Do I have a lemon or am I building a strong future?

Question

In 2020 I purchased an 8 unit apartment building in the south shore of Chicago.  It is about a mile south of where they are building the new Obama presidential library.  The whole area is getting gentrified with rent going up by about 25%.  It took a year to get the property moved from the bridge loan, but now I have it as part of a portfolio loan at 4% for 30 years.  In 2021 it was paying well and producing good cash flow.  After the pandemic everyone started moving and the building has had a number of issues.  It has not cash flowed positive in 16 months, and will not for at least another 3, due to repairs.  Half the money has gone towards turnover costs: new cabinets, new flooring, and other upgrades.  The other half has gone towards surprise repairs: boiler repair, gas pipe leak, water heater repair.  The value of the property has been consistently rising with the repairs, but the lack of cash flow is strongly dragging me down.

The numbers:

I originally paid $480K for the property and just had it appraised at $675K.  My portfolio loan is $620K  with a monthly payment of $4,000.  I would be able to sell the building and clear the debt for three other houses I have on the loan.  That would free up monthly income of $4,000.  Right now my portfolio is breaking even.  All the cash I get goes towards the portfolio loan and the apartment building that needs repairs.   If the apartment building stopped needing repairs it would start paying out $5,000 per month.  I have been waiting for the repairs to stop but they haven't.  Should I sell now and free up my cash for other investments and more flexibility or is the long term investment good enough to suffer through the fact that it continues not to cash flow?

Justin Moy · Answer

I think the first step is to walk through every inch of that building with a GC and get a completed list of everything else that is needed. Sounds like you've done a lot of the work already and if you're almost at the end of that rainbow it's likely worth it to finish it through.

If you walk through and are finding a longer road than you're willing to travel down, then you can stop the work and start the process of selling it.

That's what I'd do!

John Warren · Answer

@Andrew Palmer there is a reason properties in the south and west side are sold at such attractive cap rates. In theory, they should be cash cows. In practice, you need to be very hands on and have your own guys doing the work to contain costs. Local operators are the ones who are clearing the 8, 10 and 12 caps. Out of state investors often have the experience you are having.

If you have some equity, I would look to sell now while you are in a good position. Put some lipstick on the remaining vacant units and use one as your show unit.

Jonathan Klemm · Answer

What's up @Andrew Palmer!  Sounds like you are stuck between a rock and a hard place.

I love that area of Chicago and completely see the gentrification happening as you mentioned.  Repairs will never stop, but at this point, it sounds like you need to do a cash analysis.....overall it sounds like you are stabilizing the building so it would be sad to sell after all that work.

You should be able to make a list of all your major capital expenditures & unit turns to figure out what's been done and what is left.  If you can outlast the short-term cash flow to get the property completely stabilized the numbers should tell you if it's going to be a cash cow at that point.

You are always going to have minor repairs.....if the building is solid from a structure and systems standpoint I'd try to out last the short-term cash issue.

I'd be happy to connect and talk more abut the building if that would help.

Andrew Palmer · Answer

Hi,

My property is 1465 E 69th St.  I would be interested to hear any local insight on the neighborhoods.

Last week management told me we had to replace the burner on the water heater.  This morning I got notified that it hasn't been done because the gas line is not putting out enough gas.  So now they're waiting for the gas company to come out and check it.  this is where expenses are continuing to get spread out further and further.

Jaron Walling · Answer

If you completed the heavy lifting, increased the value, get fully occupied, and don't like the cash-flow it's time to sell. Really need to predict the life of the building and potential issues.

Mark Ainley · Answer

@Andrew Palmer my reply would be based on how close are you really to Obama library. There are areas north in South Shore that will receive true long term benefits and there are areas south of 75th that are currently ripe for speculation and now is the time to get out. Feel free to reply here or DM me and I will give you my thoughts knowing all I know of the area.

Jay Garrison · Answer

There is a housing crunch in most of Chicago, and on the southside there is a quality housing crunch. If you can cash flow $5000 per month just hold steady, that's good stuff. Plus the area is appreciating, albeit unevenly and in fits and spurts. None of those repairs you mentioned are just lost money, like fixing damage done by tenants.

How often are you going to have to do those things anyway? Cabinets, boiler repairs, new flooring... definitely not a lemon.

Hunter Reed · Answer

Sell the property, pay off more debt. Like my mentor says there is always a better deal out there.

Gino Barbaro · Answer

@Andrew Palmer

That's a tough question. If you think the area will continue to grow, and your goal is to hold it long term, then I would hold on to it. That is the problem with buying old buildings. The numbers may look good initially, but with all the cap ex that has to be put in, it usually eats up any cash flow.

If you put in all the work and the property is stabilized, then it may be a good idea to hold. You are limiting your downside risk of your other assets if you do sell. It sounds like the repairs aren't going to stop anytime soon.

Sometimes, it's a good idea to take some profits and redeploy into another asset

Good luck

Gino

Chris Seveney · Answer

@Andrew Palmer

What is the reason for the repairs? Is it maintenance / ongoing that will continue to be ongoing or are they one-time repairs that will slow

Concern I have is you have it appraised but if a buyer finds that it needs $200k left in work then all of your equity is gone.

Whether I hold it or sell it would be based on what really needs to be done to the property and do I have the time, patience and money to do it

Your property manager should be doing a full assessment on the property referring repairs which it sounds like that may not be what’s happening.  You will want to talk with them as well

Do I have a lemon or am I building a strong future?

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