Investor · Harrison Township, MI · Member since 2015 · 131 posts · 45 votes
Hey all,
We're super interested in getting into apartments, but I'm struggling on a few things when it comes to the analysis.
1. When considering work that needs to be done to the property, such as remodeling rooms, should we consider that as upfront money or somehow spread it out in our analysis? I know investors often do a few rooms a year or something like that. Obviously, having an additional 80k in expenses added on to the purchase price makes your cash on cash return and overall ROI look a lot worse. How would I go about factoring that in over say 3 years? Subtract from cash flow maybe??
2. We're looking at a property that would cost us about 600k plus the repairs. We don't have that kind of scratch so we'd need a loan. We would probably put together some private money in addition to a commercial bank loan. Who should I consider approaching first, bank or private money?
I've attached our current analysis below. It's a work in progress so feel free to pick it apart!
Any other input would be greatly appreciated as well.
Buy & Hold Owner · Redlands, CA · Member since 2015 · 5k+ posts · 2k+ votes
9y
I like "Cash-n-Carry" approach; ie: make the property perform and support itself. By that I mean, buy w/o any room rehabs (assuming all are serviceable, but just out dated). Get it operational, all your support systems working and cash starts flowing.
Now when you get your first vacancy, REHAB this unit before filling it. The property has supported the remodel via cash-flow, not your long term loan. Your taxes improve the following year (capital improvement) as does your cash-flow because with the rehab you can increase your rent on that unit.
Improving the YE NOI then forces an appreciation and better value (as measured by a recalc of the CapRate).
Developer · Houston, TX · Member since 2015 · 1k+ posts · 1k+ votes
9y
You should do the rehab upfront as you can possibly roll that into the loan. So that leverage will actually help your return not make it worse. Your cash flow should be just for R&M and make ready type of repairs. And then you should have ongoing CapEx reserves (which I guess is technically from the cash flow) for the big ticket items.
Investor · Bellingham, WA · Member since 2010 · 308 posts · 230 votes
9y
@Ryan York I recommend running the numbers both ways against the rent bumps to see which produces the results you're looking for. Different factors such as your intended holding period, whether or not you have an IRR hurdle and others can make a difference. That said and as @Michael Le pointed out a properly written loan request would roll the rehab into the overall cost of the project and be financed at the lender's LTV which would reduce your out of pocket up front.
Buy & Hold Owner · Redlands, CA · Member since 2015 · 5k+ posts · 2k+ votes
9y
I like "Cash-n-Carry" approach; ie: make the property perform and support itself. By that I mean, buy w/o any room rehabs (assuming all are serviceable, but just out dated). Get it operational, all your support systems working and cash starts flowing.
Now when you get your first vacancy, REHAB this unit before filling it. The property has supported the remodel via cash-flow, not your long term loan. Your taxes improve the following year (capital improvement) as does your cash-flow because with the rehab you can increase your rent on that unit.
Improving the YE NOI then forces an appreciation and better value (as measured by a recalc of the CapRate).
Real Estate Investor · Encinitas, CA · Member since 2016 · 3k+ posts · 3k+ votes
9y
Jeff B. I'm considering a property where I would have to do that. My question is: what about items like exterior wood rot, exterior repaint, maybe some foundation shoring up, windows, etc.? Things that (in theory) should make the building more appealing to a *better* (more qualified) tenant. It can cash-flow as-is but I'm concerned a semi-dilapidated exterior would keep the tenant quality as-is and made it hard(er) to justify the subsequent interior renovations.
Jeff B. I'm considering a property where I would have to do that. My question is: what about items like exterior wood rot, exterior repaint, maybe some foundation shoring up, windows, etc.? Things that (in theory) should make the building more appealing to a *better* (more qualified) tenant. It can cash-flow as-is but I'm concerned a semi-dilapidated exterior would keep the tenant quality as-is and made it hard(er) to justify the subsequent interior renovations.
hmm - - that's a different matter. Those really need to be resolved.
I would request the seller to repair the foundation and wood rot+paint. His appraisal will be adversely effect if he does not correct. Curb appeal is your first line in marketing and will turn away good tenants if it's "tried & dilapidated" just as you guessed.
Windows are easily upgraded with retro-fit dual pane E-glass at anytime - - only takes a day for a qualified contractor.
Be sure to get an inspection on Roofing and if aged property, add Electrical & Plumbing. These will be on your nickle but worth the price to discover now vs later.
Your DSCR (noi/debt-service) is 1.059; I fear you are low as typically today it should be 1.2-1.3
The Expense ratio is high; you do not mention management, insurance, reserves or capex so I'll assume you know and just did not show. See what you can do to reduce expenses to correct the DSCR
Real Estate Investor · Encinitas, CA · Member since 2016 · 3k+ posts · 3k+ votes
9y
@Jeff B. Whoops, looked like I hijacked the thread accidentally, those are @Ryan York 's numbers. The property I'm looking at is completely different but in a similar scenario when you know there's going to be a good amount of rehab: what to do up-front vs. unit-by-unit.
