11 unit deal. What am I missing on this one?

Question

I've got a deal that looks too good to be true, but I can't find anything wrong with it.  Can someone, or several someones look it over for me?

It's 10 Units near SLC, Utah.

Purchase Price - $400,000 No special terms

Gross Rents - $83,820

Gross Expenses - $ 46,453 (Including $13,000 Utilities, Tax, Ins. 3% capex reserves, and 10% for each of Vac/coll loss, management, and maintenance.

NOI - $28,985

Rents are pretty much at market rate.  I'm more scared about them being high than hopeful about raising them, but the contracts match the rent roll

Expenses have been verified with bills and tax returns except for my %10% figures on maintenance and vacancy/collecitons and 3% capex reserves.

Management: It seems to have so-so  management.  The manager is a guy on his own, works out of his car, and just hits the streets.  He knows everything about everybody in the area and the tenants know and like him.  He collects rent in cash and keeps mediocre records of income/expenditures.

Location: t's in a low income area. only 1 or 2 of the 11 residents have cars.  Parking might be a problem if not for this fact.

Where would you all dig deeper?  Am I missing anything?

Fred T. · Answer

Is this Section 8 or Retirement?

What is your preferred CAP Rate?

What is the condition of the properties? Deferred Maintenance? Life run-outs around the corner?

Why is the Seller Selling / Motivation?

What does the Infrastructure look like within a 1 mile radius of the Subject?

What is the Unemployment Rate, Job Market and Growth Expectations around the Subject?

What Class would you consider this to be overall?

Notwithstanding the above questions, a 7.2 CAP with no room to add value would not be a deal I would venture into...but let's see what your answers to the above are...let's work this deal out!/

Blair Poelman · Answer

This is why I don't like this deal:

"The manager is a guy on his own, works out of his car, and just hits the streets.  He knows everything about everybody in the area and the tenants know and like him"

That sounds a lot like a slumlord.  Not saying he is, but sure sounds like it.  And yes, we do have some slums here in the great state of Utah.

When a serious investor wants to buy this place and get an upside on the sell, he's going to fire the guy that works out of his car and put a professional manager in place.  I've found in my experience often times lower end tenants stick with this kind of manager and will do just that -stick with him.  So when you fire that manager, you're running a HUGE risk of losing your tenants, or having the place fall apart.  I've seen this happen countless times, literally countless.  Slumlording is a relationship business - not healthy relationships , but a relationships nonetheless.

Regardless what the market value is of the property, I'd cut my offer down significantly and plan on evicting everybody and starting fresh.

Fred T. · Answer

first off you don't go changing matrices just to make the deal look better...big mistake

You should know what the market vacancy rates are for that area before you play in that sandbox.

Maintenance Reserves can be figured at 1% FMV on average. If you have low income or fixed income / section 8 then i would double that. Yes its sad to think that way, but again this is a business and you have to do proper Risk Assessments to be successful.

Management rates you should also know for sure...no guessing with that since you should have a good PM Firm on your Investment Team.

Recent P&L or tax returns will help you to verify all other expenses IF the property was previously managed. If the Owner managed it, i would ask for the receipts for the last year at a min to verify the numbers given by the property owner.

Use your Team to verify your assumptions and then simply do the numbers. If they work out to a CAP you are happy with then so be it...if they don't negotiate a lower price or walk away.

Good Luck!

Paul Gwilliam · Answer

This is a C class property.  Decent employment numbers in the area.  It is not section 8 or retirement.  There is some deferred maintenance that I would have to do.

I guess the other thing I'm struggling with at the moment, specifically on this deal is how much to estimate for Vacancy/Collection and Maintenance.  I understand that 10% is probably too much, but I want to be conservative.  If I go 7.5% on each of those it takes the property to a 8.8 Cap rate which is definitely better.  However, I'm not interested in "better" numbers unless they're real, I want real numbers. Help!

I know it depends on the area as to what is normal, but I also think I'm on the high side and there is more meat on the bone than my numbers show.  None of that reflects in the numbers I shared, though, so that is why I said it looks good.

Ben Leybovich · Answer

@Paul Gwilliam - why do you think it's a great deal?

Chris Winterhalter · Answer

@Paul Gwilliam

I'm in agreement with the others and would specifically make sure to calculate for deferred maintenance/rehab costs (very carefully).

Low income properties are definitely more difficult to manage & "ghost" expenses can quickly add up (making assumptions go out the window very quickly).  You mention the rents are market however are the tenants market, section 8 or another type of subsidy tenant?  Rents are around $700 month on average?  Depending on the size of unit that might not be a terrible rent per square foot for a low income property.

If you can get the price down, properly allocate for all rehab/deferred maintenance costs, separate utilities, you might be able to make it work.  A big question is where is the area trending.  Good luck!

Brie Schmidt · Answer

I agree with Fred... a 7 cap with no opportunity for value add is not a good deal IMO.

Mason Hickman · Answer

What utilities will you be paying for that goes into the $13,000 you mentioned? This seems highly unlikely on a 10/11-unit if you are going to be covering heat/electric/water/trash sewer.

I would dig deeper in to the cash collection of rent, as well. Poor records in that area could be a red flag of the tenants that you want to keep.

11 unit deal. What am I missing on this one?

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