Need help with creative structuring for my LOI on a 16-unit

Multi-Family and Apartment Investing
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Need help with creative structuring for my LOI on a 16-unit

Nicole (Dunlap) Pendergrass
Rental Property Investor · Bronx, NY · Member since 2011 · 195 posts · 322 votes

Hi All,

I am currently writing an LOI on a 16 unit apt building but need some ideas on creatively structuring the deal. I want to give the seller about 3 offer options and he can pick the one that fits his needs best. Any input from people really good with numbers would be great!

Background:

Only 10 months worth of income and expenses are avail bc the owner just purchased the building at that point and didn't have previous year's info. So I averaged the monthly income and expenses and x12. There is no debt service - it's free and clear. The owner has managing the property himself for a while, but recently hired a property management company w/in the last few months. Vacancy has been really all over the place those 10 months, but last I heard there were 3 units vacant (18.75% vacancy) that the PM was working on filling. The avg vacancy for the past 10 months is 26%.

Financials

Gross Rental Income: $84,000

Operating Expenses (including extra I've added for cushion): $56, 000

Asking: $250,000

But at that price, I would be in the negative at 26% vacant (assuming traditional bank financing at 20% down - which no bank will finance a negative building anyways). Even if I got the property fully occupied and averaged 10% vacancy for cushion, I would only cashflow about $400 p/month. Also, even with no debt service, the building currently only cashflows $500-$550 p/month at 26% vacancy. I keep harping on the vacancy because I know it would be smart for me to purchase based on the past year's performance (even if I know it's bc the owner didn't know how to manage!) and not just the last month or two.

The owner is very motivated and I'm looking for a way to structure multiple offers where I can:

1) take over control the building with maybe them being an equity partner ( giving them a % of the monthly cashflow and % of back end sales),

2) maybe put an initial purchase price of something small upfront like $80k (is it reasonable to think I can bank finance the $80k w/20% down? If not I am prepared to raise the $80k) and then they get the balance of whatever purchase price we agree on in a year or two? I'm assuming once I establish a history of the property performing I could refi to pay them their equity... does anyone know how much history a bank likes to see?

3) also considered forming an entity where we are both members and have them refi for the purchase price, give them their equity and then removing them from the entity

I asked about seller financing as another option and they are willing with about 50% down... but that is too much. Of course if I could convince them to get me into the deal with no real money down that would be great (no need to beat me up about "no money down" deals, I know they're rare).

Sorry I know this ended up being looooong and all over the place, but if you can understand what I'm trying to say please comment :-)

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  • David Gerlt
    Newport Beach, CA · Member since 2011 · 8 posts · 1 vote
    13y

    Nichole,

    Sounds like a great opportunity.

    One thing you might want to consider is a master lease with an option to purchase 3-5 years down the road. More experienced investors might want to chime in here, but I would expect you could get the seller close to his price on your buy option, then agree to pay him the $500 cash flow, and then get the additional units rented and you could keep that cash flow. Then you might be able to increase rents for additional cash flow and perhaps share some of that with the seller. Then on exercise of the purchase option you can get him his 50% (with the idea that in the meantime cash flow has increased and a good loan is more likely). You might want to offer a nominal amount for the option, like $1,000.

    The trick is the condition of the building. Will it need major repairs soon? If so he should agree to share in those expenses. There really should be repair reserves to make sure there is money available for unforeseen repairs. Also make sure he did not fill the place with a bunch of deadbeats just to get the numbers looking good who will stiff you on the rent or with relatives on sweetheart below market long term leases.

    You should also consult with a commercial broker that has listings in the area of similar properties to find out what the cap rate is. That normally sets the price of apartment properties. At least that way you can determine if this is a serious bargain or not.

    Good luck!

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  • Chris Da
    Real Estate Investor · Phoenixville, PA · Member since 2008 · 105 posts · 38 votes
    13y

    why are they selling it ?

    0Reply
  • Nicole (Dunlap) Pendergrass
    OP
    Rental Property Investor · Bronx, NY · Member since 2011 · 195 posts · 322 votes
    13y

    They just gave me the standard answer of we just want to get out of it and move on to something else. I do get the "feeling" that there's something they're not saying.... I know the area isn't the best (I'm guessing C or C-) and most of the tenants are on some type of government assistance (he said not section 8). But I feel like I could uncover anything I might be concerned about during the due diligence period.

