Looking at a Multi-Family property - does this make sense?

[Brian C.]

I'm hoping someone can confirm my thought process, as I'm new to MF investing: At this point, I've reviewed the owners financial statements and I'm comfortable with the amounts. The 2015 financial statements show a NOI of $66k and the average CAP rate in the area, based on recent sales, is 6.5%. Is it reasonable to make a $1M offer ($66k / 6.5%)? To me this seems like an offer at market and should be fair. Anything higher must be supported by something unique to the property, which I haven't found during my due diligence. Also, based on my own analysis there appears to be an opportunity to add value by rehabbing units, raising rents and running a more efficient operation allowing for a $10k increase to the NOI over a year period. Assuming an all cash offer (to keep things simple) and based on my ProForma $76k NOI, does it make sense that this property would yield a 7.6% return? I appreciate the help!

[Brent Coombs]

@Brian C., what am I missing? You've got $1M to spend, but you only want 6.5-7.6% GROSS return on it? 

Edit: OK, cap rate includes expenses. That's not SO bad.

More comments later. I'm just making sure of the facts...

[Brian C.]

Hi Brent - the $66k is the NOI (after expenses, but before the mortgage). Also, I'm in CA so CAP rates are very low.

[Patrick Liska]

Your going to be putting money into the rehab to get the new income, so you will have the money invested/ mortgage against the new NOI, the math with all the numbers would have to be done to see if you get a 7.6 CAP. that is a way to get the offer price for the place, just make sure you run comps to see if that size place is a good deal for the price and the area. but seems like a good offer.

[Brent Coombs]

Originally posted by @Brian C.:

Hi Brent - the $66k is the NOI (after expenses, but before the mortgage). Also, I'm in CA so CAP rates are very low.

Aah, so there WILL be a mortgage! Then that net return WILL go down!

Most of my comments will be along the lines: try paying LESS than market!

How do ALL Wholesalers do that? They don't do ANYTHING that you can't do - all for a quick turnover buck! Seems to me, if you're going to be up for fifteen-thirty year mortgages, paying back millions of dollars, you might want to put in a bit of effort to find proper "deals" in the first place? Cheers...

[Brian C.]

Patrick Liska so what you're saying is that if I expect $100k in rehab costs, my offer should be $900k? ($66k / 6.5% = $1M - $100k = $900k). Thanks!

[Patrick Liska]

that is correct in the offer price. as @Brent Coombspointed out, you will have a mortgage on top of all this, the NOI should not include that figure in it. so make sure the income will cover your mortgage and then leave you with some money.

[Derek Carroll]

Brian C this approach of subtracting out repairs is not exactly how the Multifamily family market works. It works more so that way on the residential flip side.

Look at it this way, if market pays a 6.5 cap rate for comparable assets in this market then you'll likely see others making offers in this range. If there is deferred maintenance or other issues with the property, which once completed will not increase NOI (think thinks that must be replaced needs a new roof, broken windows ect) then you could expect to deduct this from the purchase price.

If, however, you find that the repairs and upgrades that you're talking about are strictly to improve the property and thus increase your NOI, then you cannot expect to deduct those costs from your purchase price. This is a "value add" strategy so you need to make sure that the costs of upgrades that you plan to make would increase NOI at more than a 6.5% cap rate. Otherwise you're wasting your money. If the improvements do help NOI then measure total costs and new NOI to determine your as complete value.

In a competitive market you'll find that buyers are looking for any value add opportunity and will glady foot the bill for upgrades. If you have reason to believe that you have first crack at the deal then there is no reason not to negotiate price down, but certainly do net expect the seller to reduce the price due to upgrades that you plan to make which will ultimately benefit you.

[Derek Carroll]

Also don't even consider debt when calculating cap rate. Cap rates at more of a market evaluation and comparison metric.

If you're looking to measure specific returns and cash flow then include debt service and use metrics like cash on cash, IRR, ect.

Happy to further explain if there are any questions.

[Mary Davies]

have you considered Detroit? for less than half of that investment you can easily (and conservatively) have a noi of $12,500.00  per month with no mortgage (free and clear)

[Account Closed]

Originally posted by @Mary Davies:

have you considered Detroit? for less than half of that investment you can easily (and conservatively) have a noi of $12,500.00  per month with no mortgage (free and clear)

 Um, at a 30% cap rate the market is saying No, Hell No! to Detroit.

[Brian C.]

Derek Carroll I appreciate the feedback. Your comments make sense. Sellers shouldn't pay for the buyer's upside and conversely sellers shouldn't expect buyers to pay based on ProForma numbers or rent upside, but instead on the actuals. Also, my NOI numbers don't include mortgage payments.

Here are the facts. I appreciate any feedback.

Asking price: $1.26M (off-market)
Size: 21 units
NOI: $66k (5.2% CAP)
Market CAP rate (based on recent sales): 6.5%
Upside to NOI (based on my analysis): $10k

Offer price: $1M (based on actual NOI of $66k / 6.5%)
Rehab: (needed for rent upside): $50k
Total investment (25% down payment and $50k improvements): $300k
NOI (with upside): $76k
Mortgage ($750k at 5% with 30amortization): $48k
Cash flow: $28k
COCR: 9% ($28k / $300k)

Does this analysis make sense and would you consider this a reasonable return based on the hot CA market?

Thanks!

[Patrick Liska]

@Derek Carroll, good point about the rehab upgrades and not a necessary repair, i wasn't thinking that way, good catch.

[Brent Coombs]

@Brian C., (me again). I haven't really got much more to say about this, except, if I had $300k cash money, this is NOT the way I would be looking to invest it. Sure, people can be snippy about the extreme bad press (some well founded, much NOT) about the likes of Detroit, but I believe there HAS to be a better return available from leveraging out that $300k than just $28k, (and just as safely, if not more so), somewhere in the country! That's another 2c worth...

[Steve Vaughan]

One can easily obtain a better than 6.5% yield in conservative equities. I know the IRR should be higher, but there are also headaches with RE.

Either way, an offer of a million even WILL be countered. Offer an odd amount like 1,012.432.00 so at least it looks like you did a detailed analysis!

[Jason Li]

Brian. Yes that's how I would analyze it. You are justifying the 1 mil offer by saying it produces 6.5% cap but you will get a higher cap after you make the upgrades.

Cali might have lower cap rates but it has higher appreciation, just like here in boston where most properties are under 5% cap

[Brent Coombs]

@Brian C., just to finish off the point I was trying to make: it's not so much a matter of 9% CoC ($28k/y) being such a bad number, it's more that I don't recommend borrowing THREE QUARTERS OF A MILLION DOLLARS to get that!

You realize that all those BORROWED dollars will only be generating zero point six four percent return of their own, right? (That's right: 0.64%)...

The risk of a potential fall in the market, vs, your trust in further appreciation in an already over-heated CA market (IMHO), is not a risk that I would take.

[Michael Sjogren]

Side note, do not forget to factor in closing costs of 3-4% in your cash on cash analysis. 

[Nick L.]

@Brian C. said), cost overruns and unexpected problems.

With margins that thin I would also keep some liquidity on hand in case your NOI dips below your debt service.

With cap rates that low and interest rates on the rise, you are dangerously close to negative leverage territory.

[Ethan Vegas]

@Brian C., I'd be careful of using a PI payment based on a 30 year amort as well.....I'd say that a max of 20-25 years is much more common. 

[Tyler Alberson]

@Brian C

I was about to say what @nick L  said. role the repairs into the note!

I also agree with @Brent Coombsundefined. If I had $300k I would look at higher returns and possibly diversifying the location, type, and class of the properties.