How to analyze a 9 unit apartment building?

[Joshua D.]

So me and my wife have 7 SFH’s and a duplex. All great returns and cash flowing great. Really interested in a 9 unit apartment building has a attached little office and a nice new storage building/garage on property. Right in are area of all of are property’s. Really fits and works for us and is right in the middle of all are stuff. Anyways my usual deals are just steals and no brainers honestly. So i can get it for $245,000 i think needs some work everywhere i could pay cash with all my lines of credit or see about owner finance which I believe is called a note? If someone could give me in site on how properly evaluate this deal? Would be a big purchase for us

[Roy N.]

You evaluate it as a business - based upon the cash it throws off.

Look at the actual revenues.  Start with the rent and economic vacancy and compare it to the averages/norms for the area.

Look at the vendor's actual operating expenses - then do a reality check to confirm if they are realistic ... i.e. where possible determine your own.  If you get to an accepted offer, you will ask for actual invoices/bills ... or {dare to dream} audited financials ...  

Look at the condition of the "assets" - the building(s) themselves - and determine immediate, short term and mid term capital expenditures. You will factor the immediate and short-term into your offer. A commercial lender may require you to maintain a capital reserve (they will collect it in addition to the debt service and property taxes {if paid through the lender}), so you will want to ensure the NOI is sufficient to service the debt, fund the reserve, and leave you some to take home. You also want to ensure the free cash flow meets your return requirements.

Folks are going to post here talking about capitalization rates (CAP). CAP can be a useful metric for comparing several properties in a given location - then only if calculated precisely the same for each property being compared. More often you will hear of Market CAP rates which is just an average of CAP rates for recent transactions which may, or may not, have been calculated with the same methodology. Ostensibly, Market CAP tells you what other folks are paying for a a dollar of cash-flow, but it does not tell you if your deal is good (for you). We never look at CAP when buying - I could care less what others are paying and am more interested in the rate of return and the growth potential of the business and the effort (cost) to reach that potential. The only time I would be curious about CAP rates is when I want to sell.

If you need metrics to measure the business, look at {M}IRR and the amount of return derived from operations (cash flow) versus asset appreciation (we model properties with zero, or negative, appreciation to get a better sense of the operational strength of the business).