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  • Scott Seaman
    Rental Property Investor · St Petersburg, FL · Member since 2011 · 79 posts · 24 votes
    13y
    How much did they buy it for 10 months ago?
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  • Nicole (Dunlap) Pendergrass
    OP
    Rental Property Investor · Bronx, NY · Member since 2011 · 195 posts · 322 votes
    13y

    @David

    Thanks for your advice! I had also considered MLO but I def have to confirm what kind of reserves they have. If they don't have any, I was thinking I could have them take out a really small debt service on the property (maybe $25k-$50k) that I could keep for reserves. This would come out of the balance of what they get whenever I refinance down the road... does that seem plausible?

    Also, as far as them just filling the property with anyone... I'm pretty sure they didn't do that since the listing I saw says 75% occupancy, which is in line with the average vacancy amount I calculated. He also told me in multiple conversations that the OM was working on filling the vacant units but they aren't filled yet because he did not want to put just anyone in there; he wanted to make sure everyone was still screened correctly.

    The PM is also working on implementing a system where the rent is deducted automatically from the debit card of any tenants that get government assistance (the money from the program is normally deposit on the debit card the same day of every month).

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  • Nicole (Dunlap) Pendergrass
    OP
    Rental Property Investor · Bronx, NY · Member since 2011 · 195 posts · 322 votes
    13y

    Not sure how much it was bought for... didn't ask. I'm going to ask around to some contacts from that area and see how I can find out (I'm sure there's an online website).

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  • Robert Blake
    Investor · Aurora, CO · Member since 2013 · 97 posts · 40 votes
    13y

    Have you physically seen or inspected the building?

    Your expenses are awfully high relative to the income, even if you reduce the vacancy to 10%. At your referenced numbers, you're not going to make much off this one at all. If you cut the expenses in half, you've got a decent little deal...assuming nothing needs fixed.

    The current owners bought it cash, 10 months ago, and are already trying to unload it. Just sayin'.

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  • Dion DePaoliPro Member
    Real Estate Broker · Northwest Indiana, IN · Member since 2011 · 2k+ posts · 2k+ votes
    13y

    The current owner purchase Subject Property 10 months ago. There has been what seems to be zero improvements or legitimate steps toward stabilization. So AT BEST, the property is worth what they paid for it, it is in the same state as when they purchased so not sure why you would want to give them profit when they added zero value. (+1 renter at the end of 10 months is not much of an impact)

    Under that same idea, a bank is not going to give them a higher evaluation, if the property even achieves an evaluation of what the current owner purchased it for.

    The numbers in your post are hard to follow. Is the $84k, gross effective income, in other words, is that all 16 units with their some average monthly/annual rental amount or does that number already take into consideration the vacancy loss you have?

    Averaging rental amounts might skew your numbers. You need to make sure your unit mix is properly addressed to be more accurate. Higher concentrations of 1 BD/1BH vs 2 BD/BH could push the average up or down contrary to actuals.

    You mention only making $400/$500 per month, is that a per unit number or a net per month for all units?

    At face value of what you posted:

    Gross Income $84,000
    Expenses $56,000
    Net Operating Income = $28,000 ($2,300 monthly)
    Cap = 11.20%

    This property sounds a bit more like a 15% to 18% cap, IMO. It is not clear how much deferred maintenance is present, which is a pretty big elephant in the room. Why hasn't this been setup for Section 8 tenants yet? Seems like there is a story there.

    If that $84k is gross potential income, the price at $250k is too high for this property as it is.

    Responses to the structure ideas:

    1. This really sounds like a glorified manager of the property manager, not sure why the Seller would agree to this. It sounds like they are more interested in getting rid of the property.
    2. If you "buy" the property, you bought it. This idea sounds more like you contribute $80k to join the owner in the property, with an option in the future to deliver some type of exit payment, through time or lump sum. You likely will not be able to finance the $80k in that manner conventionally. A bank will not lend you $80k to join them, the bank will want a lien over the entire asset which if the Owner stays in, could be a refinance or if you purchase it outright is a purchase loan. Provided the property and the owner and you can all qualify for the refinance or purchase loans.
    3. This is a flawed idea, if the sale price is $250k, no bank will allow 100% cash out, ever. So you will not be able to use a refinance to capture the purchase price. Cash out refinance will have a lower LTV than a purchase money mortgage, I am guessing around 65%. That may even be a long shot if the property is not stabilized in the banks eyes. Further, having or including a straw man borrower, the current owner who is then removed post financing, may fall under fraud, likely not a good idea. A bank will keep an eye on the principals of the company and may even have a provision that the bank be alerted if ownership of the LLC is amended.

    Not knowing what the Owner at this point is not a good thing. Again, it seems like little to no value has been added. Under that same idea, the property can't be worth more than what he/she paid for it just 10 months ago. You can look up public record and see what the sale price was. You NEED to know this. This will add some additional insight into what else might be the problem here. An investor who knows what they are doing doesn't get into this property and then bailout in 10 months. I am inclined to think there is a decent sized issue/problem that has not yet revealed itself yet.

