Would you buy a property receiving under market rents?

Question

I'm looking at a duplex that has tenants in place. Each unit is rented for around $800, but market rents are $1500. The leases end in October and August, so if I were to buy it with a loan I would eat a part of the mortgage for four months on one property and six months on another. In order to get to the higher market rent, certain updates we need to be made to the units. The duplex has been hanging on the market for a while, likely to the aforementioned leases being in place.

My questions are:

Would this be an opportunity you would look into buying, and why?
How do you handle the updates?
How would you handle the tenants?

Thanks so much!

My questions are:

Would this be an opportunity you would look into buying, and why?How do you handle the updates?How would you handle the tenants?Thanks so much!

Kyle Joseph · Answer

Yes, I would look at this deal. If the in-place rents generate don't generate enough cashflow to cover your debt service, you'll want to plan to bring additional equity to the deal to cover the shortfalls. And even if you have enough cashflow to cover debt service, you may not hit typical bank lender DSCR covenants. Check with your lender to make sure they are comfortable lending with this period of 3-6 months where your cashflow is light.

In terms of updates and tenants, it sounds like you may have time to complete them at the end of each lease expiration. So when lease 1 expires in August, ask the tenant to pay $1,500 (or whatever you would be satisfied with) or vacate. If they vacate, do your renos and have the unit rented by October. Once that unit is filled, do the next one. That way you have some rent coming in at all times. If it's a really tight rental market, these tenants may be willing to pay more in rent and you can defer when you need to do the updates.

Happy to look at some numbers with you if helpful, just let me know.

Ned J. · Answer

These are exactly the ones you want....value add.

Scott Johnson · Answer

I appreciate that, Kyle! I was also considering asking them if they would like to pay the 1500 month and get the renovations. That point I would have to put them up in a hotel or some temporary housing in order to get the place fixed up.

Ricardo R. · Answer

@Scott Johnson great topic! I will try to give you my best, with the hopes that it will help you out and you can leave me an honest review. Okay...

Yes, infact this is specifically what we look for when buying investment properties... undermarket rent. Because they are undermarket, most mom and pop or uneducated 'investors' will just see it for what it is, maybe they'll run some simple numbers, and ofcourse the numbers with the below market rents and the now new purchase price don't likely pencil out and so... they will walk away and keep looking and are usually the ones complaining that 'it's hard to find any good properties in today's market'... where in fact that is exactly where you as a savvy investor make your money.

Being a savvy investor you realize - as you have mentioned - that the rents are below market a.k.a. value add opportunity... and so becuase of this and because there is less competition due to the reason most other 'investors' are ignoring it right now as I have mentioned. You are able to have access to it and buy it with relative ease and in fact, you can use this as a point of leverage and negotiation with your Seller in echoing to them that the bldg. currently does not cash-flow that well for you and you have to renovate - although your Seller may already be aware that rents are below market and has already priced it accordingly... if this is the case, then just buy it without without using 'below market' rents as a negotiation point.

When you listen to podcasts or read books or anything else regarding advice on 'buying below market' this is partly what they are referring to... THE MISTAKE however is that most people think that it just means finding something that is easily seen at face value.. for example most think that it's as easy as seeing a 3BD/2BA listed at $200K where every other 3BD/2BA is $300K, so that's what they keep looking for... it's rarely ever that easy and if it was.. you whould have tons of competition if it even stayed on the market at all! ... In most cases it is kind of like this property... You find a property that 'SEEMS' to be a bad deal and 'seems' to produce no cashflow BUT upon a little digging you find that indeed it is a great investment because the rents are below market -- hence, buying below market value. Now ofcourse this is also assuming that the property is priced accordingly as well.

Personally, assuming you like the numbers... I would just focus on $800/mo. rent and tight cashflow in negotiation with the Seller and especially considering that to get that higher rent you will need to undergo and pay for some upgrades and then.... just buy it. I would just factor in the difference between $800 and $1500 until leases run out as part of my 'closing costs'.

Now, as far as undergoing the actual updates themselves... I'm sure there a tons of opinions but personally I like to use one of two methods - METHOD 1: Clear out the bldg., carry out your renovations, this makes it easy, no Tenants to answer to or to bother you, clean slate... but no cashflow while underway. - METHOD 2: Leap frog... Carry out renovations one unit at a time, fill it with a new Tenant before proceeding with the next one. -- Again, I have used both, it's a matter of personal preference and the depth at which you are renovating.

Tenants: Well for sure get estoppel certificates before closing. Then you can either leave them be until they expire, or let them know that you will be undergoing renovations, let them know the new rent and possibly have one tenant living in a existing unit, while you renovate the other side, to which they will move in to the new unit once complete at the new rent rate. However, in my experience inherited Tenants hardly ever workout and even less so when rent is going up by that much.

I sent you DM on BP, hope you can assist and I hope I have helped you some.

Would you buy a property receiving under market rents?

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