Small apartment complex - is this a bad deal?

Question

Hi Everyone,

My first post!  I'm excited and humbled, hope to learn from all of you and contribute as much as I can as well toward group growth!

I'm looking at my first apt complex, price at $825k.  3 units:

1. unit 1:  1 Br, 1 BA, 450 sq ft rents at $1400

2. unit 2:  2 Br, 1 BA, 805 sq ft rents at $1,800

3. unit 3:  2 Br, 1 BA, 805 sq ft rents at $1,500

If I put 20% down I estimate my monthly payments for debt servicing at $3,150.  Assuming 50% of gross rents for cost/vacancy that would leave me at $28,200 NOI annually but $37,812 for debt servicing resulting in a loss of $9,612 per year.  In other words a losing deal and a pass.

I've got a couple of questions:

1. I wanted to run that analysis by this group of gurus to see if I'm missing anything?  This is a bad deal as is correct?

2. If I was going to make the owner an offer, how would i back into the price?  I played with my excel model a bit and even at $550k purchase price I'd only be cash flow positive of $3,000 annually.  Any other suggestions?

3. Cap rate for this property is about 4.1%.  The other properties within my area all have a similar cap rate, would this mean that in order to purchase a small apartment in my area I'm banking on building appreciation, rent growth and since I've heard "you make your money when you buy" that they're all not worth doing?

Thank you so much in advance for your thoughts.  Hope to help everyone here as well.

travis

Eric Heinen · Answer

1.  Those are some pretty terrible numbers, you couldn't even make that work doing an owner occupied purchase with 3.5% down or significant value add.  Is this property in California or east coast?

2. Yeah, run away.  825k would be the purchase price of a 16 unit in my location.

3. You'd be speculating on appreciation most likely.  Invest in other markets.

Travis Kubota · Answer

Awesome advice Allyssa, thank you for taking the time to reply.  It was enlightening to learn that below 5 units is considered residential and I didn't know about the 1% rule either.  Very good to know!

I'm looking to take risks to build wealth, have about $300k to make moves with (and gaining access to $2-4M is probable with syndication) so a more aggressive approach is preferred.

Allyssa McCleery · Answer

Because this property is only 3 units you would not evaluate the value based on income and cap rates. The value is determined by the comps in the areas. This is true for properties with less than 5 units, they are considered residential not commercial. The 50% rule is good for quickly analyzing and determining if you should go into deeper underwriting but should not be using to determine what your offer will be to the seller. Make sure you are accounting for vacancy, repairs and maintenance, pest control, landscaping, insurance, property management, etc. This is a bad deal because it only brings in $4700 per month. Following the 1% rule you would want to purchase this for $470k or less. It also depends on what you are looking to get out of an investment. Are you looking to take a bit more risk and build wealth or are you looking for something stabilized to preserve wealth? To make money on the buy that means that you are buying something below the appraised value so you have increased your net worth upon purchase because the asset comes with built-in equity.