    If you can take the property on yourself, in terms of capitalizing the purchase either through debt or equity, I would pursue that angle and leave this current owner out of the picture as much as possible. I would also start to position the conversation back closer to what they paid for the property and keep any profit on their side very, very minimal. They don't deserve a return if the property is fundamentally in the same state as it was.

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  • Nicole (Dunlap) Pendergrass
    OP
    Rental Property Investor · Bronx, NY · Member since 2011 · 195 posts · 322 votes
    13y

    @Dion

    Your post is extremely helpful…. Thanks a lot. Sorry about the confusion with numbers, let me clarify some things:

    • $84,000 is gross effective income and does NOT include the vacancy
    • Unit mix is 12 one bedrooms at $460 p/month and 4 studios at $375 p/month
    • The average monthly cash flow is $504 net p/month total for all units – but that DOES include average vacancy of 26% (averaged from the last 10 months)
    • The current vacancy for this month is 18.75% (3 units vacant) so the current total monthlycashflow is $1,010

    As for the Expenses:

    • The Operating Expenses given to me were $31,950 for the 10 months. Annualized that’s about $38,340.
    • My budget’s expenses come in at around $56k for a few reasons:
    1. Their management fees were way too low at about $3,400 annualized (they’ve only had PM for about 6 months but were managing it themselves prior). I estimated PM at about $8400 at 10%.
    2. They didn’t have a line item for repairs and maintenance, so I estimated about $8,400 at 10%.
    3. There were a couple of other smaller, misc line items I estimated but the two mentioned were the biggest ones.

    I def need to speak with some lenders about this to see their parameters and what their valuation of the property to see what my refi could be. I do admit, there’s a lot more research that needs to be done, but if they accept an offer I can iron out those things and come back to the seller to renegotiate if something won’t work as we planned.

    *note: had no idea having the seller refi and then be out of the deal would be considered fraud – good to know!

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  • Robert Blake
    Investor · Aurora, CO · Member since 2013 · 97 posts · 40 votes
    13y

    You seem to be referring to cash flow when you're really speaking of Net Operating Income. Since you want to finance this, you might want to look at how your debt service is going to come out of your NOI, leaving you with little (10% vacancy) to negative (18.75% vacancy) cash flow.

    Gross / Scheduled Rent
    -Vacancy
    +Other Income
    =Effective Gross Income
    -Expenses
    =Net Operating Income
    -Debt Service
    =Cashflow

    I also wouldn't focus on individual month's numbers because they're going to fluctuate a bit and not looking at a rolling average can be misleading.

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  • Dion DePaoliPro Member
    Real Estate Broker · Northwest Indiana, IN · Member since 2011 · 2k+ posts · 2k+ votes
    13y

    EGI = $84,240
    V Loss = $16,560 (3 units at $460 annually)

    Net Income = $67,600

    Expense = $56,000

    Net Operating Income = $11,680 ($973.33 per month)

    Cap Rate = 4.67%

    That is not a bargain. This property is not worth $250k in my eyes. At 100% occupancy, it "might" be worth the $250k, again not knowing what deferred maintenance is really present.

    A lender will not be able to speculate about a real property value on this, that will require an appraisal. Generically speaking this property as a C- or D property, the cap needs to be closer to 12%. That is going to make this closer to $145k, about half of what they are asking. If I were a betting man, I would think you find a similar purchase price for the current owner when you look at the sale history.

    Agreeing to pursue this property at the Seller's $250k and then attempting to negotiate down based on due diligence seems like you are just wasting your time, money and resources chasing a deal that may not be able to get done at the right number. You could find yourself losing your EMD and all your due diligence money. That is not prudent investing.

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  • Nicole (Dunlap) Pendergrass
    OP
    Rental Property Investor · Bronx, NY · Member since 2011 · 195 posts · 322 votes
    13y

    The property is currently free and clear (no debt service) so the NOI = Cashflow for the owners. If I were to have them refi when I take over (assuming they're staying the deal in some way so there's no straw man going on!) I've adjusted my cashflow to reflect the new debt service...

    Let's say I had them do a cash out refi for $80k (assuming a monthly debt service payment of about $490):

    • at the avg 26% vacancy, the cash flow would be about $12
    • at the current month's 18.75% vacancy, the cash flow would be about $520
    • And if I got the vacancy to average 10%, the cash flow would be about $1,135
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  • Nicole (Dunlap) Pendergrass
    OP
    Rental Property Investor · Bronx, NY · Member since 2011 · 195 posts · 322 votes
    13y

    Understood Dion. I wasn't going to offer full price... I think the max is $200k, but they would not get that full amount upfront, they would get it after I stabilize the property and refi (assuming the value would support the refi amount) or sell. And you're absolutely right that to get the cap rate needed for that type of property/area I would have to get it for probably even less than you stated. That's why if I were to take on a deal like this I would want to come up with as little as possible upfront and give them an equity position for their equity down the road.

