Fourplexed leased to drug rehab business - good idea?

Question

Hi, I came across purchasing a fourplex under master lease by a residential drug rehab business. Master lease is for 2 years followed by 2 year renewal option and rent escalators. Owner of this rehab owns several rehabs already. Anyone with experience investing into properties leased to rehabs? What should I watch out for? Is it even a good idea to invest in this particular situation? What to look for during due diligence period? All advises appreciated.  (property is in Los Angeles county). Thank you.

Will Fraser · Answer

Hi @Igor Nastaskin, I'll speak from a slightly different angle here since @Corey Hawkinson, @John Mocker, and @John Warren have illuminated some excellent points already.

I own a fourplex being (illegally) used as a homeless/drug convalescence center near other properties and it has destabilized the rest of the area.  Seriously . . . in that one building 2 of the other tenants (4 year tenant and 8 year tenant) have served notice and in the building that surround it there is a churn like we've never seen before . . . because there is also a steady stream of all of the trappings of a distressed lifestyle + recent drug usage.

I am under contract on a 20 unit that was run as a drug rehab center for years prior and, because is was a self-contained property surrounded by industrial and retail it didn't affect the area, but still led to some "interesting" challenges in the inspections period.  However, because the management was skilled and the location conducive to it, it created a good cashflow for the owners, a much-needed opportunity for the people in the program, and now is off to its next life.

The lesson:  think of the property in the greater context.  It WILL matter that it is a rehab house . . . it just will.  The question is, will it hurt other things around it, or are those things sufficiently isolated in such a way that it won't be a barrier to your operation or that of your neighbors?

Rob Massopust · Answer

Hmm

Does anyone know of an operator in So Cal that would be interested in an 8 room boarding house that this might work for?

Corey Hawkinson · Answer

@Will Fraser Great points! This reminds me of another important piece to consider. Would you (person who started this thread, not Will) have the ability to accept/reject tenants? I overlooked this because I have that ability. I run a background check on every potential tenant.

In my case, my property fits in with the neighborhood and people would not realize it was housing for former homeless individuals unless they were told. It is not transitional housing where people are only there a short time. 5 of the 8 tenants have been there over a year. If this is more transitional housing you will likely face the issues that Will described.

Corey Hawkinson · Answer

@Igor Nastaskin I own something you might consider similar, a 4-unit property that is rented by an agency for people that used to be homeless. Like anything, there are pros and cons for this type of investing. Here are a few for me that you might also face.

Pros:

The rent payment has been on time every month because it is paid by the agency.

I feel good about helping homeless people turn their life around. I realize this might matter less to some people.

By leasing per bedroom I am able to receive higher total rent.

The agency has an employee at the property at least once a week working directly with the tenants. That employee notifies me of things I should know. (When they can, obviously laws exist that limit some things he can tell me and we follow all laws.)

Cons:

Vacancies can take longer to fill. I know that sounds crazy when you think about the homeless population because I should have a huge waiting list, but the truth is other factors apply. The agency needs to get people to qualify through the county/state for the program and they also need people that fit in well at the property since they live with another person.

There are more work orders at that property compared to other properties. Make sure the cash flow is strong because if it is like mine it will be a more active investment compared to other properties.

Information I would want to know if I were you:

How long has the agency been in business? How large? Can they provide financial statements?

What is the source of funding for the leases? By this I mean, does the state pay? Individual insurance? Direct from the people recovering? If it is government funded I would do additional research. A benefit for you is that you’re in a state that is decidedly on one side of the political aisle. I’m not going to argue which side is better, but a problem can occur if the state is 50-50. A swing from one side to the other can lead to funding changes for specific programs.

How long does each individual typically stay at the property? What is the average vacancy? Does the rental amount change based on vacancy or does the master lease pay the same even if the property is half vacant?

How is damage treated at the property? Agency pays? Security deposit from each person?

How comfortable are you with the people you meet from the agency? Meet more than 1.

Sorry for the long message but that is what I thought of off the top of my head. I’m sure I’m missing some items I would want to know.

John Warren · Answer

@Igor Nastaskin I think this could be a fascinating investment if the numbers work. I would focus mostly on the health of the business. Is it well run? Does it create consistent revenue for the owner? Is it in good shape as far as state licensure, etc? I would also focus in on payment history. Ask for bank statements, etc. This could be a very easy deal to manage, almost like a net lease situation where you rent commercial property to star bucks.

Fourplexed leased to drug rehab business - good idea?

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