2 potential deals 36 and 38 units, ready to move up - St Louis

[Mackal Smith]

I have been pretty successful so far in my real estate investments. I'm still working full time, but over the last year and a half I have been able to pull together a total of 17 units made up of duplex/4 plexes. I'm really loving what I'm doing. I'm in the middle fixing up a new acquisition and getting it ready to rent, however I'm really interested in getting into some bigger properties. I've been doing a lot of reading and listening to podcasts and I'm anxious to start but I want to make sure I'm not missing something as I start to evaluate the properties and think about syndication.I have a partner I took on for the last couple of properties I have acquired and both of us are anxious to get started.

That said, I have found a couple of apartment complexes that seem to be a pretty good deal. I'm using much of the same criteria I have used on my smaller properties to evaluate but I want to make sure I'm not missing steps. Both of the complexes feature single bedroom apartments. they are both multi-building (one story) complexes with each building housing 4 to 8 units. The 36 unit is around 1.1M and the 38 unit is at 960K. Both are in the same general area I invest in regularly. I would call the area a B- or C area.

I'm asking each of the owners for OPEX costs, vacancy rates, CAPEX they have done over the last few years, and any improvements they have made to the properties. I suspect the utilities are split (at least gas and electric) but I would bet that the water/sewer/trash are shared so I expect that OPEX cost to be significant. There might be the ability to use RUBS to split those costs out, but I haven't seen the mechanicals on the properties yet.

I have a great relationship with a Banker here in St Louis, so I figure the loan probably won't be a problem although I'm not sure whether they will want a sponsor for something the size of these complexes or not.

My partner has friends that he thinks will want to invest, and I have access to other investors through numerous REIA's and other networking contacts I have made over the last couple of years so I feel like getting the downpayment will be fairly straightforward.

My question for this forum is this:

I feel very confident evaluating duplexes/4 plexes. I know what to look for so I feel like I have at least the basics down. There are things like cockroach infestations I need to think through on at least one of the properties and they all are going to require some roof work and/or getting the apartments up to speed. Those are costs that really are not going to increase my NOI (except the apartment updates) at all but they have to be done.

What are my next steps? How should I go about evaluating these enough to feel confident to make an offer. On my smaller properties, I'm more than happy to make offers sight unseen because I know the area and I know what I can get for rents, etc. I'm just a little out of my ballpark on 36 or 38 units.

Any advice would certainly be welcome!!

[Albert D.]

@Mackal Smith  Congrats on your success!  

The best way to evaluate a larger commercial property is the income approach.  In essence, the NOI over cap rate to derive the value.  

Net operating income, NOI, is the rental income minus operating expenses.  The NOI should be the actual NOI of last twelve months (LTM), not pro forma estimated by seller or agent.  So you will only be paying for the current actual income performance of the property but not further improvement that you'll have to work hard to achieve.  In your case, without knowing any actual numbers, I would make an assumption that the LTM rental income is around $194,400 (assuming $500 rent per month per unit, 10% vacancy, 36 units; $500x90%x12x36=$194,400).  Further, I'd assume that 50% of the rental income goes to your operating expense. That'll leave you an NOI of $97,200 a year. But when you get the actual numbers, you'll have better idea of how the NOI looks for each property.

The cap rate is NOI over purchase price.  Typically, you can look into similar properties in your area to find comparable cap rate in current market environment.  However, it is hard to find good comps at times.  If this is the case, I'd use your desire cap rate to vet deals.  For example, if you determine that you will not invest in a property that generates less than 8% return for you, then a 8% cap rate should be used in your analysis.  Without knowing your market, I'd use 8% for simplicity purpose.

Now, we have NOI of $97,200 annually and a desired cap rate of 8%.  So the value of the property so you should be no more than $1,215,000 (=$97,200/8%).

This is a simplified approach to evaluate your 36-unit.  But do keep in mind that there are a lot of variables go into the formula here so you'll have to adjust with actuals and your own unique situation.  One big item is deferred maintenance.  That can significantly change the cap rate.

Hope this helps.