Operating expenses for 80 door multi-family

[Tracey B.]

I'm doing some due diligence on a multi-family, and the proforma expenses are running at 71%. :wowie: I'm pretty sure the expenses are overstated, and I have my own ideas about where they're too high, but I'd appreciate the benefit of fellow investors' experience, please. :cool:

HVAC and electricity are individually metered, and there's no gas, so water is the only utility borne by the landlord.

Here are the figures they've given, per unit per month, and where I think they're overly high:

I think they may still even be a little high, but I'd rather be too conservative at this stage in my due diligence than not allow enough; I still want my figures to be believable to a lender.

Your thoughts, please? Thanks! :)

[Jon Holdman]

Anything provided to you by the seller or their agent is going to try to make the property look as good as possible. If they're showing expenses at 71% of gross rent, they're going to be at least that high. There should be actually data to back up the numbers you're changing.

Sounds like this is a good turnaround candidate. These expense are higher than what they should be, but they could well be reality. I would actually assume that reality is even worse. If you can fix these,you'll significantly improve the value of the property.

[Joel Owens]

So is this property in Australia you are looking at??

I specialize in Multifamily but do not know anything about Australia as I am in the United States of America.

You would have to dig into the numbers to see if it's a deal or not and what can be improved.

Posting more info would help.

[Tracey B.]

The multi-family is in Texas and yes, it's a turnaround opportunity. I would plan to relocate and don't really want to rehash all the pros and cons of that particular issue here, other than to say I'm aware of many challenges. ;) I'd like to focus on expenses for now, please. :)

The expenses are proforma. They're a mix of actual expenses from the past and present, spread over the 80 units, because the lender has taken over and has evicted a bunch of tenants, but not brought in any new ones, so occupancy is very low, about 20 units. I'm quite sure the expenses won't pan out this bad because when I probed the realtor as to how he calculated the proforma expenses, he did stuff like this:

Utility expenses, for example. He used year-end P&L from a previous year, when the property was operating properly (ie at 90%-ish occupancy). But then he did something bizarre... he divided it by the 20 units currently occupied to come up with a figure per unit per month! So it's overstated by a factor of nearly 4, which tallies with my commonsense that water supply only (not heating; that's individual) for a 1/2BR unit shouldn't be $57 per month.

So given this piece of mathematics, I'm pretty confident I can get the expenses lower than stated. I guess I'm not so much asking whether the stated figures are what expenses are currently being incurred, but asking whether my adjusted figures sound realistic and achievable after my intensive "intervention".

[Jeffrey K.]

It is good for you that they calculate expenses like this. You should run your own numbers and go for it if it makes sense.

[Will Barnard]

After "intensive intervention", you can assume that your expenses will be much closer to the 50%-60% ratio of gross once you get back to 90% occupancy.

I see the math that the other person did taking utility costs over a one year period during stabalized occupancy, then averaging that out over the units, then calculating those costs by the 20 or so currently occupied units which gets you a very large expense. Typically, a seller or seller's agent will make the expenses look lower, not higher, so this can boad well for you in your negotiations.

Please understand that turning 20% occupancy to 80%-90% occupancy will take the better part of a year and you will be major cash flow negative for the first 6 months or more. Knowing that, you will need to have a large cash reserve. I do not think that such a property will support debt financing from an institutional or even a private lender so it sounds like an all-cash acquisition to me.

First, verify that the rental rate for this complex will support $460 per door and if that figure is an average, or best case scenario of gross rent. Lets assume for now it is ana average number per door and pricing your rehabbed units which are vacant at that price will fill rapidly.
$460 X 80 doors is a gross income "potential" of $441,600 annually. Upon stabilization, expect your operating/capital expenses to be around 50%, plus fill in a vacancy/loss to rent factor of 10% for a total cost of 60%. This will keep you well inside a safety zone. Using these figures, you have the following:
$441,600 potential gross
($ 44,160) vacancy/loss to rent
($220,800) Expenses (Operating/Capital)
------------------
$176,640 Annual Cash flow (no debt service)

So how much will you pay for the ability to make this income stream, then reduce out your costs of rehab, makeready, time, etc and come up with your final offer price by working backwards. This is the easiest way to arrive at your max offer price on buidlings with such poor occupancy levels.

