7.5 Cap 10 Plex purchase/ Am I missing something?

Question

I am looking at purchasing a 10 plex. It is in a solid C+/B-  neighborhood. The only issues I have with the building/ neighborhood are a flat roof ( which was replaced in '16) and the house across the street is vacant and boarded up. Other than that it is a solid neighborhood and the building is purpose built. I have bought rented and sold 1 SFH and looking to move into smaller multi family.

It is currently over priced but in talking with my property manager, he said it will end up selling at 7.5 cap. The problem is it will only cash flow at $75/unit per month at that purchase price. There is some up side though. Current monthly rents total $5,711 but with the current condition of the units and market rents, that could be up to $6,000 by the end of the year. That coupled with the current owner is paying for all utilities which could be put on RUBS or sub metered. That would save close to 14K in expenses figuring I could bill out 90% of the utilities to tenants.

After rents are up to market and utilities sub metered, I could refi and pull out 100% of my money and cash flow $120 per door. Option #2 refi and pull out my money plus another 78k and cash flow $75/mo.

Am I missing something? Seems like a solid deal if I can pull all my money back out and have a cash flowing property. Is it okay to cash flow a little less on the purchase knowing i'll make it up in short order? Thank you for your help.

Kurt Jones · Answer

You're not necessarily missing anything, but you are noticing some important things. First, you're looking at a razor thin margin for positive vs. negative cash flow. $75/door is nice until the market turns against you or you have a prolonged vacancy/ need for rehab of the unit(s). Without seeing a full underwriting of your deal it's hard to tell.

Also, everyone gets caught up in the A/B/C grading of neighborhoods and it's pretty much apples to oranges all the time. Yours sounds like it's not the greatest area as the house across the street is boarded up (think crack house/homeless squatters). Neither good nor bad but just another data point that adds risk. I own a property in a similar area and it's not my favorite but it cash flows $250/door so I can tolerate it. You just need to get comfortable with this deal or move on and find one that you are comfortable with.

Jacob Sampson · Answer

It seems unlikely that within a years time you are going to bump units up to market rent while also having tenants begin to pay for utilities.  That process will likely take longer than you expect, it will likely be more costly than you expect, and rents are probably not as undervalued as you expect.

Causing that much change that fast may cause a high level of turn over which will uncover a bunch of deferred maintenance.

All of that is to say, it may still be a good deal, but you may be underestimating how much cash you will need or just how quickly you can create the improvement you want.  And then I would second @Kurt Jones you are working with very slim margins and all the uncertainty I mentioned can eat that up quickly.

Edward Liu · Answer

Aggressively push for rent increase likely will cause high turn over.  You need to plan for 50-75% turn over with existing tenants, which includes turn over cost.  It will suck up a lot more cash than normal % of maintenance/CAPEX.

Don't assume you can turn basement into units.  Check for city regulations first.  Many cities requires 2 exits for basement units and many times ROI for basement units is not good.  You want rents to cover CAPEX of basement change within 3 years.  Your rents likely will be lower for basement units.  Assume $500 per month per unit with 3 units, do you think you can complete build of 3 basement units with $20k?

Wayne Brooks · Answer

“Market rents” would be those invluding utilities, I presume. Renters know the difference between $500/mo with utilities included and $500/mo Plus utilities.

Aaron Gilbert · Answer

Account Closed thank you. I have done the underwriting and expenses work out to 50% although that was with the offer at a 7.5 cap. I think you are correct that I am being overly optimistic with the class of neighborhood. I have not spoken with the/a broker yet but my property manager said it WILL sell at a 7.5 cap in this current market once the asking price reflects such. Current asking price is 495k, 7.5 cap puts it around 335k, and cash flow of $100/ door or more would put it under 300k. From my understanding this is a partnership that is splitting up and needing to sell. It has been on the market for 100+ days I believe. Im trying to get everything ready and try to find any errors before they have to drop close to what it is actually worth.

Account Closed · Answer

@Aaron Gilbert underwrite the deal yourself from the ground up. What are rents for similar units going for in the area? What is the vacancy for similar units in the area? Use 40-50% as your baseline for expenses. You can also check online and see what typical cap rates are for C/B MF properties in that area (or call a local broker and simply ask). With that information, you can back into a fair market value. My minimum cash flow per door would be $100, bar none. Also, how long has the owner been interested in selling it? If it's been a while, offer him 15-30% less than his asking. At least then you can anchor to a lower price in negotiating. Personally, with a boarded up house across the street, this sounds closer to D class than C and far from B. B class to me is blue collar stable - can you confidently say this is the tenant mix?

Charles Soper · Answer

Also watch out of the 1/1's, they tend to attract a more transient tenant so even if you're signing year leases you could potentially have 10 unit turns a year, and that could prove costly.

Rick Versace · Answer

Not sure if someone mentioned this, but I would be sure to look at other similar properties in the area and make sure implementing RUBS is a viable option. You don't want to plan on that being extra income if it's not something other properties in the market are doing. If the current rents are what they are because of all utilities included, and you try to increase AND make them pay for utilities you could end up having a hard time getting the units leased up.

Good luck! Hope all goes well.

Aaron Gilbert · Answer

@Anthony Rosa, thank you and I will definitely be doing this on future options. We threw out a number today to try and start negotiations and got rejected without counter. On to the next with more wisdom than before. Thanks all!

Anthony Rosa · Answer

Before looking further. Go visit the area at various hours of the night on a warm day.  A boarded home indicates the worry of squatters and copper thieves.  I'm in NY, about 30 miles north of NYC in a B++ area of A+ town, and there was a house vacant for almost two years and nobody could tell the homes were vacant.  The lawns were always cut, etc... Check out the area for a piece of mind!

7.5 Cap 10 Plex purchase/ Am I missing something?

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