First MultiFamily Opportunity - Next Steps?

Question

I've been able to pick up 3 SFRentals in the last year. I've been looking for Multi-Family opportunities and came across an older 8 unit apartment near a college campus. All of them are 2 bed/2 bath units. The units are rented under market by the elderly owner and has been poorly managed overall (stated by the Selling broker). The property is older 1982, but looks to be in pretty decent shape. Here are the prelim numbers I was given. What information do I need to seek out next?

*100% occupancy Revenue would be $64,800, but with unpaid rents, evictions, etc. he collected $35,962.50

*Expenses: $24,053.07 (Insur $4,830; Maint $6,745.03; Tax $12,069.70; Util $408.34)

*NOI: $11,909.53

There are outstanding rents owed on 6 of the 8 units...but I don't know the story yet (a $7,105.12 eviction; b $1,350; c $675; d $4,450 vacated; e $7,545.38 eviction; f $8,152.50 eviction)

Current rents are $675/unit and should be around $800-850.

CAP Rate appears to be 7.00 based on other properties listed in the area.

Phil Morgan · Answer

Wow there is a lot going on there! First I would ask if people are on term leases or month to month. Sometimes older owners don't even have leases, they just collect rent and hope for the best, so that would be my first question. Make sure you are running your numbers on what they ARE collecting and not what they SHOULD be collecting, that will be a huge difference. If he is shoving a proforma down your throat you can tell him to pound salt, you will have months of evictions, renovations and attorney fees to deal with before you ever get to a proforma number. Find out local tenant laws and know how long the process is going to take to do the evictions. Make sure you inspect all units to get a true idea of condition before pulling the trigger on anything. The one decent unit they show you should not represent the other 7. An agent told me this and then I found a 400lb pig living in one of the other units. Never trust a sellers agent, never.

You have a lot of work ahead of you but this could be a fun and profitable project if you get it for the right price, and have a good attorney on call.....

Scott Skinger · Answer

A few pieces of information to consider:

-Agree with @Phil Morgan for sure, never trust the seller's agent or the seller for that matter...doesn't mean that there are not good ones out there, but they will have to earn your trust and you still need to verify everything

-Forget about cap rate for now. First off, an 8 unit at a 7% cap is probably not a good deal. Second, you  aren't going to be able to use the NOI/Cap rate anyway, or the seller will be paying you money (see below on expenses). Third, you need to focus on cash flow and purchasing this building at a number that will allow you to have positive cash flow

-The expenses at $24K are too low. I don't know what market this building is in but you are at about $3000/unit. This is very market/building specific but I would budget closer to $4000/unit for preliminary underwriting and it could easily be higher. There are all sorts of expenses not included above, the biggest being PM and capex reserves.

-There is a lot that you don't know about deferred maintenance/capex. Do you need a new roof? HVAC? How much work on the units to make them rentable? Can you put more $ in and get $850 or higher? All of this is important information as it is going to determine how much money you need up front, what your potential ROI is and what price you need to buy this building at.

-To buy a building like this you can't buy on actuals, or again, the seller would be paying you, you have to buy on potential. HOWEVER, this requires a sound strategy, solid underwriting and experience.

I think the best route for you is to find a more experienced partner or an experienced PM. If you can't find either of those I would walk away as this project is too risky and there is too much unknown.

BTW, if you want a "guesstimate" price, here is where I would be at with the very limited info we have.

-$800/month x 8 units x 12 months = $76,800 x .90 occupancy = $69,120

-$4500 x 8 units = $36K expenses = $33,120 NOI/9% cap = $368K

-$368K - $50K (just a guess at deferred maintenance) = $318K

-I would be offering closer to $300K, which is around $37.5K/unit (how does this compare to comps for 2 BRs in area?)

*this is very rough and a quick swag, you need to completely underwrite the deal in a spreadsheet and consider other factors including financing, exit cap rate, actual expenses (yours not what they report), etc.

Good Luck!

Patrick Soukup · Answer

@Ed Matson is spot on. This is by no means a turn key opportunity. You are going to have to go through evictions, renovations, rebranding the property and getting it leased up. This sounds like a great opportunity, but is more than likely NOT a side hustle opportunity, but rather a focus project for a few months.

Shawn Lowery · Answer

Taxes appear quite high for that price point.  You might have an opportunity to appeal to further boost NOI.  It's all relative though, that might be par for the course in your location

Ed Matson · Answer

@Phil Morgan is correct.  The current value of the property should be based on the current and not future NOI.  The property is not selling because the property's asking price is based on its future and not current value. 75% of the tenants are not paying on time.  How can the NOI be positive? This is a substantial project to turn around this "train wreck".  Do you have the required time, experience, and knowledge to do so? If so, this may be a good opportunity if it is in a good area and can eventually be a good investment.

Scott Skinger · Answer

The warning against using cap rate is for a  few reasons:

1. You can’t come up with a realistic offer price using a cap rate and an actual NOI on a property that is unstable. This property is probably negative cash flow when you look at their real actuals and factor in your expenses.

2. You need to buy at a price that is providing you cash flow after all expenses and debt, regardless of cap rates

3. And once you get a handle on what the actual NOI is a 7 cap is probably too much to be paying for a 8 unit class c building. In 5 years you will have to sell/refi and it is conservative and wise to underwrite the sale at higher cap rate so you don’t end up selling for a loss. In the Chicago market I would be targeting buying a class c train wreck 8 unit at closer to a 9-10 cap.

Patrick Soukup · Answer

I'd much prefer a vacant building rather than one with delinquent tenants. Evictions are costly both financially and emotionally.

Matthew Allen · Answer

Thanks @Patrick Soukup. Appreciate the feedback.

IF the evictions have already been completed, would your opinion change about the prospects for this project?

Matthew Allen · Answer

Is the warning on using the 7 CAP because it will skew my offer too low...thus insulting/unattractive to the Seller?

First MultiFamily Opportunity - Next Steps?

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