Reason being, if you take the current income stream (which properties such as this are valued based on income) you would get $460X20 doors occupied X 12 months = $110,400 current annual gross
Expenses are well above the typical %0%-60% range due to low occupancy so this is actually a current cash flow negative property. Valuing it based on current income is impossible since the building(s) is obviously worth something, not nothing based on income. This is why you must work backwards.

Hopefully the way I typed this in my feable attempt to explain it in detail was not confusing.

[Will Barnard]

By the way, what is the ask price for this complex?

[Tracey B.]

Thanks, Will, I totally agree and that's exactly how I'm approaching the process of determining my bid.

The rent of $460 per unit is about 10% below area comps. Every figure I've researched has an upside on what the realtor is claiming!

Asking price is < $10K per door, so < $800K. Taxable value > $1M. Current mortgage >$1.5M.

Given how much equity is being left in the deal, I have found several lenders who have indicated they will lend, provided the appraisal comes in OK. (It's underway; I'm quietly confident.)

[David Beard]

Hi Tracey -- you seem to be doing a nice job with your due diligence, and could be closing in on a nice deal.

Do you have firm rehab estimates from a contractor who has inspected every square inch of the building? You may be be looking at more than just paint and flooring, given the caliber of tenant that inhabit these types of properties (obviously a lot of them had to be evicted).

Being all-in at a price such that you'll get gross rents of 4% per month is where you need to be on these low-end apartment complexes. I agree with Will that 60% should be your MINIMUM assumption for vacancies, expenses, and replacement reserves, for this type of property. Sounds like your revised numbers are right on top of this.

Finally, I'm stunned that you have lenders willing to do this deal at this level of occupancy. Is this hard money? Virtually all banks want to see Debt Coverage Ratios at 1.25 or better and some stabilization before they commit funds. It's NOI that pays the mortgage.

Do you mind me asking who these lenders are? I'm looking at a very similar REO deal ($10K/unit after rehab, weighted average rents of $425/mth), but have had zero luck finding a bank lender for the purchase. I was resigned to a cash purchase with a refi at the 9 mth to 1 yr point.

[Joel Owens]

There are some areas that were hit hard by storms awhile back and also have a flooded multifamily market.

So there are good areas and bad areas of Texas.

You might want to message Bryan Hancock as he buys apartments with his fund in that state and might be of some help.

A bigger factor besides the numbers is supply and demand.Say you get it rehabbed.How will the apartment building stack up against the competition??

Apartments are like restaurants and other businesses in that all have a break even point and above that point is where the profits really start rolling in.

Do other apartment buildings offer in-suite laundry in each unit for example or is a coin laundry on site or do tenants have to drive to a laundry mat??

You want to find out what is typical for the area and exceed that expectation if it's a cheap item to change.

Maybe refacing the pool and adding a waterfall and updating the common area.Redoing or adding an exercise room.Making a small playground area or adding a basketball hoop or tennis court.

It depends on the area but the little things will go a long way.

Are rents per unit going up,declining,or staying flat in the area?? Many buyers of distress I do deals with base rents below market.

They come in and do value added items to the property.Then the base their purchase price on below market rents.They want to lease up for cash flow as fast as possible and not waste time.

After the first year they can up closer to market at that time.

Dropping from 90% to 20% occupancy shows something bad is going on.Even if the previous owner was losing the property they would sign up a bunch of tenants at a little below market rates so they could suck a bunch of cash flow out before being foreclosed on.

When you buy low enough you can rent below market.When landlords are fighting for tenants in a market and an investor buys a foreclosure to rent out it puts downward pressure on the rents.

Then other multifamily owners are pressured to maintain debt service with lower rents and more foreclosures happen.

Don't depend on that banks numbers. If the buildings are separate then you can rehab and update in stages. Lender will want to see draw schedule,blue prints,track record of rehabbing,and absorption rent up schedule time line.

[Will Barnard]

Tracey, ignore taxable value, it means nothing to you right now as far as using it to judge value of property.

