Potential deal, but potentially delusional seller.

[Matt Hernandez]

Hey guys, I am looking at a multifamily deal in the Columbus OH market. 

At first glance, this deal has potential.  Here is some important information

• 32 Units
• Class C property in a B neighborhood
• A block from nice shopping, restaurants, etc.
• Original owner held since building in the '60's, recently passed
• Owner's daughter is out of state, with no experience in real estate (she is a lawyer though, so not clueless)
• Expenses appear very high (reported 75%)
• Many tenants who havent had rents raised in 5-10 years
• Rents sit around $0.73/SF, there appears to be room to take them to $1

Here are where things get interesting:

• Reported Financials
  • GPI $222,000
  • Expenses $152, 327
  • NOI 44, 646

Based on the expenses, I am comfortable saying that I could remove some, (for example, they are paying 2 management companies, one of which is family owned, I believe to reduce taxes). I could fairly easily take the NOI to $72,000 without doing any upgrades. This provides a good deal of value add, but its not cheap. There are 8 buildings which needs new windows, roofs needs to be done within 5 years, and kitchens need upgrading. Even when accounting for this, it's still looking good.

The problem is the asking price. The seller is basing their ask on a pro-forma NOI of $120,00 - 3 times what they reported. I think this is unrealistic. While I am willing to pay a small premium for the potential and location of this property, they are asking full retail value for what it could be when turned around.

They are asking a 6.25% cap, which is reasonable.  But their value is $1.95M.  Mine is closer to $1.2M  (and thats with a generous assumption on expenses).  The realtor said he doesn't think theyll consider anything below $1.6-1.8M  (the realtor acknowledged that the price was high, but basically said that inventory is low so they can ask it - which i disagree with)

What do you all think? I am going to submit an LOI, but I don't think I'm going to be able to hit $1.6 M. Should I just walk away from an unrealistic seller?

[Tom Mole]

@Matt Hernandez

Many questions come to mind. You said that a 6.25% cap is reasonable, so I'll assume you've checked that rate is what the market will bear in that neighborhood. Have you actually vetted this?

Have you asked the seller how they reached their valuation? Many sellers just pull the price out of their butts based on what they want, not based on market valuation. This is so frustrating. Often they hear from their real estate agent who says "the inventory is low", but the agent doesn't have a clue how to evaluate and a commercial deal.

How motivated is this seller? You said that you'd pay a premium for the potential of this project, but I think you've factored that in when you accepted that the NOI could easily be pushed to $72k. That is more leniency than I would give the seller. I buyer As-Is, Where-Is and How-Is in current state and condition and so should you. That means, given a 6.25% cap and actual NOI of $44,646, the price should be $714,336 and at their asking the cap is a mere 2.29%. Based on your belief in your ability to lower expenses I figure your max allowable offer at $1,152k. DO NOT OFFER A PENNY MORE THAN THAT! Bottom line: that is the bottom line.

Delusional? Yep! Most assuredly, but a big part of negotiation is education. Explain how commercial valuations are done. Explain about the cost of sitting on the market for a long time. Find your seller's pain and amplify it. Have a chat about the cost of waiting for the market to catch up with a highball asking price. What happens if this apartment sits on the market for six months to a year with screaming tenants and clogged toilets. Then, show how accepting your offer solves all the seller's problems.

If she's still unwilling to let go of her inflated expectations, then let the market teach her. Just keep following the property and renew your offer every few weeks or so. No matter how much you might love this project, it's still not worth it to pay the seller for what you have to do to make the property worth what she's asking for it. That's just stupid.

On the off chance that someone comes along and meets her price, well good for her. There's just no accounting for "stupid money". At least it won't be you taking the loss. There are plenty of apartments out there no matter what her agent tells you.

Stay smart my friend. Submit your LOI, negotiate/educate, then hold your ground. Great find. Now go find another.