Multi-Family Home/Apartment

Multi-Family and Apartment Investing
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Multi-Family Home/Apartment

Andrew Bertram
Investor · Havre De Grace, MD · Member since 2015 · 31 posts · 3 votes

I am in the process of listening to the entire series of the bigger pockets podcast(thanks @JoshuaDorkin and @BrandonTurner).  I recently listened to show 47 w/ @JoelOwens and was intrigued by some of the math he implemented in evaluating multi-family rentals.  I live near Baltimore, Maryland (in Havre de Grace, Maryland) and near me, is a unit which is interesting to me.  Its list price is much too high (I believe) but would love some feedback on the home itself.  Additionally, I'd love if anyone could help me to make sure that my math adds up correctly.

The unit is  6 unit multi-family(which if I'm not mistaken crosses a threshold into apartments from a multi-family home) built in 1830 which is fully leased.  I know that Maryland is strict concerning lead-paint certifications but the listing indicates "lead paint certificates on hand."  The exterior of the building is very attractive and though I haven't yet toured the house (I don't know if it going to be worth my or an agent's time) the pictures online seem to indicate that it wouldn't require much more than cosmetic work inside.  The neighborhood and schools, while not the best in the county, are far superior to many dangerous neighborhoods and schools in Baltimore City.  I live less than 5 miles away and it is a nice town that we hope to be up and coming in the future (I am not counting on appreciation at all, but the potential is there).  It is near Aberdeen Proving Ground (APG), a military base which provides a wealth of job opportunities in the area.

Some of the downfalls of the place are that it offers only street parking (but has a large fenced in yard, which I would consider turning into parking, however, street parking is common for the area.  One improvement I would potentially want to make to the building as a whole is to add central air conditioning.  I would imagine, given the building's age, that it would need to have the duct work put in to accomplish this, which would have a steep price tag.  I would also imagine I would need to restructure the lease agreements with the tenants (potentially losing most if not all) to adjust rents (which I will address later) and because currently the owner is footing the bill for utilities, something I would not be looking to do.  And, assuming the worst and that the units aren't on their own meters, that could represent another expense.

Now down to the math.  As I mentioned before it is a 6-unit building.  It has 4 2-bedroom units, and 2 3-bedroom units.  I would be interested in examining the entire layout of the interior to see if there would be room to restructure these apartments in order to add a unit, or find a way to get them to generate additional income.  Comps I have seen on apartment rentals seem to be in the 800-1000 range for 1-2 bedroom apartments and I haven't seen any 3 bedroom prices.  Currently, realtor.com indicates that the building is bringing in $4,600/month gross rent ($55,200/year) and that expenses are $14,327/year.  I can only assume that the $14k number is simply the costs of utilities and that other expenses are not being calculated.

According to the math from biggerpockets.com/show47: 

First of all, I want to mention that I am not sure what the cap rates are in the area, nor how to find them out.  So, I'm going to plan for wanting a 10% cap rate and then I could adjust accordingly.

The original list price was $569,000 and now after approx. a year on the market, it is down to $474,900.

$55,200 (gross annual rent) x 40% (60% operating expenses) = $22,080(net rent) x 10 (10% desired cap rate) = $220,800 seems like the price that would make sense at the current rental rate (again, please check my math).

$55,200 (gross annual rent) x 40% (60% operating expenses) = $22,080(net rent)/$474,900(list price) = 4.6% cap rate.

So working backwards, 

$474,900(list price)/10 (10% desired cap rate) = $47,490 (desired net annual rent) / 40% (60% operating expenses) = $118,725 (desired gross annual rent) / 12 (months) = $9893.75 (desired monthly rent)

That means that to purchase at the current list price, I would probably need to increase rents by an average of 2.15 times in order to achieve a 10% cap rate.

While this overall deal may just not exist as a deal, I wonder if anyone has suggestions on how they would deal with a property whose numbers don't quite add up but could potentially look good with some tweaking.  

I also didn't add the costs of repairs to the total purchase price so that price would have to be assumed to have been negotiated down so that my purchase price + repair/upgrade costs = $474,900 or the $220,800 if rents couldn't be improved.

Finally, I'd like to do some calculations based on what an actual deal would have to likely look like in this place.

I think the rents could easily be negotiated up to $6,000/month (gross) and the utilities negotiated out.  That being said, that is not nearly enough to account for the current list price.

$6,000 (gross monthly rent) x 12 (months) = $72,200 (gross annual rent)

$72,000 (gross annual rent) x 40% (60% operating expenses) = $28,800 (net rent) x 10 (10% desired cap rate) = $288,000 (purchase price + repair/upgrade expenses)

I apologize for the exceptionally long post here.  I hope to hear back from some people concerning my math, to make sure I have it right and about any thoughts they have on the whole thing.

