What could I have done differently on this offer

Question

I recently sent in an LOI for a 12 unit apartment. The property is located in a C- neighborhood with a moderately high crime rate. The current management company allowed a sex offender to live in one of the units. The property has a long term lease for a billboard which make up about 13% of the monthly income without any maintenance.

At listing agent offered this property at a cap rate that is about 3 points higher than the market. He listed the property at 5% vacancy even though it's fully occupied right now.

For my calculation, I used very conservative numbers.

• Instead of using 5% vacancy, I used 10% because I expect a high economic vacancy for the type of tenant that was put in place. 
• According to the broker, operating expense ratio right now is at about 20%. The average ratio here is around 35-40% and more for all bills paid. I looked at the P&L to find out what was the highest cost for each item on the P&L for OE and add them all together. It was closer to 30%, so I used that.

I offered a 95% financed option (65% comes from a bank, and 30% seller carry back) at full asking price and the seller liked it. However, the seller wanted a high interest rate for the seller carry back loan which would drop the DSCR below what my lender allow. Seller 's agent at that point basically told me to not waste their time if the term doesn't work out. I offer a cash price of 25% below asking price and they didn't even look at it.

I'm sorry for the long post. Can anyone give me your feedback?

Mike B. · Answer

@Vi K. I think having conservative numbers is a good thing. Needing a second to be able to get into the deal is what is taking away all of your return.  If you can't find a deal that has enough meat to support that, then you might find it more advantageous (and less risky) to partner with investor money. Raising money is a whole new game, but it is not as hard as it sounds. There is money out there for solid investments with secure real estate behind them, it just takes organization and time to cultivate it. You also need to be aware of SEC securities laws so you don't find yourself in hot water. A great reference for this is a book by syndication attorney Gene Trowbridge "It's a Whole New Business".

Vee K. · Answer

@Giovanni Isaksen : Thanks for the encouragement. I really appreciate it!

@Steve L. : We are talking about a property under $900K. When I originally structured the deal, with a low interest rate on the 2nd, my SDCR would be over 1.5. However, with the seller's rate, it dropped down to 1.05.

@Mike B.  : The 1st lender didn't indicate about withholding replacement reserves. But for my calculation, I did that anyway. That's part of the reason why I offered a cash price of 25% lower than asking price.

The only upside is the long term billboard lease. It has 6 or 7 years left and a 3% increase every year. Our plan was to take over and place better tenants in place. Right now they have a registered sex offender living in one of the units.

I don't think the seller or the agent will deal with me. I mainly wanted to know if I were overly conservative with my numbers. And how could I do a better job in the future so that seller's agents don't think I'm wasting their time.

Steve L. · Answer

I don't know how aggressive the bank will look at the note or how big the 35% is.

Rate is 5% and every year you have a balloon payment (say 25% of the note).  If you don't make the payment, the rate goes up to 7-8%.

If you are only able to get a 1.05 DSCR it probably is not a stellar deal.  Most Class-C apartments are a lot higher than 30% expenses you mentioned too.

Dorance Creighton · Answer

@Mike B.  Thank you that a good tip! I'll check the schools and other online options.

Leslie Pappas · Answer

very useful information.  Thanks- Leslie Pappas

Mike B. · Answer

@Dorance Creighton No problem....it literally is THE book on syndications. In fact, the state securities prosecutor that taught my masters level syndication course in school used it as his bible to teach from.

It can be pricey on Amazon....check your local college if they have a real estate program because you can probably pick it up in their bookstore for less than half the cost of the Amazon pricing.

Dorance Creighton · Answer

@Vi K. Sometimes you have to be careful. Some agents can get really sensitive when presenting offers to sellers. (Its almost as if they own the building). Also they don't want to upset their seller and potentially lose the listing. (Sometimes sellers need "tough love" from their agents to be brought to reality).

In my opinion your numbers were conservative  but not over conservative. Let the agent and seller cool off and keep in contact with the deal. Even if it goes to pending status deals fall out of escrow all the time. This is often the best time to present your offer again.

Dorance Creighton · Answer

@Mike B.  Thank you for the book recommendation I've been looking for information on syndication.

Mike B. · Answer

@Vi K.

Maybe the deal is just priced too high and it will take several months of no response for the seller to come back to reality or at least find a broker who will give him an honest evaluation. Keep it on your radar and hold firm to the price that makes sense for your to pay.

Vee K. · Answer

@Mike B. My cash price based on my calculation is too low. That's why I needed seller to give me a second to do the deal at asking price. Thanks for the book recommendation. I will check it out!

What could I have done differently on this offer

Most Popular Reply