Came across a wild deal. Am I nuts?

11 Replies

Perhaps it isnt wild and I'm still too new. This would be my 4th deal after 3 duplexes. Came across local landlord who has 4 properties for a total of 18 units. 3 6-unit buildings and a duplex. Wants to sell them all as a package. Properties are in a solidly C-Class neighborhood and in C class condition. Not falling apart terrible but not a meticulous landlord or up to my standards. 

Bundling them into 1 deal, this is my math. 

$193k in yearly income. 

$54k for taxes, insurance, utilities. 

$15k for maintenance, (8%) of total income. 

$10k for 5% vacancy. 

$114k NOI.

Asking Price = $700k. 

16.2% Cap rate after expenses with self management. 

3.63 GRM.

Landlord is willing to hold paper. I am running through 2 BRRRs so most of my money is tied up which is why selling financing is key here. My questions: 

How would you approach this? The cap rates are very high compared to so many deals I see here. 

Because the deal is spread across 4 properties, do you see too much risk? 

How would you approach the seller's terms? I am thinking to attempt to get the longest term under reasonable rates to maximize cash flow. 

@Tom De Moya

Tom: Based on what you shared, this looks like an interested deal. A few thoughts:

1) Vacancy: My gut tells me that you'll see more vacancy or "economic vacancy" than 5%. Economic vacancy takes into account bad debt on units that are leased.

2) Operating Expenses: I'd expect a 45% - 50% operating expense ratio on a "C class" asset like this. Make sure the seller's numbers are real. You might consider asking for his 2017 schedule E.

3) Seller Financing

a. Liens: Make sure the seller doesn't have other liens on the property that you might become responsible for at sale.

b. Terms: I'm a big fan of maximizing cash flow ... consider requesting an interest only loan with an early retirement clause. This will allow you to maximize cash flow and pay down the debt.

Howdy @Tom De Moya

3 - 6 units plus a Duplex = 20 units.  Sorry, I needed to point that out. Also agree with 5% Vacancy being too low.  I always go with a minimum of 8.34% (one month) for analysis purposes.  If the actual turns up to be lower, great, you win. 

Why exclude PM from the analysis? It blurs the actual Operating Expense and gives a false NOI. You need to account for all possible expenses to help justify your offer. What is the norm for Cap Rates in that area? That is what any appraiser would probably use. Know what the market Cap Rate is! NOI and Cap Rate has a direct impact on the property price.

After the purchase if you want to work like a dog and not pay yourself for it, that’s up to you.

Class C property in Class C condition. You did not include any Rehab estimate or CapEx reserves. I assume you plan to make improvements.

Are current rents within market rates?  Is there room for increasing them?

What is your end goal with this purchase? Value Add? Cash Flow? 16% Cap Rate? If it's $200 per unit cash flow ($48,000 annual), using your $114K NOI, your monthly loan payments to the Seller would need to be $5,500 ($66,000 annual) or less. If your NOI is closer to 50% of GSI ($96,000) then cf per unit drops to $125. Just be sure of your numbers and investment criteria.

@Tom De Moya

For C class properties if you're calculating anything less than 10% each for Vacancy and R&M for the first year or more you're likely in for an unpleasant surprise. If there's major CapEx needs and you haven't factored those in as well you can really get killed quickly.

Early on I started out with a 20 unit multiple property C-class seller financed deal and it almost bankrupt me as I didn't do my analysis correctly.

It's great that the seller is willing to hold paper but be sure you aren't massaging the numbers to create a better deal than what's really there and be especially certain you have sufficient cash reserves to tackle a project of that size even if it's 100% financed.  

I agree with the above posts, but don't get discouraged. I would certainly go seller financing and I would go Interest Only at 5%+/- for 5 years. But you need to verify the numbers and factor in independent management. Did I mention that you need to verify the numbers?  Also do an insurance loss run and make sure your insurance won't be 3x the existing policy. Been there and it sucks. 

Diamond in the rough... that's what it may be, IMO. 

