Should I SELL or KEEP this building?

[Joseph Shapiro]

Fellow investors,

I purchased an 18 unit building in a major US city some 4 years ago.  I stand to net about $800K (after fees, but before taxes if I were to sell it today  Would you sell this C class property in a nice workforce area knowing:

- I have put in a total of $600,000 into the property (HUD costs + capex)
- I cashflow about $1,500/month from it (takes into account property management fee).  By refinancing from my standard mortgage to an IO (interest only)  loan ($1M balance), cash flow would increase to $3,300.  Total cost of refi (including cost to end loan early with current bank will be $50,000)
- Rents are currently on average $100 lower than market (no upgrades required). With natural churn it would take likely 3 years to get whole new set of tenants to achieve the rent bump up.
- Assuming I refinanced and bumped up my rents [over 3 years] cashflow would increase to about $5,100 a month

I purchased the building in the hopes of supplementing my 9 - 5 job or better yet replacing it after the loan was paid.  However, netting $800,000 and recouping my $600,000 is enticing.    

What would you do and why?

THANK YOU

[Mike Smith]

I agree that we all need a few more details. What was the purchase price and total improvement costs? What is the annual NOI (Net Operating Income)? Don't confuse monthly cash flow with NOI, as NOI includes reserves for CapEx, vacancies, etc and NOI does not include debt service payments. Evaluating a multi-family project based solely on cash flow is taking a wild stab in the dark. You could have the property on a five year payoff and be making dramatic reductions in principal or you could have a teaser rate interest only ARM and be making zero principal reductions and be facing a balloon payoff soon.

Owning multi-family rentals in similar to running a business.  Evaluating your business based on how much cash is in the register at the end of each day would be a total disaster.

That being said....

Assuming your $1500 per month cash flow is actually NOI, you are netting $18,000 per year. I don't know what area you are in, but in the Boise market, multifamily projects are trading at a 4% cap rate for rent stabilized newer buildings. If your building is older, but in good shape, let's go with a 5% cap rate for valuation purposes. $18,000 / .05 = $360,000 valuation.

If you can sell it and net 800k, I would do it immediately.  Most seasoned investors on BP wouldn't pay you over 350k for it.

If you are able to raise rents and obtain an NOI of $60,000 ($5,000) per month, the value at a 5% cap would be $1,200,000. However, most seasoned investors are not willing to pay today for a property based upon the rents in the future.

As Mr. Wonderful on Shark Tank always reminds entrepreneurs, if you project to do 20m in sales in 2025, he will pay you in 2025 based on 20m in sales.  He won't pay you in 2020 with 2m in sales for a 20m projection in the future. 

I know some people say not to use cap rates for analysis, but I feel is simplifies the math substantially. Generally, if you are investing in multi-family real estate, the lending terms (LTV, interest rate, etc) are all very similar, so it's a waste of time to include debt service, debt paydown, etc when comparing multi-family projects. However, if you are trying to compare investing in the stock market vs. multi-family, it's worth running the IRR, tax advantages, etc for that type of comparison.