Looking at buying my first 9 unit apartment building?

[Joshua D.]

So me and my Wife are familiar with buying single family homes which we have 9 of them and a duplex. I could really use some help analyzing numbers to make this work and make sure im doing this right it would be a big purchase for us. They can take $245,000 for it its 9 units has a office space and a detached garage new storage space. How would i run the numbers on something like this to make sure it cash flows well and makes sense? all the units on average rent from $475-$550.  theres a dumpster there that costs $149 a month. Water is $98 a month and sewage is $49 a month. she also pays electric i believe. Taxes are $3,298. guessing insurance would be around $200-$250 a month. Just called are insurance company to find out and they will get back to me. It does have foundation issues i can get looked at and fixed for a good bit maybe $20,000-$40,000 can look into that also. How do i analyze this correct and make sure its a good deal. Does the 2% rule still work for apartments i use it for single family homes. Any advice would be greatly appreciative. It fits are business model really good and in the middle of all are places. I can have my 2 employees look over everything too if turns out to be a good deal. Please any help would be greatly appreciative. If anyone needs anymore info from me please let me know.

[Scott Skinger]

@Joshua D. Your numbers in the calculator do not make sense to me. I believe you are making an investment decision with bad data. I'm only being blunt about this because I want you to sit down with a financial adviser, accountant or somebody you have on your team to help you out so you don't lose out terribly on this deal. 

From what I can gather, you are buying this building for $245K, you think it will cost $40K to repair and $2K for closing costs. You are bringing $7000 in your own funds to help pay for the repair costs. In total, you are spending $287K, the bank will lend you $280K (LOC or refinance of your SFH portfolio?). Because you are only using $7K of your own money, the CoC calculations are showing you making over 100% CoC returns annually. This is VERY misleading for the following reasons.

1. Yes, the most important thing is making sure that this building cash flows but you are already getting pretty tight here. The things that I see that you should be careful with:

-$2,400 seems low for insurance, I would double check this and make sure that you complete coverage, making this mistake can wipe out your whole portfolio if you are sued (btw, this building should be in a separate LLC from your SFHs)

-does tenant pay electric/gas? what about utilities when units are vacant? there are all sorts of other little expenses that you will have, licenses/permits, legal, accounting, pest control, etc. Maybe covered in your numbers, but they are tight

-one major expense can blow your returns for several years

2. THIS IS THE IMPORTANT PIECE. You need to consider closing costs, $ to repair, $ to operate in your ROI returns. You are getting a loan based off the equity in your SFHs. This is like getting cash. You can take this money and do anything with it. You are taking these $ and buying a 9 unit building. Your closing costs, your repair costs and your operating capital should all be included in the amount that you are putting into this project when you're calculating CoC returns. This may be confusing. Let's just consider the following.

-First off, $2000 closing costs seems very low, have you verified this number with your bank? Commercial is different than residential. Are you including property inspection? How about legal? For now, let's just say that this number is $2000

-$40K for repair costs is a big number for a building cash flowing $8000/year. The big problem is that this expense is for deferred maintenance that the seller should have already taken care of.  If you spend $40K on foundation and other repairs it is going to take you 5 years before you get ANY positive return just on this number alone! In addition, this is adding no value to your building, meaning tenants aren't going to pay you higher rent just because you fixed the foundation, etc. See more on this below when I talk about value.

-You need to set aside funds for a reserve and operating expenses from day 1 and I don't see that. What if the furnace blows one week into you owning it? What if the roof needs $2000 worth of work that the seller didn't disclose? The point is that you have to be prepared for the unknown and be able to fund unforeseen events. I know that you have a LOC, but it is best to operate this building as its own separate entity, own bank/operating accounts, etc.

In total, you are spending AT LEAST $50K of your cash. You can invest this anywhere. Your investing it in a building that will make $8000/year, maybe. That's over 6 years just to break even on your investment and work for free.  

3. How much are you going to sell it for? ARV/comps aren't used on commercial property (5+ units). You need to use the formula Sale Price = NOI/Cap Rate

There's a lot that impacts your NOI (raising rents, operating more efficiently, etc.) and Cap Rate is area dependent, so a complete description is too much for this post, however, being conservative, let's assume the following. Your NOI is somewhere close to where it is now in 5 years ($30,950) and the Cap Rate is 10% (which might be low). That puts your property value at $309,500. This is just an estimate, market conditions will dictate what your property might sell for but this is a good ballpark estimate for this example. Even if we don't include broker seller fees we're talking about making $309,500 - $287,000 = $22,500 after 5 years if you sold. I won't do the math but that is not a good return on your money...and this is probably be optimistic.

I don't want to be Debbie Downer but based on your numbers, this is NOT a good investment. I may be missing something, but I would absolutely go back and check your numbers again. Additionally, I would not buy a building of this size that needs that much foundation work. The seller needs to credit you this money or fix it themselves.

Once again, I'm sorry. I would rather be the bad guy and even risk looking stupid making a mistake in my analysis of your deal,  if it will prevent you from making a big mistake and losing what you have worked so hard for. 

Good Luck!