Investor · Harrison Township, MI · Member since 2015 · 131 posts · 45 votes
9y
Jeff B. Thanks for the replies. That's helpful.
Is there some metric you would use to consider whether or not the cash flow is sufficient to fix the units as they come vacant?
Say you had three units come vacant in the same year. I expect it would be a challenge to have cash flow that could pay for 10-20k of repairs in one year.
Would you go through the current leases and see when each one is ending and shoot for cash flow that can pay for that, or would you just collect your cash flow and rehab the units when you can?
(1) Is there some metric you would use to consider whether or not the cash flow is sufficient to fix the units as they come vacant?
(2) Say you had three units come vacant in the same year.
(1) I did a break-even analysis to determine just how many units vacant could I tolerate before going cash negative; ended up being two --
that's two in 6units x 12months or 2/72unit-months and I found that to be acceptable.
With only one vacancy/month, the rents being collected provided a goodly sum toward the rehab and only a portion of the reserves (ie CapEx) need to be tapped. In 19yrs of cash-n-carry, even with the fire, I never lost money on the 6-plex.
(2) well, sort of. Two units went down due to fire and in the middle of rebuilding I had an adverse eviction. As the insurance had Lost Rents coverage, I was still at 1/72 unit-months and still no losses.
Investor · Indianapolis, IN · Member since 2017 · 21 posts · 7 votes
9y
@Michael Le How do you get a bank to roll the rehab into the commercial loan? Simply add it as a line item into your loan request document as such? Or would you roll it into what the seller owes you, similar to how you'd get the seller to pay closing costs on a conventional loan? I assumed that getting a commercial loan would be tough enough without adding rehab costs. Then again, if you can argue and prove why it'll be more beneficial to NOI and DSCR, I'm sure they'd be more than happy to earn more via down payment and interest.
Developer · Houston, TX · Member since 2015 · 1k+ posts · 1k+ votes
9y
@Patrick S., no, you don't roll it into what the seller owes. I mean, if you can get the seller to pay for it then that'd be great but it doesn't work that way.
As for it being harder to get a commercial loan if you add rehab, you have to remember that a lender will already be appraising the property. If there is already a lot of deferred maintenance, they will have concerns and might make you do the repairs anyway. But if you can show them that you can increase rents by doing this rehab then they are more likely to let you roll that money into your loan. So instead of a $600k loan it will be $680k. So while your debt service is higher you can also more quickly get your gross potential rents higher because you're doing the rehab sooner than later.
Investor · Indianapolis, IN · Member since 2017 · 21 posts · 7 votes
9y
@Michael Le Thanks for walking me through that. It makes sense that the bank would be interested in loaning you money to improve the property and generate a higher NOI, thereby helping you meet your obligations to pay and improving the value of the property that they effectively own. I'm more familiar with conventional residential loans, which will not provide money for rehab unless you're getting an FHA 203k loan.
Investor · Charleston, SC · Member since 2015 · 113 posts · 50 votes
9y
You can increase the price you offer the seller by 10% and have him credit the repair money at closing. A lender will typically allow up to 10%. If repairs are over the 10%, find out what your lenders DSCR requirement is and that will tell you if you can add the CapX to the expenses for x number years. If not, you may need to get a bridge loan. Ask the lender you deal with and they should be able to tell you the best options.
Debt is usually cheaper than Equity. The exception of course is if you're having a private lender put up the capital and paying a set rate without having to give up equity. Hope this is helpful.
Investor · Charleston, SC · Member since 2015 · 113 posts · 50 votes
9y
Just saw you have the DSCR in the spreadsheet to toss the previous post. lol You can increase the price you offer the seller by 10% and have him credit the repair money at closing. A lender will typically allow up to 10%. If repairs are over the 10%, you would find out what your lenders DSCR requirement is (1.25-1.35) and that will tell you if you can add the Cap X to the expenses for x number years. The 1.05 is too low so the next step is a bridge loan with the Cap X included in the loan. Once the property stabilizes you would want to get a perm loan. For this size property this may not make sense. Ask the lender you deal with and they should be able to tell you the best options.
Debt is usually cheaper than Equity. The exception of course is if you're having a private lender put up the capital and paying a set rate without having to give up equity. Hope this is helpful.
What may be an option is ask the seller to do some creative financing so you can bring it up to market standards and get a private lender put up the capital for repairs. Could do seller financing on a 6 or 12 month term or a lease option etc... Once the property is stabilized, get the perm loan.