Underwriting for 30 Units

[Terri Shields]

Good evening BP!

I am underwriting an Indianapolis Class C community property

Two buildings, totaling 30 units (studios and 1 BDRM/1BA)

Initially I began negotiating by providing the seller a letter explaining my underwriting adjustments to include an adjustment of expenses to 55% of rental income which (based on the cited 8.42% CAP Rate) brought me to an offering price of $813K. I didn't expect the seller to take this offer seriously, however the broker called me and provided me actual P&L #s for the first quarter which "basically" aligned with the ProForma both income and expenses. He has three LOIs already, two of which are around $1M (the third lower) but if I were to guess, the potential buyers are from out of state and the seller seems to be emotionally attached and would rather sell to a local (of which I am). I believe this gives me an edge.

Based on my conversation with the broker and my research, I revisited and lowered the adjusted value for expenses to 50% (vs. 55%) which brought me to an offering price of $913K. I have not yet initiated an LOI. I wanted to get an idea of thoughts from the BiggerPockets community before moving forward.Based on the above numbers, is $913 reasonable? Or a better question might be what am I overlooking?

                                   ProForma        Adjusted

Gross Rent                170,000

Physical Vacancy      (3,401) 2%     (10,500) 6%

Other Income            2,400

Expenses                (65,894) 38%   (85,020) 50%

NOI 103,145 76,920

CAP Rate 8.42%

Listing Price          1,225,000

Assuming CAP rate is correct, my offer would be $76,920/8.42% = $913K

[Scott Skinger]

Did you underwrite this to see what your returns (CoC, AAR and/or IRR) are going to be like? Do you know what condition the building is in? Deferred maintenance/capex? What's your strategy once you take over? What's your disposition plan? What exit cap rate are you underwriting at? What type of financing terms are you talking about? Is an 8.42% cap rate the right cap rate for small class c buildings with all studios/1BRs? All of this information and more is important to figure out to know if this deal is going to work for you.

Cap rate is a very misleading and dangerous way to value/buy a property. Does the building cash flow? What do similar buildings sell for on a per unit (studios and 1BRs) basis? How about the size of the units?

You can use the cap rate as one data point to see if the sale/offer price makes sense but there is so much more information that you need to underwrite and consider before knowing what the "right" price is.

Good Luck!