Thanks

Andrew Bertram

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  • Travis Lloyd
    Real Estate Broker · Fairfield, CT · Member since 2015 · 312 posts · 231 votes
    11y

    Hi Andrew,

    Your math is correct as far as the calculations. I think it is important to understand a bit more about the assumptions that go into the equation, to see how much it can vary. 

    You mention wanting to purchase at a 10 cap. Take the same numbers you have and look at what the purchase price would be at a 9 cap, and even an 8.5 cap. A little change in cap goes a long way, and while everyone wants a 10 cap (and I don't know your market there in Maryland) there are plenty of places where an 8 cap is a great deal!

    To understand the prevailing cap rate in your area, first let's look at what goes into a cap rate. An investor may have a specific cap rate floor, which serves as the lowest rate they will purchase a project at; however, the market cap rate - or rate at which a building owner can expect to actually sell their property is determined by the supply in the area, demand for that area, and the amount of deferred maintenance in the property (which does NOT include things like adding duct work or adjusting layout to get more units) but does include things like the roof, windows, lead paint, fire doors, electrical wiring, plumbing, etc. All of the main infrastructure of the building. Two side by side 6-unit buildings could produce the same NOI, but not trade at the same cap rate purely due to the level of deferred maintenance in one building or another.

    You can look up recent sales in your area of multi family properties (look at 6-10 unit properties - 2-4 units would be a different class and may or may not trade at a different rate). Most recent sale listings will still publish gross rents and "expenses". Calculate the cap rates at which they traded, and use photos / descriptions to ascertain the level of deferred maintenance present for each. You should be able to find a range for that area. When we did buildings in Manhattan, we got EXCITED about anything we could purchase at a 6 cap or above! If we got a 7 cap, it felt like stealing! In Kentucky, we bought a property at almost a 12 cap - and I would NEVER have paid at a 10 cap there.

    I say all this because if you take your example of $55,200 gross with 60% exp, the 22,080 NOI at an 8 cap would bring your purchase price to $276,000. Quite a swing for two little points.

    The other assumption I would examine more closely is your 60% operating expenses. That seems high, and would be exceptionally high if you converted utilities to tenant-pay. On a 10 unit building in one of the highest property tax cities in the country, WITH landlord-paid utilities, our stabilized operating expenses are 48%. There is a certain economy of scale that you benefit from - the more units, the lower that percentage goes (to a point). On a 105 unit property in New York, our stabilized operating expenses were in the low 30s! Now on that project, they started at about 45%, but through a full renovation, we reduced maintenance costs, and bringing rents to market rate pushed the top line up (expenses don't rise at the same rate as rents).

    While I don't have a standard % for you to use - this is something that is very easy to get a fairly accurate estimate of. You can lookup taxes online. That is one of your largest expenses. When you research recent sales to compute the area's cap rate - you will find information about what others are paying for things like insurance, trash, and water/sewer. As for utilities - take the numbers from your own home and adjust by the number of rooms in your house. Multiply that by the number of rooms in each unit and add up the total. This will give you a good estimate. If your house has 8 rooms and your heating bill averages $200 for 8 months of the year, thats $25 per room for 8 months. If the two bedroom apartments have 4 rooms (2 beds, kitchen, living room), then add $100 for 8 months ($800) for each of the 2 bedroom apartments. Add $1000 per unit for repairs and maintenance assuming that you're going to at least do some renovations in the beginning. Add $2,000 per unit if you're not expecting to touch the units.

    Once you figure out the prevailing cap rate in the area, and have a better estimate of operating expenses, you will probably find that the owner's price and what you can offer will be less disparate than you at first thought.

    If you want help going over the specifics, shoot me a message and I'll happily take a look.

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  • William Allen
    Investor / Wholesaler · Nashville, TN · Member since 2014 · 1k+ posts · 667 votes
    11y

    You got a fantastic answer here from @Travis Lloyd but one thing I want to point out is to avoid running the numbers with adjusted rents and including the renovations / utility changes that you would apply.  I don't mean not to run those numbers, you certainly should as you want to see what you the property WILL BE worth and how you can add value.  However, the property is currently valued at what the current owner is doing and how they are running the property.  That is where you can make money, you increase the value on these multis and commercial properties by doing things like raising rents and metering utilities.  So, don't adjust the numbers to justify a high sales price.  Use those in your favor to justify your offer and then use your projected numbers to give you the new value.  

    From your post I wasn't sure when you started running the numbers at the projected new rental rates.  I think you have that concept, I just want to make sure you aren't looking for a way to make the numbers work when they don't.  Good luck!

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