About to purchase first 4-plex - rent raise trap???

Question

Current rents on 4-plex are $750, $750, $750, $750. They have rehabbed and are claiming market rents are now $950, $950, $1100, and $1100. With 25% down payment and current rates, it is currently being sold for a CoC return of 2.74% with current rents. If you raised rents to the new claimed market value after rehab, the CoC return is now 8.16%, with the valuation of the property now being $100k more than it was purchased for.

My question is... why would they have rehabbed the property and then not raised the rents themselves? There's $100k of value being left on the table. I would like to take advantage of this, but scared I am missing something?

My question is... why would they have rehabbed the property and then not raised the rents themselves? There's $100k of value being left on the table. I would like to take advantage of this, but scared I am missing something?

Jon Kelly · Answer

@Steven Barr you're asking the right question.

The likely answer is: it's easier to convince a buyer of a "value add" opportunity than to actually perform the value add opportunity. The seller knows the property and the tenants. The seller knows the challenges that will occur in raising rents 25-50%...

Frankly, it's laughable, just like the 2-8% CoC, that someone would put that in the description and expect a buyer to purchase.

Christopher Reeder · Answer

@Steven Barr

It is possible the current owner and/or property management performed the rehab and get the units occupied several months ago. This enhanced the marketability of the property and stabilized the income streams. Depending on the specific market, rents could have increased beyond their projections of a rehabbed property resulting in the spread they have quoted.

As others have said, a 1-4 unit will be valued based on comps and not based on NOI * cap rate. The option to maximize rents after acquisition is a selling feature to support their asking price. Perform your market research to validate rents for this type of unit in this market can support the figures they have advertised.

In the hot markets, sellers are pushing rent proformas which in turn elevate their asking price. Though this logic is linked, one’s own ability to execute the seller’s advertised plan can be different than what can actually be achieved by the buyer.

Account Closed · Answer

The due diligence suggestions are good. There could be something not disclosed--the roof needing to be replaced or something like that.

Another possibility is that the rehabbers ran out of money and needed to rent the apartments and dump the property as quickly as possible.

For me, market rents have increased a lot over the past couple years and some of my longer term tenants are 40% below market and it is not reasonable for me to increase their rents by hundreds of dollars. Instead, I don't renew their leases. Then I rehab and re-rent them at market value. As you mentioned, the property's market value is increasing substantially.

John Brodeur · Answer

@Steven Barr, I would suggest doing some due dilligence, by looking at rental comps and purchase comps in the area. You can do this using a number of online tools (zillow, realtor.com, rentometer, and if you have a buyer's agent ask your realtor to pull info from the mls.) If this is a property on market I would highly recommend you working with a buyers agent who is familar with investment properties who will be able to help you wade through this process.

As this property is under 5 units it's value would be determined based on comparable sales and not based on the NOI like commercial properties. So being able to increase rents does make the property more attractive to investors, but it's not necessarily equal to 100k. It might be or it might not...it all depends on what similar properties have sold for recently in that area.

All that being said if you do your due dilligence and it makes sense for you to purchase go forward with it, but don't just trust what the seller is telling you.

Theresa Harris · Answer

If they had a turn over in tenants, they should have raised the rents.  I'd also ask the sellers directly.  Make sure you get copies of the leases, pro-rated rent and deposits written into the contract and if any leases are expiring tell them not to renew as you either want it vacant upon possession or you will renew the lease yourself after closing.

Marian Smith · Answer

@Steven Barr Thats a fair question.  Ask them.  Did they promise the current tenants that if they put up with the hassle of renovation that their rents would not go up?  or something.  Because if my landlord was going to renovate and raise rents I would move to somewhere already fixed up and not deal with workmen in my place.

Sean Walsh · Answer

@Steven Barr I have a tenant paying $1400/mo for a 2BR/1BA that would rent for $1600/mo if it were on the market today. I’ll probably raise the rent when the lease comes up in October, but by how much, I’m not sure yet. She’s older, I really like her, and don’t want her to leave. She’s also been very patient about some inconveniences caused by infrastructure problems in the building that we’ve been trying to fix.

I just wanted illustrate there’s several reasons landlords aren’t currently getting market value for their units. As previous commenters have mentioned above, a quick look at what comparable apartments are renting for is the best indicator of what the units will rent for.

Jonathan R McLaughlin · Answer

@Steven Barr don’t worry too much about “1-4 unit properties are valued on comparables” No. you should value it based on how much money you can make and how hard you have to work to do it.

Check rentometernand other sources for market rents,  then ask how much you want to be paid for the work of bringing them there. Will it be easy? Will you have vacancies? Evictions?

And when people say “you can get X” it’s always great to say “that’s awesome! Why haven’t you done that?!”

They will usually tell u the truth either on purpose or accidentally

John Brodeur · Answer

@Steven Barr, I am not familiar with your individual locality, so you would want to look at the zoning and local municipality ordinances for what type of building this would be considered. Most towns and cities or counties do have their property records online and searchable, so this would be a good first place to go to do some additional research on how the property is currently set up.

One of the properties I own does have a detached two car garage. It was permitted, and allowed as part of the residential property and it is rented out separately from the apartments (although I allow tenant's first opportunity to rent if they want to.) Even though this property has 2 separate garage bays it is still zoned and considered a duplex according to the municipality. The property can only be used as a residential property so there is limited use for the garage. AKA it can't be rented out for a commercial business use, but could be rented out for typical residential use (storage of a car, extra stuff, lawnmower etc.) This has never impacted the ability to get a loan on the property, although it does increase insurance cost a bit as the insurance needs to account for the separate structure.

Are you currently working with a realtor? I would say these are great questions to ask your agent as you are performing due diligence on the property. If you are working with an agent who is familiar with investors / investment properties they should be able to help guide you in this process.

Steven Barr · Answer

One caveat is that there is a garage being rented out under the table. If we got this unit city approved, it would then be a 5-unit. Do you know how that would affect our ability to sell bc it would now be a commercial 5+unit? Also, would that affect our loan at all, given it would be a residential loan?

About to purchase first 4-plex - rent raise trap???

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