though) 

So much dependency on one employer is a little troubling, unless its something that's not going anywhere, like a power utility or a military supplier.

It is not one of those, but I do believe they have some contract with the military to build parts for them. There is also rumblings of a large 300+ employer coming into our town, but haven't heard much more than that.


I feel the rental market will continue to be this way for years to come.

This may well be true, but until you put some evidence behind this statement, it's just speculation. It's always tempting to paint a favorable picture in your mind when you want to do something like this, but you need to think about this like a business and get some actual facts to support your theory.

I know that I am wanting to be positive about this, but I don't see how it will/could change drastically in the next 5 to 10 years. I think the only thing that could do that is if a company leaves, but no idea if that is going to happen.  One of the larger employers (about 300+) just renegotiated with the union, and signed another 4 year deal which was last year. And even if we hit another housing recession I see rentals doing even better. People will always need a place to live.

I am curious as to something you have on your profile on BP or on your website. Can't remember where I read it, but you mentioned you are predicting a multi-family crash in the near future (only a few years). Why do you say that?


2) Rental rates on this building in my opinion are VERY low. $325 for a one bedroom (twelve total) and $360 for a two bedroom (eleven total) WITH water/trash included. I feel that those rents could be raised to at least $350 to $375 for a one bedroom and $425 to $450 for a two bedroom AND change water so that tenants pays.

What are the actual market rents in the area?  You need to do this research.  They could be higher, which would be a good thing for you and make this deal worth doing.  Assuming rents of $375 and $450, that brings you to about $108,900 for yearly rents - once you have re-tenanted the property, which will take at least one year. However, we also know that your taxes and insurance are going to rise, let's assume by about $15,000 for both.  So that still leaves you with NOI of only about $45,000, assuming that all the other costs stay the same, which I doubt they will.  $45,000 of NOI on a $690,000 deal only gives you a cap rate of 6.5% - too low in my opinion, even in this market, for a deal like this.

Rental rates vary throughout town depending if it is a SFH or a multifamily unit. We don't have too many multi-familys in our area. Only 6 different "larger" ones that are all around 20 to 40 units each. One of which I wouldn't touch with a 50 foot pole. There are quite a few SFH rentals, and one guy owns about 138 of them. I would say your standard/average is: 1 bed $350 to $500, 2 bed $450 to $600, 3 bed $550 to $700. This number has grown to this over the past five years. I would say used to be 5 - 10% lower. There are nicer units out there (condo style) that rent for $1,000/mo. Only a couple of those.

I would do some more research on local rents and see what the market rents are for a newly renovated C-class asset, given its location.  If there are any local properties that compete with this one, call them up and pretend to be a renter, and ask them their rents.  Be sure to try to get an idea of the size of the apartments and the amenities.  You might even want to sign up and visit a vacant unit, pretending to be a renter so you can get a good idea.  This is called "shopping" the competition, and it is a very good way to compare the rents in the market.  Make sure you do this with all the competing properties.  If you can establish that the local rents are really more in the $500-700 range, then you may have something here.

In terms of research on newly renovated C-Class buildings I would say there are none. Many of the buildings have not changed hands in a few decades. There are a lot of income based apartments also, but none that have sold and been renovated. On a slight side note I would say that I see people preferring a SFH over an apartment building if the rent is relatively the same. At least that is what I would lean toward if I were looking for a rental. Do you have any experience on apartment buildings like this one (all interior hallways, 3 stories, laundry in basement)? I did the math on the buildings rents x units, and the total amount that should have be collected in 2016 was about $94,000 yet he only collected $83,000. I see that as constant vacancy, or people just not paying their rent. I am not sure if that is poor management or if he just couldn't get the building full. He did say though that he had no trouble filling it at one point.


I'd say that you want this deal to be an 8% cap rate at the very least.  At this sale price, that means $55,000 of NOI.  Or, at the current NOI, that means a sale price of $500,000.

3) Still learning on the CAP rates (which I should know by now), but what in your opinion is a good CAP rate to shoot for? I am assuming that a higher CAP rate is better, but I still am not sure.

Yes, higher is better.  The calculation is NOI/sales price = cap rate, so the higher the cap rate, the higher a percentage of the sale price the NOI represents.

Another very important calculation is the debt service coverage ratio (DSCR).  It will be hard to get a loan for a commercial property if the DSCR is lower than 1.25x.  The calculation here is usually something like NOI minus required reserves (usually $250-350/unit/year)/debt service = DSCR.  So, assuming again the NOI is $40,000 and you have $300/unit/year of required reserves ($6,900), that leaves about $34,000 to work with.  However, at this sales price, on this NOI, and assuming a 75% LTV loan at 5.00% interest your annual debt service is going to be $43,116.  You will have a DSCR of about 0.80, rather than the 1.25X you need to qualify.  And, in my experience, you really need a DSCR of at least 1.5x to make any money, because you will have capital needs to pay after you pay debt service.

4) I never trust a sellers numbers (especially when they all end in zeros!) And the seller did do a lot of the work himself. That was probably why the travel bill was so high as he lives an hour away. I would not have that bill, but would probably be tacked onto the repairs because I would try to hire more out.


@Warren Straley , I'm not predicting a crash, but I am predicting a correction.  Of course, I don't know when, exactly, this is going to happen.  No one does.  But this cycle is very long in the tooth.  If the bull market were a 9-inning game, we'd be in the 11th inning of a tie game now.  There is a lot of investor fatigue.  Transaction volume is way down because the product has been churned through and prices don't make sense in many, cases.  To make deals make sense, people are underwriting with zero vacancy or forecasting unattainable rent growth or exit cap rates that make no sense.  Lenders are pushing back because underwriting is getting too aggressive, and they are not funding deals at the leverage that buyers want.

All of this says to me that we are very close to the end of this game.  One little dinky Texas League blooper could end it.

But, as I said, we're not looking at 2008 again.  Lending standards have been much tighter this time around, and the economy is not based on a house of cards as it was before.  But that does not mean there won't be some pain.  So, when you are looking at a new deal, it's really time to be conservative about it.

In any event, it seems to be that you really know your market.  I would look into the issue of the missing $11,000 in revenue.  It could be a collections problem that you need to get to the bottom of.  It may require some evictions and raising tenant standards going forward.  I definitely think the asking price is rich on the deal and you should try to negotiate it down and have a better cap rate going in.  And underwrite the deal with the new insurance and tax numbers before doing anything else.

Good luck with this!  Be sure to let us all know what you plan to do and how it turns out!

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