How to analyze a multi-family deal before due diligence

[Brian C.]

I recently visited a 10 unit multi-family property with a broker and liked the property. In most circumstances, I request the rent roll and last 2years of financials, so I can run an analysis on the current actuals, to calculate the market value as is, and compare it to my own upside ProForma. However, in this case, I received a rent roll and some handwritten (more like scribble) expenses which contained the actual utilities paid each month and insurance. I asked the broker again to request the financials, however he said the original owner, of 40 years, doesn't have financials readily available and I would need to rely on the available info until we make an offer and entered the due diligence period. The broker's advice was to use the rent roll, a 3%-5% vacancy factor (class A area in SoCal), calculate property taxes based on the asking price, use the actual insurance and utilities, include $500-$700 per unit for R&M, $200 per unit for replacement reserves and a management fee if we needed a 3rd part PM. Does it make sense to use these amounts when calculating the value of the property and my offer price? I usually use actuals, not a mix of actuals and my own estimates. What if the owner just raised the rents used on the rent roll? Does it make sense for me to include 12 months of rent based on the rent roll? What if there's a ton of R&M or other costs I'm not aware of? Is this a common situation and should I just make an offer using my best guess until we get under contract and into due diligence? I appreciate the help!

[Roy N.]

Originally posted by @Brian C.:

Roy N.

Thanks for the feedback. I have a few follow-up questions:

1) if the property is currently self-managed, is it appropriate for me to include a PM fee in my analysis when valuing the property? This will decrease the current value and ultimately my offer price. Is this common practice and will the seller understand as long as I'm using industry/local market averages? Same goes for landscaping, etc...

Even if you are self managing, you should pay yourself.   Additionally, what happens if you are forced to engage a PM (say you break your leg or need to travel out of country for your day job)?  Best to ensure you can afford property management before you buy.

It's not pointless to do all that work yourself if a) you enjoy doing it or b) you believe it to be a good use of your time.  However, any experienced buyer is going to make allowances for landscaping, property management, custodial services, maintenance, etc. if you do not have actuals in your financial statements.

Your CAPEX reserve (set aside out of NOI), is budgeting for when you will need to make major capital expenditures in the future (roof, windows & doors, HVAC, appliances, etc). If the property requires a major expenditure now because the Vendor has not kept up on maintenance or capital improvements, then you should factor the cost into the purchase price. viz. We are looking at a complex in which one building requires a new roof (~$100K) and new kitchens and baths in approximately half the units {the units are presently vacant and not rentable} (~$150K) we would reduce our offer accordingly (by $250K).