@Tom De Moya Looks good at this point keep verifying everything. High cap and seller financing could be a sucker deal too. So watch out! Get financials and have your accountant look them over. Tell the seller your accountant is asking for 5 years worth. Seller should have no problem with that. Make sure a licensed inspector inspects everything-you hire him! This is an exciting and ambitious deal do your homework and make it a winner, or discard, depending on your discoveries. All the best and keep us updated.

Thank you for all your replies. 
@Tyler Kastelberg what is the strategy with the interest only loan that I saw @Chris Martin also post about. Is it to use the cash flow from those first 5 years to fund capex improvements and hope it appreciates enough to sell within 5 years or refi? 

@John Leavelle

I'm excluding PM because I plan to do the all work myself. I am local and I prefer hands on management. Cap rates on this deal are a good 50% higher than normal for the area hence my excitement. My initial plan was not make any major capex moves unless needed. There is some room for increasing rents which I have detailed in my shared gdoc. My end goal is to have enough cash flow to step away from the main 9-5 within 5 years so i was thinking adding 20 units to the portfolio can add the velocity I want. 

@Ryan Murdock thanks for the input. I have upped my vacancy requirements to 1 month of rent for all properties. 

Assuming these suggested changes, my analysis starts to change. If this was structured as a 30 year, 25% loan, I'd jump on it with 100% confidence. My next step is to understand the terms the seller is wiling to agree on. Even considering a 10 year, 100% financed packaged, I don't see it working towards my cash flow heavy goals. Am I wrong? Any other ideas? 

Please feel free to view and comment on my analysis below. 

https://docs.google.com/spreadsheets/d/1qUfF8CfOwSE-8zIDo316xazK3joIVdzt4wk-Q1V6Ph0/edit?usp=sharing

@Tom De Moya

Find out what the seller is willing to do for financing. If he's willing to stretch it out for 20-30 years at a fixed rate that's ideal....and rare.... but it does happen. 

If he will only do a shorter term figure what your exit strategy is when that time is up. 

If you're in a hotter market or you are confident you can force appreciation through property improvements etc then it'll be easier for you to refinance with a bank at 75-80% LTV when your balloon payment comes due.

If your market is anything like mine 5 years interest only (or even a 20yr amort / 5 yr balloon) can be risky if you don't anticipate a lot of appreciation because you'll have little or no equity when it comes time to refi to pay off your seller. You'll have to be prepared to make up a 20% +/- shortfall on what the bank will lend you. 

It all depends on the seller's situation. I've done 5 year terms with balloons, 25 year fixed, and a few in-between. With seller financing there are no set "rules" so negotiate what you can that benefits both sides. 

@Tom De Moya

Tom: Without being hands on the deal, it's tough to advise you on how to re-invest the cash flow. The idea of an interest only loan is to give you the power of choice.

Best of luck! Let me know if I can be of any assistance.

Is there a lot of deferred maintenance on it? Cap rate seems too good to be true!

@Tom De Moya , if there's any single homes in the area possible to buy for $35-50k, then this whole bundle is not a super deal. ie. Verify sold comps as well. 

I'm a little suspicious when a Seller is too keen to hold their own note. ie. What's the real reason for selling for drip-feed returns only, when they're already getting that anyway? 

And, you're not really considering managing 20x units yourself, are you? All the best...

@Tom De Moya

I fully understand you plan on managing yourself.  That’s your choice.  However, when analyzing any rental acquisition deal you should always include PM as an Operating Expense.  Whether you pay yourself or not is not the point.  You need to be able to compare apples to apples.  Evaluate ALL properties with PM.  That is considered a normal part of doing business.  That is also part of why your Cap Rate looks as high as it does.  You need to take a deep breath and take the emotion out of the analysis.  Focus strictly on the numbers.  You seem to be massaging them to make them better than possible they truly are.

No immediate Rehab planned. Ok, then you better have a decent Reserve fund already and/or account for substantial CapEx withholding. I am a firm believer that Murphy is an avid Real Estate participant. Don't let him come calling unprepared.

I truly hope you can get this deal figured out.  I am in a similar junction in my investment goal.  Looking to move up in Multi family size.

I could not use your link.  Please try to repost it.

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