    If I were to give them a flat out offer without anything creative, the most I would pay is about $100k as it stands now.

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  • Dion DePaoliPro Member
    Real Estate Broker · Northwest Indiana, IN · Member since 2011 · 2k+ posts · 2k+ votes
    13y

    No offense Nicole, but you are trying to make this something it is not and to some extent I am not sure you get it.

    If I am the owner. Why do I need you to refinance and pull $80k from MY property? (I do not)

    Through this same line of thinking, you are not giving any 'consideration' (legal tender) for your interest, so you are not really buying anything and you may find they can simply remove you from the deal for a nullified contract. If they decided to let you join in any form to begin with. You gave no consideration to them which is needed to have a binding contract in most cases.

    It really seems like you are trying to put this deal together with no capital. Thus the only party with capital in the picture is the Seller. "Seller" seems to also be a key word. The property is listed for sale, they want out, for whatever reason. It seems your main plan is to somehow keep the Seller in the deal, that he seems to want to get out of.

    It seems that much of your time has been spent crunching numbers however, I am not sure that any of that is leading you in the right direction. Who cares what the debt service "might" be on a refinance on a property the Seller wants to sell and you want them to refinance. It really has no bearing. Not only is the Seller a barrier in the financing of the property but so is a bank. If the property is still on shaky ground, a bank will not finance this property anyway. You may find some debt but it is not going to be market interest rates.

    I dont' mean to be mean or cruel and perhaps I am just the pessimist here but, it seem like you're going through a ton of brain damage to come to an understanding most of what you're working will not work. If it were me, step 1 is figure out what the property is worth. Look at what they paid, if it is around the $140k mark, I would talk to them about that number. Perhaps include what they might have paid in closing costs and humor (slightly) any other proven expense. The purpose is, let them get out whole but they are not making a 20% return for doing nothing. Then you have a real number to work with. With that number you can raise capital for the deal, if you need to, either debt or equity. I wouldn't spend another millisecond on trying to keep this owner, who bought this 10 months ago and essentially has mismanaged it the whole time, in any deal. It seems like he is a little incompetent or he is trying to pull a fast one on people (that is not partner material). Once you have the number and leave this guy out, you can then start to work on the finance structure. If you need to finance it, then talk to a local bank or credit union and gain an understanding on what loan terms the property and the borrowing entity may qualify for. That will give you and idea of what type of equity you will need to purchase and improve the property. From there, you can inject your own capital or talk to your investor network to fund the equity and pursue the deal.

    Good luck.

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  • Nicole (Dunlap) Pendergrass
    OP
    Rental Property Investor · Bronx, NY · Member since 2011 · 195 posts · 322 votes
    13y

    Thanks Dion, no offense taken... I appreciate your candor.

    My main thought process was getting them at least some money upfront through the refi, but them being able to walk away from the management of the deal. I wouldn't want to "partner" with them, I would have all control of the building and decisions.... I was just trying to figure out a way to structure something like that, so I wanted to throw out a few ideas. But your comments are what I was looking for, why certain things will or won't work.

    I also understand needing to give consideration so that the contract is legally binding, so of course I would give something in that regards.

    Thanks again for the input

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  • Carmen Alexe
    Commercial Loan Broker · GA · Member since 2012 · 26 posts · 8 votes
    13y

    Hi Nicole,

    Dion's advice is very realistic. As far as giving the seller upfront money I don't see how you can do it through a refi. To refi a property it means you must be on title but what is likelihood the seller will transfer the title to his property without you putting a down payment? Not only that but even hypothetically if you try to refi one day after taking title, the lender will use the purchase price when calculating the LTV, you'd have to wait at least one year typically to be able to use the appraised value. I hope you get where I'm heading to.

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  • Bill Gulley
    Investor, Entrepreneur, Educator · Springfield, MO · Member since 2009 · 21k+ posts · 12k+ votes
    13y

    You won't close a refi the next day anyway. I just blew down to my question type answer.....why noy just make an offer at your best deal, if they say no, move to plan b. I'm not one to advocate giving sellers a list of options, clogging their minds and you may end up giving them an idea for a worse option as a counter. KISS! You can't control any negotiation by giving options, it's not the Price Is Right...LOL :)

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