Bank owned 6 plex

[Karen Dayley]

I have been looking at a bank owned 6 unit property that has been on the market for over 700 days.  It is owned by a local bank. They are asking $195K. There are 5 - 2 bedroom and 1 - 1 bedroom apartments. Most of the units are vacant and need work. They need flooring, cabinets, etc. before they can be rented.  We have estimated the repair costs to be $40,000. The rents are advertised for $400. We made an offer of $120K and they countered back with the full amount and said they had other offers pending.  We didn't proceed from there.  I have waited 30 days for the property to go pending, but it hasn't, so I'm now considering submitting another offer of $140. Any thoughts on how the bank will look at another offer?

[Ken P.]

The after-repaired-value (ARV) and after repaired rents are the key numbers to understand for this purchase you're contemplating. You don't mention how you're planning to finance this purchase, but if you find a bank to extend a commercial loan, you'll likely have to put at least 25% down, or $30k if you get it for $120k, and when you add in closing costs it could approach $35k. $40k in additional rehab costs means you'll be into this building for about $75k, or more realistically over $80k when you include carrying costs while the property is being rehabbed and you're finding tenants.

Applying the 50% rule, http://www.biggerpockets.com/renewsblog/2013/06/14..., to total income of $2400/mo leaves $1200/mo for mortgage and profit, if rents stay at $400/mo. At a cap rate of 10%, the price should be around $140k (($1200/mo x12 mo Net Operating Income) / 10%). Of course if the rents should actually be $500 or $550 a month then the NOI will be higher and the price should be higher, but where the rents are now, your offer seems reasonable, with a bit of room to go up. While the bank might object and say the rents can be raised, that can't happen until after the $40k in upgrades happen, which is going to be your money and time, not theirs.

The monthly payment on a $90k loan balance @ 5% amortized over 20 years is $600, leaving $600/mo cash flow.   On a $80k investment, $600/mo is 9% cash on cash; OK, but not great.  Add in the value of the hundreds of hours you'll spend on this endeavor and the return drops to 8% or less.  If you can boost the rents to $500, cash flow doubles to $1200/mo, and the cash on cash return (18%) starts to look juicy , so raising rents has to be part of the equation for this to make sense long-term, IMHO.

After repairs, the total money wrapped up in the building is your $80k, and the bank's $90k, or $170k total. If you can finance on the ARV, the cash on cash and ROI can be stellar. ARV on a multifamily takes advantage of something called forced appreciation, which comes from being able to raise the rent, which raises the NOI. If you raise rents after upgrading the units to $525, which seems reasonable for your part of KY, then your NOI jumps to ~$19k, so value at a 10% cap rate jumps to $190k. Refinance that with 25% down and your new loan amount is $140k, paying off the earlier $90k loan and putting $50k back into your pocket (minus refi costs).

Refinancing means you would then have only $30k out of pocket into the project.  Cash flow drops because of the higher loan, to $650/mo, but that is a 26% cash on cash return based on only having $30k invested.  And remember, you still have 25% equity in the building, or $48k, so in effect you've created $18k in wealth from nothing that is paying you $650/mo in cash, and your equity is increasing as your mortgage is paid down and as rents go up over time.

Good luck, let the forum know how this goes!