I too am alos stunned that a lender would even think of lending on a current negative cash flow property. At 20% occupancy, it can not support the monthly costs for operating expenses, let alone debt service.

The ask price of under $10k per door is a good start because at $460 monthly rents per door and 20% occupancy along with the amount of makeready/rehab you will have, you need to be under that figure.

After working my numbers based on info provided, I would value this property at $1,175,000 after repairs and stabilization. So if your repairs/makeready are to be $400k or less, you will want to be at a max acquisition price of $775k.

I arrived at this figure by doing the following:
$460 X 80 doors X 12 months = $441,600 less 60% expenses = $176k NOI I would want a return of at least 15% for this so a 15 cap would value this at $1.175M, then I also assumed $5k per door for repairs (typical makeready costs are $2500-$3k per door + building/equipment repairs and common area repairs and upgrades. So, $1.175M less $400k = Max price of $775k

I would then also factor in the time of stabilization and my outlay of cash for the rehab and makereadies and want a return for that too, as such, my best offer price would be under the $775k beacuse of these factors. If you figure a minimum of 6 months to get to a high enough occupancy to support expenses, then I would want at least another 25% return on the $400k which would be $100k. So if you reduce out that $100k from the $775k, I would want this deal at $675k and as such, start your first bid lower than that.

Hope this has helped.

[Rich Weese]

As one who owns apts and SFRS in Teaxas, it is a fantastic state. There are still some areas that are difficult to turn around, but occupancy is strong and getting stronger.
Some municipalities are looking to higher assessed values or raising taxes to offset the bad economy. Be aware of that.
You got great replies in this thread, imo, so use them. I've been very happy with my investments in TX made over the past 18 months- roughly 200 doors of apts and sfrs. Good luck. Rich

[Tracey B.]

Thank you all for your feedback. The appraiser's as-is figure has come in about where I expected (well over $1M), and I'm waiting on the ARV figure. I've done a bit more probing and now feel confident that my forecasts of operating expenses are realistic.

As several of you have suggested, finance is proving difficult. The lender who at first said they thought they could finance it, changed their mind :(, but have referred me to another lender who thinks he "may" be able to finance it.

I'm not optimistic on finance, but I'm also not giving up as I've ploughed a lot of time and a bit of money into this, and it's a deal I really want to do, and a property that I feel confident that I can turn around.

I don't want to answer all the questions in public, but rest assured that all the issues raised (location, reasons for low occupancy, condition of interior of units, possible high-value improvements, etc) have been considered.

Thanks again! :)

[Chris Martin]

One quick point on utilities, specifically water. Make sure your utility rates are accurate and cost hasn't escalated significantly. Where I am, water rates have recently about doubled and some owners who pay water are past their annual budget after 4 to 5 months. Caught a lot of people off guard.

[Bryan Hancock]

Thanks for thinking of us Joel...Tracey contacted me about this opportunity this evening and I have one of our DFW-based principals engaged to help her out if we can.

[Joel Owens]

Your welcome.......... :)

[Will Barnard]

Tracey,
You may want to consider a funding partner or a private investor willing to loan a portion of this deal, assuming you have enough cash to put in as well.
Institutional financing will be next to impossible on this deal, but private financing or a money partner will do the trick.

[Jonathan G.]

Another thing to remember is the city. I would try and engage the city inspector to understand what is the status with the city, previous code violations etc. Be aware that in Texas a city inspection will usually take place upon change of ownership and a list of new demands and requirements can be part of your routine during the first year, especially on older buildings…. beware of Arlington in TX – they do this on purpose.

Good luck!

[Jon Klaus]

Is this on a street that starts with F? If so, look real hard at crime rates.

[Tracey B.]

Originally posted by Jon Klaus:

Is this on a street that starts with F? If so, look real hard at crime rates.

No. :) I've looked quite extensively at crime rates; even though it's not the property you mention, crime is my primary concern. I've been fortunate to speak to a lady with young children who's lived in a house across the street for more than a decade, and the neighbourhood patrol officer. I'm confident the crime is primarily petty "crimes of opportunity" and have some strategies for reducing that. The local PD has awesome support programs for multi-family landlords which I'm sure will also be helpful. :)