I feel like I may be missing something on this?

Question

I am working with a seller on three 5 plexes that he wants to sell as a package deal. He is not willing to separate them at least not at this time. All units are currently occupied. Here are the numbers:

Asking price - $630,000

Down payment $126,000

Monthly Rent - $7,585 ($91,020 annualized)

Expenses - $1,825 monthly ($21,891 annualized)

NOI - $69,130 Annually

10% Vacancy - $9,102

Debt Service $3,000 monthly ($36,000 annualized)

Cash Flow - $2,002 monthly ($24,027 annualized)

Cash on Cash return - %19

Cap Rate - 9.5% after vacancy deducted from NOI

Average rent $506 over all units

The property has new vinyl siding, new windows, and new roofs in the last 5 years. Five of the 15 units have been renovated. Several units appear to be under rented and they should be able to be increased over time. They also bought out the laundry so they are not splitting the profits for that. It also has land included that may be used for future expansion (i.e. garages). I am not sure how much to account for in maintenance on the property. I feel like I am not accounting for something else that may be very important. Any insight would be greatly appreciated. Thanks in advance for taking the time to provide input.

Joel Owens · Answer

Step 1: Determine if rents are market.

Rent is averaging 506 a month per sellers numbers. You would need to see if they did first months rent half off or free. That would bring effective rent down. Compare that number to the going market rents.

Step 2: Ask if landlord pays utilities?? If they pay water etc. take gross scheduled rents and knock off 60% expenses.

91,020 X .40 = 36,408 NOI

10 cap  364,080 sales price with no additional deferred issues. 3 5 units you are dependent on surrounding buildings and how they are run versus owning a whole complex.

I will not even go into the additional steps as this property is overpriced junk.

At the sellers sales price it is almost a true 5 cap for low end rentals per door and write down repairs needed to other units and likely a 4 cap. This person it seems is looking for a dummy buyer.

Anthony Peric · Answer

I'd ask to review his tax returns and you'll probably see the actual expenses, etc. If the seller won't show them, then you know it's a sour deal for you.

Oren K. · Answer

@Micheal  Rieves - There is no way that expenses are less then 25% even if this was a new build. On a such a low $ rental, even if they did a good job on the updates, I assume it is an older property and you would be lucky if expense run less then 50%.

@Michael Worley - It may be highway robbery but there are many markets where that is the going rate. What about places when they 'only' charge 8% but also 1 month rent on new leases and 1/2 month for renewals. Works out to 12 - 16%.

Joshua Nudell · Answer

@Micheal  Rieves,

You are forgetting:

Maintenance @ 5% ($4,551)

Property Management @ 10% ($9,102)

Capital Expenditures @ 5% (not 10% because you stated some of the important stuff is newer like the roof, windows & siding) ($4,551)

So your cashflow of $24,000 is actually $6,000.  That's horrible for a $120K investment (in real estate anyway).

As @Joel Owens says, this is not a deal and looks to be overpriced.  Especially for such low rent units.

Micheal Rieves · Answer

@Joel Owens

Thank you for the input Joel. The tenants pay their own utilities. He pays for the main areas of the building. He has long standing renters in several of the units. Some of them have been there 20 years or more so he inherited them and they are still there. He says he does not want to raise the rents because he wants to keep the long term tenants in place. Once a tenant leaves, they remodel and increase the price. the newly remodeled units are going for closer to $600. Would the units that need to be remodeled count as deferred maintenance (causing a reduction in price discussion)? Secondly, do you always use a 10 cap as your point of reference when evaluating small multi's?

@Joshua Nudell

Thank you for the figure on maintenance. I was not sure what a good range was. The current owner does most of the maintenance on their own. I remembered the property management initially but forgot to add it when I was adding the numbers to this post. It sounds like you are saying normally maintenance would fall under the 10% capex normally?

@Michael Worley

I appreciate your input. I also thought high $30k to low $40k per door was reasonable for a small apartment building. I thought the value of a commercial property was based strictly on the numbers but then I heard that what other properties in the area are selling for can also effect the value. Have you heard this before?

Oren K.

I appreciate the response Anthony! I planned on getting more verification to the accuracy of the numbers.

@ chris s.

Thanks!

I appreciate everyone's input as it has been an informative discussion. What am I missing here: 10% vacancy, 10% property management, 10% cap ex. NOI should be 70% of gross rents right? If rents could be increased into the $600 range does any of this make more sense?

Micheal

Oren K. · Answer

@Micheal  Rieves - No - now you did not include operational expenses. Just using gross rounded numbers:

Operations - 50%

Vacancy      - 10%

Prop Mgmt - 10%

CapEx        - 10%

That's 80% as a starting point before financing / any debt servicing. Debt servicing from your numbers above are ~38-40% (36K/91K). You are now at negative cash flow by 18-20%.

To bring this back to positive cash flow, you better be very very certain all the costs are that much lower then the above.

Good luck.

Chris Soignier · Answer

I'm strongly suspicious that the seller is under-reporting expenses.   W/o auditing the books, it doesn't feel like a good deal to me.

Joel Owens · Answer

VALUE is in the eye of the beholder.

A seller will calculate it one way and a buyer will the other. A seller will sell best case scenario and diminish greatly the chances of anything bad happening. A prudent buyer simulates the worst case scenario happening and buys on that premise. This way anything less than a disaster is a positive with the property.

A seller can choose not to sell and a buyer can choose not to buy.

When you have the cash the buyer makes the rules. I am looking at a few commercial projects now for retail but will only buy on my terms or I will just hold my cash and wait for the right deal.

Waiting for the right deal isn't the end of the world. Buying into the wrong one can have consequences that last for years or decades before you recover from it if ever for investing.

Michael Worley · Answer

How do you know he's not factoring in maintenance? He's got expenses, which isn't broken down by line item. Maintenance is likely included in that figure already, as could be property management.

BTW - 10% property management for a MF property is highway robbery.

Michael Worley · Answer

$42,000 a door that rents for $505 a month seems in line. I am not sure of your area, but you may wish to look into what the price per sq foot rental rates are. What are the sizes of the units? What is the unit mix? Is the laundry a net positive (the utilities on laundries can be quite expensive. The expenses seem a bit low, but they just did a lot of capital improvements which may explain that number.

As for what to expect in maintenance costs, well that varies of course but nationally for multifamily naahq.org publishes repair/maintenance costs at 3.7% of gross rents. With total operating expenses at 38.5%. Your actuals may vary, but those are the national average. Capex is 8%. If the seller's numbers vary greatly from those figures you should investigate further. It may be a value add opportunity for you, but it may be a money pit. Due diligence is key.

I feel like I may be missing something on this?

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