$3MM+ Deal Review, First Deal

[Troy Hebert]

Hey everyone,

As mentioned previously, I am a finance professional looking at real estate deals on the side, and still looking for my first deal. I have found what I believe to be a good one and have fully negotiated the price with the seller, but it’s a pretty large deal especially for my first. I’ll have a limited experience partner splitting the down payment, and the same property manager will manage the properties pro forma (and on a long term employment agreement). But it is ~80 units across 10 different properties, roughly $3.2mm total deal. I also have substantial seller financing here / limited cash equity at risk.

1. Because it's a proprietary (no brokers or agent) deal, I've had issues finding data for the area. Agents are reluctant to give me any information or spend any time as I already have my own deal and I'm not willing to cut them in for $100k just to get access to MLS. But would be great to look at the cap rates over time in the area or similar. Any ideas on how I can see data here for multi-family and see how volatile/cyclical the local market is?

2. What’s keeping me up at night is primarily where the value of the portfolio can trade. I’m buying the properties at a 9.6% cap rate in a class B-C area. The properties are really in excellent condition and have been very well maintained, with a very long track record of renting out (historical vacancy of 7%). Overall at that cap rate, even after servicing P&I on my commercial loan, it generates $100k per year in free cash flow (including significant allocation to capex reserves).

So I look at that kind of cash flow, after capex reserves and vacancy, I get more comfortable. The valuation would have to fall to a 12% cap rate for the value of all the properties to be at my loan amount/wipe my equity. I just can't see it falling to that level, but have no data (see 2009). $300,000 of NOI and not being able to sell for $2.35mm? Surely someone would scoop that up right? Or maybe it cycles and the price of all 80 units can fall by 35%?

I guess the question is how possible is it to fall to those levels? Should I even care that much at this cash flow level? I can just hold it, and assuming rent prices don’t drastically fall, and generate almost $9k per month in cash flow and pay down almost $100k a year on the loan. Doesn't really matter what the market at that time is valuing those assets. 

How likely are rent prices to fall drastically? Rent would have to fall by $100k on $640k net rent today (incl. vacancy) or 17% across the board at all 80 units for me to go cash flow negative after debt service. I personally feel like that’s extreme and wouldn’t happen, but maybe someone here has seen this before. In my world of private equity and LBOing businesses, these types of events can occur as you’re dealing with an actual business that sometimes is cyclical, has customer concentration, etc. But this is basic multi-family renting. Keep in mind the average monthly rent per unit here is like $700.

3. How difficult is it to replace a property manager? The existing one has a long track record owning/working on these properties, and we'll have a legal agreement in place, but there is some key man risk here. If he dies for example, does anyone have experience hiring new property managers in rural areas? The properties are not in NYC. It could require someone moving to the location.

I’m just feeling like I have an exceptional opportunity here with great financials even modeling a downside case. It’s just hard to foresee how bad a downside case really could be in reality. Some of the greatness in this deal is the scale/size, the ability to generate some serious cash flow and equity in a diversified portfolio, but at the same time if things go south those large numbers become a real problem for me personally. So just trying to find out how bad this could get.

Thank you in advance!