Is Multi unit pricing to high?

Question

I have been researching recent sales in the Baltimore area for Multi unit apartments from 20-200 units and it seems the per unit pricing is to really high compared to the rent. With properties built in the 1960-1970 that have seen some or all the units renovated, the per unit prices are $85-130,000 for an average size 2BR/1BA with 600-900 sq ft. These are mostly class C to B in older neighborhoods that are renting for 700-1100, usually with only water/sewer included.

Comparing that to the 1-4 units I have been able to find the average cost per unit is $60-85,000 and the sq ft of the units are 700-1200. These are renting for 700-$1200 on the higher end for big apartments with storage, parking and sometimes 2 full BA. Averages in the 900-1050 per month, nothing included.

With the additional costs to manage the higher turnover, larger multi unit buildings, how does it make sense to pay such a premium for a larger unit count? The few large deals I have seen that had much lower per unit costs had a ton of deferred maintenance or very low occupancy and were usually in class D-C areas. I have experience rehabbing and really upgrading properties for sale and rent but you cannot singlehandedly change the flavor of an area just by making it an Oasis in the desert.

What would be a conservative unit cost to rent ratio that would signal a good deal, using a safe 50% for expenses.

Ian Barnes · Answer

@BOB CRANEY I haven't see a good deal for multi-units in Baltimore for about 2 years now.  Anyone selling now is just looking for suckers, and there are a lot of them.  In the next downturn, a lot of mortgage holders  in Baltimore will be selling foreclosures for roughly 50% of their value now.

Bjorn Ahlblad · Answer

@BOB CRANEY  MF has been getting so much press in the last 12-18 months prices have gone insane, certainly in my market. I am finding that properties that are now coming on the market are priced 40-50% higher than where they should be to make money renting them using the 50% rule for expenses.

There has been tremendous price appreciation during the last 5 years and I am not confident it will continue at near the same pace for the next 5. Obviously others disagree with my thinking, people are still buying them no matter the price!

Kevin Dean · Answer

Hey @BOB CRANEY you present a couple of really good questions here.

#1. Why are the larger apartment complexes selling at a higher sales price per unit as compared to the smaller 1 - 4 unit properties?

One of the advantages of investing in larger properties is the economies of scale you are able to realize on the expense side.

For example, management fees are an expense which has an inverse relationship to size. So, as the size of the property and amount of revenue generated increases, the management fee as a percentage decreases. For example, you may have to pay a 10% management fee to a property manager who manages a four unit property. Property management fees for 100+ unit properties are usually 3 - 4%, and can be as low as 2%.

These economies of scale happen across a number of expenses which occur in the management of large multifamily properties. As a result, your NOI per unit should increase for larger properties. Because the larger properties are valued based on their income, this can result in a higher per unit sales price as you scale up into larger properties.

#2. What is an average expense ratio to use when analyzing properties?

My guidance is to never use a rule of thumb when calculating expense ratio for larger apartment complexes. There are many reasons why I would advise against using a rule of thumb, but here are a few reasons why your expense ratio can change significantly from property to property:

-Age and Class(A/B/C) of Asset - In general, the older the property, the higher the expense ratio.

-Location - Every location in the United States has a different labor costs relative to rent. As a result, payroll per door varies significantly throughout the country. For example, in Los Angeles, your payroll per door may be $2,000 per unit. In Tennessee however, payroll per door may be as low as $800 per door.

-Size of operator - in general, the larger the operator, the lower the expenses. For example, a large operator such as Sam Zell of Equity Residential is able to utilize in house lawyers to lower property taxes, in house accountants to lower professional fees, in house construction which can negotiate lower costs for Capital Expenditure items and will also most likely have a centralized marketing department that is able to service all of their properties in a cost effective manner. Most of these efficiencies will not be able to be realized by a smaller owner who owns 500 to 3000 units. As a result, the larger operator can offer a higher price for the same property, and still generate equivalent returns.

-Utility expenses - These can vary widely due to geography, age of property, tenant class and whether or not utilities are paid by the owner or the tenants.

-Taxes - These also vary widely geographically and as mentioned above, can change based on ownership.

In conclusion, the first takeaway is that you may be comparing apples and oranges when comparing properties of different sizes, even if they are in the same market. Secondly, if you use rules of thumb for evaluating expenses, you will either be missing out on great opportunities, or will be overpaying when expenses turn out to be higher than expected. Take each expense one at a time and build your expense ratio line by line.

Another thought, your observation when comparing per door sales price across different property sizes is great. Doing this in different markets may expose opportunities that are overlooked by others.

Let me know if you have any other questions. Thanks!

Brandon Hicks · Answer

@Kevin Dean

Keep in mind that the 2-4% you mentioned does NOT include the cost of employee (maintenance, management/leasing staff) salaries. I often see the total costs around the 10% mark for larger deals once those costs are factored in.

Account Closed · Answer

@BOB CRANEY

"What would be a conservative unit cost to rent ratio that would signal a good deal, using a safe 50% for expenses."

That's hard to say nationally and I'm NOT an expert in the Baltimore market.

I can relate though as I live in Denver but buy in Southern US.

Going big allows you utilize, best in class, 3rd party management and there's no need to be geographically constrained. You can live where you love invest where it makes sense; we averaged 37K per door, in 2018, across 4 syndications and 245 doors.

All were B & C class with value add/upside opportunities BUT were cash-flowing from the start.

We're looking and do believe there are good deals out there BUT we're sticking to our mandates; if the deal doesn't hit the hurdles we set in-place we don't move forward.

Hope this was helpful, don't hesitate to reach out.

Dino

BOB CRANEY · Answer

Good point BRANDON. I see a lot of the benefits of scale in multifamily but the you can only overcome the substantially higher costs of overhead at a much higher unit count for it to make sense.

BOB CRANEY · Answer

Ian,

Do you own any multi family now or part of any syndications? If so what kind of per unit price did you pay going in or were you only looking at the NOI bump from a value add rent increase? It just seems to me that even with some decent savings with scale efficiency that paying a price per unit that will net less than 1% rent ratio will leave a deal to skinny t weather any kind of slight down turn

BOB CRANEY · Answer

Great thorough response. As a small player in a big pond my efforts to become efficient with the 13 units I own, have mainly been to renovate properties with an eye for the long game. By bringing a property up to modern condition with completely updated systems, structure and design. I am set for a 10-15 year run with nothing but turnover costs to account for.

I have never seen a full blown budget breakdown for a good 100-250 unit deal so I have a hard time comparing that to my excel pro forma on my self managed 4 unit.

Is Multi unit pricing to high?

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