Advice on potential purchase

[David Troup]

Hi everyone,

I'm a newbie here, I just discovered these forums for the first time, and what a great resource it is. Thank you to all who participate here and offer the benefit of your experience to others.

I am not a new investor, I have owned a number of small to medium-sized multifamily properties over the years. I currently own two properties in Texas, a 20-unit and a 23-unit, both of which have been generally profitable (I've had them for about 10 years each.)

I recently became aware of a buying opportunity in the same city. It seems pretty good to me, but I'm looking for some other points of view before I get in too deep.

The property I'm looking at is bank owned. It looks as if perhaps the former owner was overleveraged on other properties and simply pulled out all the money and didn't pay his bills. The property does not seem to have any of the problems (trashed units, missing appliances, etc.) that you often see with REO properties. It's more or less completely full and, although it's not going to win any beauty pageants, seems to be a solid C/C+ property in a good location. No major deferred maintenance is obvious except perhaps a good paint job.

The property is 32 units (11-2/1, 20-1/1, 1-Efficiency) with monthly gross income of about $19,000. They are estimating expenses + reserves at about $12,000 per month; I think this may be low, at least for a while, and I'm using $13,500 for expenses for now. That means net income of about $5,500 per month before debt service.

The bank (a smaller local bank) is willing to finance 95% at 5% to a competent operator (that's where I'd come in.) So I think very conservatively I should be able to cash flow about $2,000 per month after all expenses, reserves, and debt service, which is a pretty nice cash-on-cash return considering the low downpayment. I don't normally believe in leveraging myself that much -- I'm conservative and would rather put down more money -- but in this case, I think it makes sense if the bank is really willing to finance most of the price.

Oh, the price -- $675,000. I'm thinking I'd like to get them down a little lower – around $625K would bring the cap rate up to 10.5, which seems appropriate for this sort of property – but it doesn't seem bad regardless, especially with the attractive financing.

So my question - am I missing anything that's going to make me sorry if I jump into this? There will undoubtedly be some surprise maintenance issues; it's a 1960 building and it's always something with these old buildings. But I think I've been conservative enough in my planning to account for much of that.

I already have a property management company that I am happy with in this city (they have taken over managing the property for the bank) and they seem to think it's going to be a great property.

I haven't done a new acquisition in quite a while so I feel a little rusty in my evaluating here. Any comments, criticism, or thoughts would be welcome. Thanks!

EDIT: Other useful info: average unit size around 725 sq. ft. There is a pool. Roofs about 5 years old. Some of the bathrooms a bit ugly, but I don't mind rehabbing units as they become vacant.

[Joel Owens]

That vintage of a building you would need to really look closely at all life expectancies.

I can tell you from listing property and selling as a commercial short sale what generally happens is this.I find owners that are upside down in debt service are treading water.Even if they own other buildings if they were all bought during the boom times they don't give out enough money to break even.

If you purchased more buildings during earlier years the debt service and properties are most likely not upside down.Older buildings like that need constant repairs over new product.

What most owners do is the bare minimum of patch and paste to keep cash flow going.

I would want to see the rental history of how long the tenants have been there.Asbestos is a biggie and so is lead paint.When you turn a unit meeting the new EPA lead certified rules cost a bunch more money and you have to use certified contractors.

So during due diligence I would get testing done to really see what I am up against.Land was more plentiful back in the 60's and development was more spread out.Landscapes change over time so if this property has a nice chunk of land it sits on you might be primed for redevelopment as a value play down the road.

Seller paid utilities are a killer and all my investors hyper focus on it for multifamily as they see it eating into their bottom line.

They see if they are holding ten years and have 5 year financing what happens when utilities skyrocket and they have to refi into a higher percentage rate loan.They will get squeezed from both ends.If they get hit with heavy repairs and turn rates they will get hit from 4 different angles.

These are the items on my investors minds that buy into the hundreds of units at a time down to 20 to 30 units.Most do not like to go real small as the financing is harder to obtain as many commercial lenders do not play in the smaller space.

The bank wanting to finance the deal sound like a small to mid size bank.They want a higher price of course to preserve margins and losses to the books.Bigger banks usually just want to shred the price and sell cheap to get it off the books at all costs because of the large volume of new loans they are doing they are better underwritten.

Remember future repairs on older vintage buildings will eat you alive for cash flow.Also it might be a C age building today but when you sell will be a D age.On exit you have to plan on selling for a higher CAP to compensate.If the market is stronger then great but if it's not your plan and expected returns will be inline with each other.

Hope it helps.