8-fam, Small Town, what am I missing? Why hasn't this sold?

Question

I intend to write an offer on a property tomorrow. It's an 8-fam in small midwest town (pop 40k, not warzone). It has been on and off the market for about 1/2 a year, it doesn't seem like there are a lot of buyers for multi-family in this area. Bottom line, they're asking $160,000. Its an old brick building (turn of century like everything in the area). Mostly 3 bed units - no central air (window units), probably some deferred maintenance. Not the best part of town, but not the worst either. I'd call it C+ with no chance for appreciation. Owner pays Trash, Water and common area electric. Rent roll indicates $4200/month.

Analysis:

Rent $50400

Vacancy 10% $5040

Gross Operating Income $45360

Taxes $4600 (verified)

Utilities $5040 (what they told me)

Insurance $2700 (verified with Ins. agent)

Cap Ex /Repairs 15% $7560

Admin Legal $500 (just in case)

Property Management 10% $5040 (although I intend to manage)

Total operating expense $25,440 (56.08%)

Gross Operating income ($45360) - Operating expense ($25440) = NOI $19,920

At their asking price its a 12.45% cap. The bank likes the deal so much their willing to finance it with the seller carrying a second. So 0 down from me. I've talked to the owner who lives out of state and bought it 20 years ago so it's paid off and wants money to buy a new house.

So the question is: What am I missing? Why hasn't this sold? Should I be extremely scared or excited as hell and just grab it? Is there any reason not to give an offer based on a 15% cap as this has sat around so long?

Jeff Kehl · Answer

@John Baughman Could just be a good deal because it's a small property in a small town. Not a ton of demand for that. But thre big concerns I would have.1) The age of the building. You could be looking at costs equal to or greater than the purchase price for any rehab. Make sure you understand the major systems, roof, hvac, plumbing/sewer, electric, windows/doors inside and out. Is their asbestos or lead based paint to deal with? 2) Regulation/Bureaucracy - How do the local governmental officials feel about the property? Zoning problems, inspection problems, historical commissions.3) The town - What town is it if you don't mind sharing? I lived in Decatur and Monticello and worked in St. Louis so I'm familiar with small town Illinois. What is the population and employment growth rates of the town? Who are the employers there? Do they plan to stay? If the town is dying stay away.

Chris Martin · Answer

If you have experience with this kind of property, then you are probably fine. I have no clue if your numbers are accurate (e.g. rent and vacancy), but I can say this. In NC, in some of the smaller towns (not the Charlotte, Raleigh type towns) you do see these kind of properties. You need to look closely at not only the numbers, but the environment (neighborhood, demographics, crime, access to services (bus, transportation, etc.) and proximity to jobs). Loss runs, LBP, functional obsolescence are all key factors as well. These properties sit around because they are not that easy to make them perform consistently. And prospective buyers realize they are all about cash flow and have little potential to appreciate in many circumstances. It sounds like you can make it work. I like to think I can too, in my little piece of class C heaven;)

Todd Dexheimer · Answer

I have owned old brick apartment buildings. You need to find out how old the wiring is, plumbing is, heating system is, etc. A lot of these old buildings are maintenance nightmares. I spend $250k renovating an 1888 building only to be bombarded with plumbing, electrical and heating issues. My building had galvanized water piping, cast iron drains, knob and tube wiring and an old steam boiler system (boiler was new, but the rest wasn't. This building had everything else redone and still cost me 20%+ of the gross income in monthly repairs

Hy Schmiedeskamp · Answer

Also this would be something I would spend the money on an inspection. I have used and recommend Bruce Hutton with Midstate Inspection Services. Bill Penn with Integrity is also good although maybe not as familiar with commercial style buildings.

Hy Schmiedeskamp · Answer

@John Baughman I have also watched that building over the last 2 years. My younger sister even lived there for a few months about 15 years ago. Quincy has several investors and the fact that no one has scooped it up has always made me wonder about what's wrong with it. On paper it looked great to me also, but my wife has yet to be convinced. A couple of thoughts: 1. Realistically the vacancy rate has been 30%+ according to people I've talked to. With a more run down place like it is, it will be a lower quality tenant with a bunch of turnover / evictions.2. Make sure it doesn't have some structural issues that could be a big deal to fix. I know the front steps look pretty rough. I have not been inside the property though. (At least not for many years and I don't remember much. 3. With other investors like Bret Austin continually adding units (like turning the old schools into apartments) and Kuntz building another apartment building on the north side of town, I feel like rents will be flat for awhile. If you can go in with no money down, I would still be excited about that. Just make sure rehabbing it doesn't eat your lunch. Keep us posted on what you find!

Max Householder · Answer

As always, trust but verify all those numbers. If the expense numbers are real and the inspection looks okay, go for it. You're the boots on the ground so trust your gut about the area, potential growth/decline, your likely rental clientele, etc.One tip I would say is to see if your insurance company will write a policy based on market value rather than insuring it as though you're going to rebuild it. We had this issue on our 4-family in St. Louis; a 100-year old building, all brick, and would cost 2x what we paid for it or more to rebuild it. We were able to find an insurer who will write the policy based on the cash/market value (what we paid for it), so in the event of a total loss we'd get enough to pay off our loan, get our equity back, and walk away. The annual premium was less than half of what others quoted who would only write it on the cost to rebuild. Anyhow, something to look into as it sounds like your building is similar.I actually like Quincy a lot. We have a good friend who grew up in Ursa, IL so I've actually been to Quincy overnight for an engagement party a couple years back. It seemed like there was some budding growth in the central business district near the river there; small shops, restaurants, and we stayed at a brand new Microtel Inn & Suites that was very nice. A lot of small towns have the potential to die off without one major employment anchor, but Quincy seemed fairly diversified and it's proximity to the river (and river crossing) and I-172 make me think it's not likely to go bust anytime soon if it's rolled with the punches for 200 years. Like others said, your vacancy rate may not be consistent, but if you hold for 5, 10, 20 years it should smooth out over time.

Chris Martin · Answer

@John Baughman I have seen insurance issues where, upon ownership change, the new owner has difficulty getting the property through the underwriter. I've seen this more than once, and with a property over 40 years old some carriers may ask for inspections (or when permits for wiring upgrades were done, etc.) or worse. Make sure you can get coverage is what I am saying. I'd also do a LBP self test and maybe even a phase I environmental depending on the building. I have done these (Phase I ESA) on industrial parcels but never looked at a building that old... so not sure if lenders or others would suggest doing it or not.

Chris Martin · Answer

@John Baughman these type properties are tough to pass on because the numbers are deceiving. I've been in your position, just not on a building that old. There may be an opportunity if you can find a builder as a partner. You'll want to be selective on your partner, though, because finding the right person could (I should say will) be as challenging as the property itself.

John Baughman · Answer

Well I've been through it. I think it would be easy to invest $100k into it. I'll do some math, but probably won't even make an offer on it. Needs significant electrical, HVAC, maybe some plumbing. Many of the walls and floors need to be touched, I can see how it could turn into an alligator to actually take care of it. There has been significant neglect. It's kind of sad, but it's an opportunity for someone, just not sure it's for me.

Joseph Gozlan · Answer

@John Baughman I honestly don't have experience with properties from the turn of the century but I have a feeling that the repairs and maintenance on these will run you higher than your projected expenses. Also, as @Chris Martin mentioned, consistency is where your key efforts and profitability will be focused at. If you can't keep the property occupied and keep turnover to minimum then you might find it challenging to be cash-flow positive.