Buy zero cashflow now anticipating huge rent increases

[Michael Andrews]

I am looking at a 4 unit building that is severely hampered by low rents for the area, which is an indication the seller has not raised rents in many years. Each 2 bed / 1 bath unit has air conditioning and is a block from downtown, which should fetch $600-$650 per month, but the current rents are on average $415 per unit totaling $1,655.00 per month in GRI. After getting their profit/loss sheet the property shows an NOI of $591.

They want an astounding $189,000 for a property which would break even at around $100,000 with a 30 year 4.5% note. Assuming the seller accepts a $100,000 price, there are two units with leases coming up for renewal at the end of April, which could be bumped up to the proper rent and push this property into positive cashflow and show a 15% COC ROI. Once the other two units are renewed at the proper rent it would push COC ROI up to 30%.

If (and it probably won't happen) I can get the property for $100,000 showing the CAP rate only supports a purchase between $88,000 and $118,000, with break even cashflow at $100,000 is it worth it to wait two months for positive cashflow and up to year for the full potential of the property?

[Jonathan Twombly]

@Michael Andrews  Knowing zero about the property other than what you wrote, I suspect that this is a deal in which the owner was either undercapitalized coming in, or skimped on maintenance, and now is in a situation where s/he cannot raise rents because the apartments are in bad shape, and s/he can't renovate the apartments because s/he lacks the cash and cannot afford any vacancy at all or their cash flow goes negative.

It also seems that they know the market well enough, or are being advised by someone who does, that they have priced the property AS IF the renovations were done and the new rents were in place.  In the current real estate frenzy, many sellers are setting their prices on value add deals to capture all the value of the value-add that should go to the buyer, who has to put in the capital and the work.  Sadly, many buyers are actually paying these prices, because they are desperate to get deals and lack the discipline to wait until the market corrects.

If you know that you can get the higher rents and are willing to accept a little vacancy in the short run, then this is a garden-variety value-add deal, assuming that you have the capital to do the value-add.

I would try to get a handle on the rehab costs (worst-case scenario), and then take that to the seller and tell him that the property is overpriced because it needs X, Y, and Z, and show them the estimates you got.  They may lower the price accordingly.  If they don't, well, perhaps it will sit on the market long enough that the seller will get desperate and come back to you eventually for a reasonable price.