How much would you pay for this property?

Question

If a seller owned a property for 30 years and hasn't raised rents in a decade or more, how much would you pay for it? The property I'm referring to has been meticulously maintained, no mortgage, owner was wealthy and recently passed away in his 80's and now the kids are in charge of selling and want to maximize the sales price on the MLS so it's not a one on one negotiation.

It's a 16 unit with average rents at $400/month and market rate is $800-$895.

Let's assume all cash purchase so mortgage payment isn't a factor and use 50% rule for simplicity:

$400×16×12 = $76,800 gross rents

50% rule NOI = $38,400

At $1,000,000 asking price the cap rate would be 3.8%

If you can easily increase rents to market at $850/unit:

$850×16×12 = $163,200 gross rents

50% rule NOI = $81,600

At $1,000,000 asking price the cap rate would be 8.2%

If comps are selling at a 7% cap rate the sales price of this property could sell anywhere between $548,571 using actual NOI and $1,165,714 using market rate NOI.

Clearly you shouldn't pay $1,165,714 based on unrealized potential, but it's also clear that the sellers would not entertain $548,571. So what would/should you pay?

Do you have any real life examples of how you handled a situation of severely undermarket rents like this? How did you come to your max purchase price?

Henry Clark · Answer

Never walk away from a deal you’re interested in without making an offer suitable to you.

Learn more about the players. How wealthy was the prior owner. Is this complex a small part of the wealth the kids got?

Where do the kids live?   What are their professions?   Who is managing the property?

Go through your own buyers broker. Don’t do this yourself.   How long listed?  What offers have been rejected?

Basically find out to what degree they will move off the price.

Make a 3 day offer.  Offer $50,000 over what you calculate the current value to be.  Show your calcs plus the $50,000.  Don’t use the 50%.  Give that to their realtor when you make the offer.  Let their realtor sell them.  Include a $5,000 non refundable offer subject to a 10 day due diligence period.

Decide on your walk away offer and walk away if you hit that mark.

If they come back.  Look for counter offers.     They don’t need 1031 option since already stepped up.  As an example if they come back at $750,000 versus their original $1mm and your original $585k. Offer them $400k now with $300k on 5 year payment with no interest.

Basically at 6% interest your way over 5 years that’s about $100,000 interest savings.  If you do conventional loan, they have to agree to a second position versus your bank.  Your $700,000 price becomes $600,000 versus your $585,000.   Tighten these numbers up with tax impact

This also keeps your property tax figure down.  Make sure they see the property tax impact in your offer versus what it currently is.

Check with your banker first on this type of offer.  Show them the increased valuation after you own it.

Determine your walk away figure.

If you get the deal do a cost seg immediately to help your first two year cash flow.

Have your Reno and rent escalation plan preset.

And have your number to walk away.  Go to the next deal.

Henry Clark · Answer

Never assume 100% occupancy.  Specially if your raising rents.

Don’t use a factor of 50%.   Take a run at the actual expenses. Definitely don’t use the 50% back to back on the same property.  Factor your property taxes higher.

As mentioned above take a hard look at capex and put a budget into your cash flow calc.

Check in contracts and any city rent control items.

Looks like a deal in the making.

Make an offer with a refundable deposit of $5,000 subject to a 10 day inspection period so they know you’re serious. Also to move them on the process. So they don’t sell from underneath you.

Bjorn Ahlblad · Answer

Before you get to a price physically check what you can. In my experience a LL who does not raise rents is not inclined to be meticulous about maintenance. Maintenance is not the same as renovating and in order to get to 800/mo. I am betting there will be sizable renovating, but I could be wrong. You need to verify as best you can. The neighborhood has a lot to do with your underwriting as caprate does. Are there leases in place hampering your plan. I don't know Pittsburg but my guess is the market has turned in your favor. All the best!

Kate Sugars · Answer

Assuming you don't need to do renovations or anything like that to get to the $800-895 rents, there's still some lease-up/timing risk associated with turning the whole rent roll to market rents. Since the property isn't "stable", I'd look at as a discounted CF UW vs. just capping an NOI. If you know cap rates are 7% today, you can project an exit cap somewhere north of that (50bps?+) depending on your hold period and solve for what you need for returns. At the end of the day your desired returns is what will drive what you're willing to pay. I usually look at value-add deals, so I'd expect my untrended return on cost (based on market rents today) to be higher than cap rates today to ensure I'm getting enough pick up in value from raising rents to get to my required returns.

Vlad B. · Answer

Good luck trying to raise rents from $400 to $800, there is no way you will get people to stay and pay double. You're in for years of gradual rent raises or else you will have 16 turnovers all at once. That will be quite pricey.

Find out more information about the Kids Landlord literacy. Don't assume they don't know what they are doing, there is a good chance some of these tenants are going to be problems. Have some reserves for the above and Expect Surprises.

Tom O. · Answer

Questions first:

1. Well maintained but how about updated? Have the units been updated in 30 years? Are you looking at 16 renovations of kitchens and baths? Floors?

2. What are the actual expenses? Does it have separate utilities for heat? You don't want to guess at the NOI even if the rents are low.

3. Are they all on leases or month to month? How hard will it be to raise rents? Obviously, you can't get market rent if the unit's are 30 years out of date.

Two ways to value the building: 1) cap rate; 2) comparables.

Yes, it's hard to find a true comp -- a 16 unit building. But you can find 4, 6 8 or 10 unit buildings and figure out the area's per unit price. I just saw a 10-unit in Fort freakin' Wayne Indiana that they want $104,000 per unit, which seems insanely high to me based on an NOI of like $60K.

But it's listed by a respectable commercial realtor and God knows every owner has the right to put whatever stupid high price on their property they can and hope for the best. Or, as my Dad used to say: "there's an asking price and a selling price."

Have you asked the sellers what price they are looking for? You said they want to put it on the MLS so isn't this an exercise in futility? They will put a big MLS price on it or it will get bid up on the MLS. Good luck. Come back and update us.

Chris Seveney · Answer

I have attempted to buy several properties like this and have always been unsuccessful because:

1. The sellers could not provide any books for maintenance, expenses and NOI

2. Rents were very low like you mentioned

3. Sellers wanted price based on todays markets rents or close but did not want to do the work to get it there.

I will not take risk of not renewing existing leases, evictions etc. get units up to shape just to make my proforma. I do not give away the upside for a lazy seller. In many cases I went up from the current cap rate but sellers were stuck. One of them is a 12 unit that is still on property which is now going on 2 years as its listed at 1.2M which the property had $4,000 NOI..... We offered $600k because it will take 1-2 years to get it to max. value and not something we will do for free.

How much would you pay for this property?

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